ter>Sam Vaknin’s Psychology, Philosophy, Economics and Foreign Affairs Web Sites Banks are institutions wherein miracles happen regularly. We rarely entrust our money to anyone but ourselves and our banks. Despite a very chequered history of mismanagement, corruption, false promises and representations, delusions and behavioural inconsistency banks still succeed to motivate us to give them our money. Partly it is the feeling that there is safety in numbers. The fashionable term today is moral hazard. The implicit guarantees of the state and of other financial institutions moves us to take risks which we would, otherwise, have avoided.
Partly it is the sophistication of the banks in marketing and promoting themselves and their products. Glossy brochures, professional computer and video presentations and vast, shrine-like, real estate complexes all serve to enhance the image of the banks as the temples of the new religion of money. But what is behind all this ? How can we judge the soundness of our banks ? In other words, how can we tell if our money is safely tucked away in a safe haven ? The reflex is to go to the banks balance sheets. Banks and balance sheets have been both invented in their modern form in the 15th century. A balance sheet, coupled with other financial statements is supposed to provide us with a true and full picture of the health of the bank, its past and its long-term prospects. The surprising thing is that despite common opinion it does. The less surprising element is that it is rather useless unless you know how to read it. Financial Statements (Income aka Profit and Loss – Statement, Cash Flow Statement and Balance Sheet) come in many forms.
The Term Paper on Balance Sheet and Annual Financial Statements
The directors are responsible for the preparation and fair presentation of the annual financial statements of the Company and Group, comprising the directors’ report, the statements of financial position as at June 2013, the statements of comprehensive income, changes in equity and cash flows for the year then ended, and the notes to the financial statements, which include a summary of significant ...
Sometimes they conform to Western accounting standards (the Generally Accepted Accounting Principles, GAAP, or the less rigorous and more fuzzily worded International Accounting Standards, IAS).
Otherwise, they conform to local accounting standards, which often leave a lot to be desired. Still, you should look for banks, which make their updated financial reports available to you. The best choice would be a bank that is audited by one of the Big Six Western accounting firms and makes its audit reports publicly available. Such audited financial statements should consolidate the financial results of the bank with the financial results of its subsidiaries or associated companies. A lot often hides in those corners of corporate ownership.
Banks are rated by independent agencies. The most famous and most reliable of the lot is Fitch-IBCA. Another one is Thomson BankWatch-BREE. These agencies assign letter and number combinations to the banks, that reflect their stability. Most agencies differentiate the short term from the long term prospects of the banking institution rated. Some of them even study (and rate) issues, such as the legality of the operations of the bank (legal rating).
Ostensibly, all a concerned person has to do, therefore, is to step up to the bank manager, muster courage and ask for the banks rating. Unfortunately, life is more complicated than rating agencies would like us to believe. They base themselves mostly on the financial results of the bank rated, as a reliable gauge of its financial strength or financial profile. Nothing is further from the truth. Admittedly, the financial results do contain a few important facts. But one has to look beyond the naked figures to get the real often much less encouraging picture. Consider the thorny issue of exchange rates.
Financial statements are calculated (sometimes stated in USD in addition to the local currency) using the exchange rate prevailing on the 31st of December of the fiscal year (to which the statements refer).
In a country with a volatile domestic currency this would tend to completely distort the true picture. This is especially true if a big chunk of the activity preceded this arbitrary date. The same applies to financial statements, which were not inflation-adjusted in high inflation countries. The statements will look inflated and even reflect profits where heavy losses were incurred. Average amounts accounting (which makes use of average exchange rates throughout the year) is even more misleading. The only way to truly reflect reality is if the bank were to keep two sets of accounts : one in the local currency and one in USD (or in some other currency of reference).
The Essay on Classification and Format in the Income Statement
Investors commonly assess a firm’s value based on the firm’s expected future sustainable earnings stream. To inform analysts and other financial statement users about sustainable earnings, firms often report income from recurring business activities separately from income effects from unusual or nonrecurring activities (such as asset impairments, restructuring, discontinued business segments, and ...
Otherwise, fictitious growth in the asset base (due to inflation or currency fluctuations) could result. Another example : in many countries, changes in regulations can greatly effect the financial statements of a bank. In 1996, in Russia, to take an example, the Bank of Russia changed the algorithm for calculating an important banking ratio (the capital to risk weighted assets ratio).
Unless a Russian bank restated its previous financial statements accordingly, a sharp change in profitability appeared from nowhere. The net assets themselves are always misstated : the figure refers to the situation on 31/12. A 48-hour loan given to a collaborating firm can inflate the asset base on the crucial date. This misrepresentation is only mildly ameliorated by the introduction of an average assets calculus. Moreover, some of the assets can be interest earning and performing others, non-performing. The maturity distribution of the assets is also of prime importance. If most of the banks assets can be withdrawn by its clients on a very short notice (on demand) it can swiftly find itself in trouble with a run on its assets leading to insolvency. Another oft-used figure is the net income of the bank.
It is important to distinguish interest income from non-interest income. In an open, sophisticated credit market, the income from interest differentials should be minimal and reflect the risk plus a reasonable component of income to the bank. But in many countries (Japan, Russia) the government subsidizes banks by lending to them money cheaply (through the Central Bank or through bonds).
The Essay on Bank of Canada and Interest Rates
The Bank of Canada has indicated that it has concerns over inflation being too low. (Parkinson). However, inflation has been rising and the Canadian economy has strengthened over the last several months. Keeping interest rates too low over a long period of time may have a tendency to over-inflate the economy and create asset bubbles while also creating pockets of greater debt, not dissimilar to ...
The banks then proceed to lend the cheap funds at exorbitant rates to their customers, thus reaping enormous interest income. In many countries the income from government securities is tax free, which represents another form of subsidy. A high income from interest is a sign of weakness, not of health, here today, there tomorrow. The preferred indicator should be income from operations (fees, commissions and other charges).
There are a few key ratios to observe. A relevant question is whether the bank is accredited with international banking agencies. The latter issue regulatory capital requirements and other defined ratios. Compliance with these demands is a minimum in the absence of which, the bank should be regarded as positively dangerous. The return on the banks equity (ROE) is the net income divided by its average equity. The return on the banks assets (ROA) is its net income divided by its average assets. The (tier 1 or total) capital divided by the banks risk weighted assets a measure of the banks capital adequacy. Most banks follow the provisions of the Basle Convention as set by the Bank of International Settlements. This could be misleading because the Convention is ill equipped to deal with risks associated with emerging markets, where default rates of 33% and more are the norm.
Finally, there is the common stock to total assets ratio. But ratios are not cure-alls. Inasmuch as the quantities that comprise them can be toyed with they can be subject to manipulation and distortion. It is true that it is better to have high ratios than low ones. High ratios are indicative of a banks underlying strength of reserves and provisions and, thereby, of its ability to expand its business. A strong bank can also participate in various programs, offerings and auctions of the Central Bank or of the Ministry of Finance.
The more of the banks earnings are retained in the bank and not distributed as profits to its shareholders the better these ratios and the banks resilience to credit risks. Still, these ratios should be taken with more than a grain of salt. Not even the banks profit margin (the ratio of net income to total income) or its asset utilization coefficient (the ratio of income to average assets) should be relied upon. They could be the result of hidden subsidies by the government and management misjudgement or understatement of credit risks. To elaborate on the last two points : a bank can borrow cheap money from the Central Bank (or pay low interest to its depositors and savers) and invest it in secure government bonds, earning a much higher interest income from the bonds coupon payments. The end result : a rise in the banks income and profitability due to a non-productive, non-lasting arbitrage operation.
The Term Paper on Ratio Analysis Of Financal Statements
The Company has been set up with the primary objective of producing and selling ordinary portland cement. The finest quality of cement is available for all types of customers whether for dams, canals, industrial structures, highways, commercial or residential needs using latest state of the art dry process cement manufacturing process. A longtime leader in the cement manufacturing industry, Fauji ...
Otherwise, the banks management can understate the amounts of bad loans carried on the banks books, thus decreasing the necessary set-asides and increasing profitability. The financial statements of banks largely reflect the management’s appraisal of the business. This is a poor guide to go by. In the main financial results page of a banks books, special attention should be paid to provisions for the devaluation of securities and to the unrealized difference in the currency position. This is especially true if the bank is holding a major part of the assets (in the form of financial investments or of loans) and the equity is invested in securities or in foreign exchange denominated instruments. Separately, a bank can be trading for its own position (the Nostro), either as a market maker or as a trader. The profit (or loss) on securities trading has to be discounted because it is conjectur ….
