This document discusses key concepts related to financial statement analysis for financial institutions. It distinguishes between investment banking and commercial banking. It defines important terms like net interest income, non-interest income, net interest margin, non-performing assets, loan concentrations, allowance for credit losses, and aging schedules. It also covers equity-related terms, types of dividends, rating systems for financial institutions, key ratios, risk-related terminology, and Basel III capital adequacy norms.

1. FINANCIAL STATEMENT ANALYSIS
Dr. C.PADMAVATHI. FCA

5. • Distinguish Investment Banking and Commercial Banking.
• Investment banking is to help large, publicly traded entities make sound investments, issue
company stock, and assist with mergers and acquisitions WHILE Commercial banking supports
small and middle-market business clients, usually privately owned, with day-to-day banking and
credit needs, including working capital and growth-related CAPEX financing.

8. Net interest income
Net interest income is the interest earned on debt securities,
related loan fees) and other interest earning assets minus the
deposits, short-term borrowings and long-term debt.
Non-interest income
The non-interest income is the revenue earned through
fees other than interest income on loans. Eg. origination
fees on mortgages, investment advisory fees, commission
and brokerage service fees, bank-issued cards, monthly
maintenance fees on accounts.
Net Interest Margin? The average yield on earning
assets minus the average interest rate paid for deposits
and other sources of funding.
Net Interest Spread : Net interest spread is the nominal
average between borrowing and lending rates.

9. Non-performing assets
An asset, including a leased asset, becomes non-
performing when it ceases to generate income for
the bank.
A ‘non-performing asset’ (NPA) was defined as a
credit facility in respect of which the interest and/ or
instalment of principal has remained ‘past due’ for a
specified period of time.
LOAN CONCENTRATIONS:
Loan concentrations may exist when there are amounts
loaned to borrowers engaged in similar activities or
similar types of loans extended to a diverse group of
borrowers that would cause them to be similarly
impacted by economic or other conditions.

10. Allowance for credit losses (ACL) is a reserve for the estimated
amount of loans that a lender will not collect from its borrowers. The lender
is required to set up an allowance for credit losses that contains its best
estimate of how much this bad debt may be. Without this allowance, it is
likely that a lender will overstate the amount of its loans receivable that will
actually be collected.
An Aging schedule is a table that shows all overdue invoices, the amount dues,
and more particularly, the number of days overdue. The accounts receivable
aging schedule provides a breakdown of accounts receivables
into categories of days outstanding.

13. Fair value as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date
(an exit price)

14. Discounted cash flow – Discounted cash flow valuation techniques generally consist
of developing an estimate of future cash flows that are expected to occur over the
life of an instrument and then discounting those cash flows at a rate of return that
results in the fair value amount
Market comparable pricing – Market comparable pricing valuation techniques are
used to determine the fair value of certain instruments by incorporating known
inputs, such as recent transaction prices, pending transactions, financial metrics of
comparable companies, or prices of other similar investments that require
significant adjustment to reflect differences in instrument characteristics
Option model – Option model valuation techniques are generally used for instruments in
which the holder has a contingent right or obligation based on the occurrence of a future
event. Option models estimate the likelihood of the specified event occurring by incorporating
assumptions such as volatility estimates, price of the underlying instrument and expected rate
of return.

16. EQUITY
Comprehensive income includes both net income and other revenue and expense items
that are excluded from the net income calculation. Comprehensive income is the sum of
net income and other items that must bypass the income statement because they have
not been realized, including items like an unrealized holding gain or loss from
available-for-sale securities and foreign currency translation gains or losses.
Common Stock: this is the amount of capital that was contributed to the entity by its
owners.
Preferred shares: these shares have rights concerning the receipt of dividends or assets upon
liquidation of a business entity, which takes precedence over the rights of common shareholders;
Treasury shares: these shares are also referred to as treasury stock. They are shares in a
business entity that it has repurchased.
Retained earnings: this refers to the aggregate amount of earnings that are recognized
in the income statements of a business entity and have not been paid out as dividends;
Noncontrolling interest (or minority interest): this represents minority shareholders’ interests
in subsidiaries that have been consolidated by the parent company but are not wholly owned by it.

17. Stock Split vs BonusIssue

18. TYPESOF DIVIDENDS
1) Cash dividend (A most common type of dividend)
The cash dividend refers to the distribution of the cash to the shareholders
as a return on their investment.
2) Stock dividend
The stock dividend is when a company issues additional stock to the
shareholders instead of cash.
3) Property Dividend
The property dividend refers to the distribution of the property to the
shareholders as a return on their investment.
4) Liquidating dividend
The liquidating dividend is when the company is winded up,
and the company’s assets are distributed among shareholders by
paying in the form of a dividend.

21. RATING SYSTEM: FINANCIAL INSTITUTIONS
Capital adequacy: The proportion of the bank’s assets that is funded with capital, indicates that a
bank has enough capital to absorb potential losses without severely damaging its financial position.
Asset quality: to assess the quality of the bank’s assets—credit quality and diversification—and the
concept of overall sound risk management.
Management capabilities refers to the bank management’s ability to identify and exploit
appropriate business opportunities and to simultaneously manage associated risks.
Earnings refers to the bank’s return on capital relative to cost of capital and also includes the concept
of earnings quality.
Liquidity refers to the amount of liquid assets held by the bank relative to its near-term expected
cash flows. Under Basel III, liquidity also refers to the stability of the bank’s funding sources.
Sensitivity to market risk pertains to how adverse changes in markets (including interest rate,
exchange rate, equity, and commodity markets) could affect the bank’s earnings and capital position.

22. RATIOS SPECIFIC TO FINANCIAL INSTITUTIONS
• Return on Tangible Common Equity :
• Tangible common equity is a non-GAAP financial measure and
represents total equity less preferred equity, noncontrolling interests,
goodwill, certain identifiable intangible assets
• Efficiency Ratio:
The efficiency ratio is noninterest expense divided by total revenue (net
interest income and noninterest income).
Pre-tax pre-provision profit (PTPP) is total revenue less noninterest
expense. It is financial measure to assess Company’s ability to generate
capital to cover credit losses through a credit cycle.

23. Terminology specific to Financial Institutions
• Average Earning Assets
A company’s earning assets are investments that produce income
effort on its owner’s part. Some popular earning assets are
deposits, notes, etc.

24. RISK RELATEDTERMINOLOGY
SYSTEMATIC RISK: Systematic risk (also called non-diversifiable risk or market risk)
is the risk that affects the whole system. It is a risk that cannot be avoided by
diversification because it is inherent in all assets.
UNSYSTEMATIC RISK: Unsystematic risk is the risk that is limited to a particular asset
or industry. These include risk factors that are local to a company and need not affect
other companies.
INTEREST RATE RISK: Interest rate risk is the probability of a decline in the value of
an asset resulting from unexpected fluctuations in interest rates.
FINANCIAL RISK: Financial risks are those that arise from activity in the financial
markets. Financial risks consist of market risk, credit risk, and liquidity risk.
MARKET RISK: Market risk arises from movements in stock prices, interest rates,
exchange rates, and commodity prices.

25. CREDIT RISK : Credit risk is the risk of loss resulting from a borrower’s failure to
make full and timely payments of interest and/or principal.
Liquidity risk: is the risk that, as a result of degradation in market
conditions or the lack of market participants, one will be unable to sell
an asset without lowering the price to less than the fundamental value.
Operational risk: is the risk that arises either from within the operations of
an organization or from external events that are beyond the control of the
organization but affect its operations. Operational risk can be caused
by employees, the weather and natural disasters, vulnerabilities of IT systems, or terrorism.
Solvency risk: is the risk that the organization does not survive or succeed
because it runs out of cash to meet its financial obligations.

26. How do we measure Risk?
Common measures of risk include standard deviation or volatility; asset-specific
measures, such as beta or duration; measures such as value at risk, and expected
loss given default.
How to Mitigate Interest Rate Risk?
1. Diversification : “Don’t keep all the eggs in a single basket” .
2. Hedging : purchase of different types of derivatives. The most common
examples include interest rate swaps, options, futures, and forward rate

27. BASELIII NORMS

28. Tier 1: Capital is a bank’s core capital used at times of financial emergency to absorb losses without
impacting daily operations. It includes audited revenue reserves, ordinary share capital, less
intangible assets, and deferred taxes
Tier 2: Capital is a bank’s additional capital used to absorb losses when winding up an asset. It includes
revaluation reserves, perpetual cumulative preference shares, retained earnings, subordinated debt,
and general provisions for bad debt.
Common Equity Tier 1 (CET1) is a component of Tier 1 Capital, and it encompasses ordinary shares
and retained earnings.
The Capital Adequacy Ratio set standards for banks by looking at a bank’sability to pay
liabilities, and respond to credit risks and operational risks.
Minimum risk-based capital requirements
(1) Common Equity Tier 1 must be at least 4.5% of risk-weighted assets (RWA).
(2) Tier 1 capital must be at least 6% of RWA.
(3) Total capital must be at least 8.0% of RWA
(4) Capital conservation buffer of 2.5%
(5) Countercyclical capital buffer should be in the range of 0 to 2.5%.
(6) Capital Leverage Ratio of minimum of 3%.

29. LIBOR : The London Interbank Offered Rate (LIBOR) is a
widely referenced benchmark rate, which is published in
five currencies and a range of tenors, and seeks to
estimate the cost at which banks can borrow on an
unsecured basis from other banks.
Secured Overnight Financing Rate (SOFR) and Sterling
Overnight Interbank Average Rate (SONIA) are the tw
popular alternatives, but are nowhere near as popula
internationally as Libor, which is being phased out by
year’s end.
Securitizations are transactions in which
financial assets are sold to a Special Purpose
Entity (SPE), which then issues beneficial
interests in the form of senior and subordinated
interests collateralized by the transferred
financial assets
Fair Value of Assets and Liabilities Fair value is defined as
the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market
participants at the measurement date. Fair value is based
on an exit price notion that maximizes the use of observable
inputs and minimizes the use of unobservable inputs