FINANCIAL ANALYSIS OF A BANK

Importance of Financial Analysis

-Measure past performance
-Determine starting point for planning
-Estimate future performance
-Determine Risk
-Predict Cash flows
Importance of Ratio Analysis
Financial ratios are used as guide lines for companies to know the areas that require
more investigation and to determine possible weaknesses in a company and the
order of priority in making further inquiry regarding the details of operations. It is
also use to facilitate comparison and trends with results of previous years or with
others in the same industry. Financial ratios are also useful in standardizing
measurements and numbers. However, we should keep in mind that the analysis
and interpretation of financial ratios is not conclusive.

CAMELS Rating System

CAMELS Rating is a supervisory rating system originally developed in the U.S. to
classify a bank's overall condition. It is used as an internal tool to measure risk and
allocate resources for supervision purposes. Its purpose is to provide an accurate
and consistent assessment of a credit unions financial condition in the following
areas:
Capital adequacy -20%
Asset quality 20%
Management 25%
Earnings 15%
Liquidity 10%
Sensitivity to market risk 10%

The rating system have

weakest.
Rati
Composite
ng
Range
1
1.00-1.49

a scale from 1 to 5, with 1 being the strongest and 5 being

Descriptio
n
Strong

Meaning

1.5-2.49

Satisfactor
y

2.50-3.49

Fair

3.50-4.49

Marginal

4.50-5.00

Unsatisfact
ory

Basically sound in every aspect

Findings are of minor nature and can be
handled routinely
Resistant to external economic and
financial disturbances
Fundamentally sound
Findings are of minor nature
Stable and can withstand business
fluctuations
Supervisory concerns are limited to the
extent that findings are corrected
Financial, operational or compliance
weaknesses ranging from moderately
severe to unsatisfactory
Vulnerable to the onset of adverse
business conditions
Easily deteriorate if actions are not
effective in correcting weaknesses
Supervision concern and more than
normal supervision to address deficiencies
Immoderate volume of serious financial
weaknesses
Unsafe
High potential for failure
Close supervision surveillance and a
definite plan for correcting deficiencies
High immediate or near term probability
failure
Severity of weaknesses is so critical that
urgent aid from stockholders or other
financial resources is necessary
Without immediate corrective actions, will
likely require liquidations, merger or
acquisition.

ACCOUNT NAMES USED FOR FINANCIAL ANALYSIS OF BANKS

1. Assets
Cash and Balances with Treasury Banks
Advances

Lending to Financial Institutions

Balances with Other Banks
Provision Against Advances
Investments
Fixed Assets

2. Liabilities
Bills Payables
Borrowing from Financial Institutions
Deposits and Other Accounts
3. Shareholders Equity
Ordinary Share Capital or Head Office Account (in case of foreign
bank)
Reserves
Un-appropriated Profit/Loss
4. Income
Interest Earned
Interest Expenses
Non-interest Income (Fiduciary activities and service charges)
Non-interest Expense (Personal Expense, Occupancy expense and
other operating expense)
Profit/Loss Before Tax
Profit or loss after Tax
CAPITAL ADEQUACY
- It is a measurement of a bank to determine if solvency can be maintained due to
risks that have been incurred as a course of business. Capital allows a financial
institution to grow, establish and maintain both public and regulatory
confidence, and provide a cushion (reserves) to be able to absorb potential loan
losses above and beyond identified problems. A bank must be able to generate
capital internally, through earnings retention, as a test of capital strength. An
increase in capital as a result of restatements due to accounting standard
changes is not an actual increase in capital.
Ratios in Examining Capital Adequacy
1. Capital Adequacy Ratio
-This ratio indicates the margin of protection available to both depositors and
creditors against unanticipated losses that may be incurred by the bank.

-The calculation of this ratio involves weighing each category of assets for
risks, deducting intangibles from assets, and adding contingent liabilities in
risk weighted assets.
-It is generally believed that commercial banks should maintain a minimum
capital adequacy ratio of 8%
2. Earning Assets to Total Asset Ratio
-It will reveal the extent to which bank's assets are put into productive

use. Investment in equipment and buildings may not directly generate

income but they are important for the bank's operations.

3. Texas Ratio
Deliquent Loans+ Non Performing Assets
Capital+ Loan Loss Reserves
If the ratio is 100% or higher, then the bank is in imminent danger. If it
is between 50-100% then a capital infusion is necessary.
4. Loan Loss Provision to Total Loans Ratio
This ratio will give useful insight into the quality of a bank's loan
portfolio.

ASSET QUALITY
It evaluates risk (and there must be some risk to earn a return),
controllability, adequacy of loan loss reserves, and acceptable
earnings; and the effect of off-balance sheet earnings and loss. The
quality of a bank's assets hinges on their ability to be collected during
and at maturity.
Ratios in Examining Asset Quality
1. Loan Loss Provision to Total Loans Ratio
This ratio will give useful insight into the quality of a bank's loan
portfolio.

2. Overdue Loans to Total Loans Ration

Total Loans 3089 Days Past Due
Total Loans
-

Indicates that either credit underwriting standards are inappropriate or

collection procedures are inadequate
EARNINGS (PROFITABILITY)
Banks, like other business entities, need to make profit. At least, three
main reasons can be identified for banks' profit motive: to provide an
appropriate return to the shareholders; to give confidence to the
depositors that the business in sound and competently managed; and
to maintain and expand the bank's capital base, in order to satisfy
prudential criteria and facilitate business growth in real terms. Above
all, earnings are the first line of defense against the risks of losses in
banking; as well as losses arising from credit risk, interest rate risk,
liquidity risk or currency risk.
Ratios used in Examining Profitability
1. Return on Asset (ROA)
It indicates the managements ability to generate income and its ability
to control expenses.

Historically, the benchmark is 1.00% or higher for the bank to be

considered to be doing well.
2. Return on Equity (ROE)

Profit after Tax

100
Total Equity

In the long run, a return of around 15% to 17% is regarded as

necessary to provide a proper dividend to shareholders and maintain
necessary capital strengths

3. Interest Spread
Spread is the difference between the rate earned on income producing
assets and the rate on interest bearing liabilities.

4. Average Collection of Interest (Days)

This is a measurement of the number of days interest on earning
assets remains uncollected and indicates that volume of overdue loans
is increasing or repayment terms are being extended to accommodate
a borrower's inability to properly service debt.
Accrued Interest Receivable
365
Interest Income
5. Efficiency Ratio
This is a measure of productivity of the bank, and is targeted at the
middle to low 50% range. This may seem like break-even but it is not;
what this is saying is that for every dollar the bank is earning it gets to
keep 50 cents and it has to spend 50 cents to earn that dollar. The
ratio can be as low as the mid to low 40% range, which means that for
every dollar the bank earns it gets to keep 60 cents and spends 40
cents, a very efficient bank. Ratios in excess of 75% mean the bank is
very expensive to operate.
Total noninterest Expenses
+ Total NonInterest Income
Total Net Interest Income

Efficiency improves as the ratio decreases, which is obtained by either

increasing net interest income, increasing non-interest revenues and/or
reducing operating expenses.
LIQUIDITY
Banks must be capable of meeting their obligations when they fall due.
If the depositors or other lenders do not have confidence that the
claims can be met, they will stop depositing or lending funds to the
bank. The acquisition of deposits and other funds is a necessary
condition for the expansion of loans and investments beyond the

amount permitted by the use of equity only. Maintaining adequate

liquidity is a key constraint on the bank's profit-making capacity.

Ratios in Examining Liquidity

1. Loans to Deposit Ratios
This ratio is a measure of bank liquidity; the higher the ratio, the
lower the liquidity.

2. Loans to Asset Ratio

A rise in this ratio would indicate lower liquidity and the need to
evaluate other liquidity ratios.

3. Cash Ratio
This ratio relates the sum of cash in hand and at banks including the
Central Bank to total deposits.

4. Liquid Assets to Total Deposit Ratio

Measures deposits matched to investments and whether they could
be converted quickly to cover redemptions.
Liquid Assets
Total Deposits