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CHAPTER FOUR
(Three) The Financial Statements of
Banks and Some of Their Closest
Competitors
The purpose of this chapter is to acquaint the
students with the content, structure and
purpose of bank financial statements and to
help managers understand how information
from bank financial statements can be used
as tools to reveal how well their banks are
performing.

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Bank Financial Statements

　 Reflect services offered

　 Overall size
　 Analysis of performance
Important Financial Statements
 Report of Condition – Balance Sheet

 Report of Income – Income Statement

 Sources and Uses of Funds Statement

 Statement of Stockholders’ Equity

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Report of Condition
The Balance Sheet of a Bank Showing its Assets, Liabilities and Net Worth
Accounting Equation: Assets=Liabilities +Equity Capital (1)

Assets= Resources with future benefits that are

owned and controlled by a company
Examples: cash, supplies, equipment and land
Liabilities= What a company owes to its nonowners
(creditors)
Examples: debt to a bank in the form of a note
payable, accounts payable to supplies
Equity= owner’s claim on assets (Owner’s equity)

Accounting System: What a company owns and what it owes

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C + S + L + MA = D + NDB + CA (2)

Accumulated uses of bank funds=

Accumulated sources of bank funds (3)

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C + S + L + MA = D + NDB + CA

C = Cash Assets D = Deposits

S = Security Holdings NDB = Nondeposit
Borrowings
L = Loans
CA = Capital Accounts
MA = Miscellaneous
Assets

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Cash Assets
 Account is Called Cash and Deposits Due
from Bank
 Includes:
 Vault Cash
 Deposits with Other Banks
 Cash Items in Process of Collection(uncollected
checks)
 Reserve Account with the Federal Reserve/BB
 Sometimes Called Primary Reserves
Objective is to keep the size of this account as
small as possible as they earn little or no interest
income
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Security Holdings

 Money Market Securities – Secondary

Reserves:short-term govt. securities, interest-
bearing time deposit held with other banks etc.
 Investment Securities
 Taxable Securities: Govt. or corporate bonds and
notes
 Nontaxable Securities: tax-exempt bonds and notes

>>>Recorded in the BS at lower of cost or market

 Trading Account Securities
>Held for Resale Only
>Valued at Market Value
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Loan Accounts

 Gross Loans – Sum of All Loans

 Allowance for Possible Loan Losses
 Contra Asset Account
 For Potential Future Loan Losses
 NetLoans
 Nonperforming Loans: Due more than
90 days

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Types of Loans

On the basis of purpose for borrowing money:

 Commercial and Industrial Loans

 Consumer(household) Loans

 Real Estate(property based loans) Loans

 Financial Institution Loans

 Foreign Loans(to foreign govt./institutions)

 Agriculture Production Loans(raise and

harvest crops, raise and round up livestock)
 Security Loans( to investors and security
brokers)
 Leases(bank buying equip>to business firms)

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Miscellaneous Assets

 Fed Funds Sold: Reserve sold

 Securities Purchased Under

Agreement to Resell (Repurchase

Agreements)
 Customers’ Liabilities on Acceptances

 Net Premises and Equipment

 Other Miscellaneous Assets: Goodwill

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Deposit Accounts

 Non interest-Bearing Demand Deposits

 Savings Deposits: Bear the lowest rate of
interest
 Now Accounts: For individuals and nonprofit
institutions>Bear interest and permit checks
 Money Market Deposit Accounts (MMDA):
>limited check>interest>notice for withdrawal
 Time Deposits (Certificate of Deposits [CDs])
>fixed maturity>higher interest rates>

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Nondeposit Borrowings

 Fed Funds Purchased: Reserve

loaned to it by other banks
 Securities Sold Under Agreement to

Repurchase (Repurchase
Agreements)
 Eurocurrency Borrowings

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Capital Accounts

 Preferred Stock
 Common Stock
 Common Stock Outstanding
 Capital Surplus
 Retained Earnings (Undivided Profits)
 Treasury Stock (Retired stock)
 Contingency Reserve (Unforeseen losses)

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 Composition of Bank Balance Statements
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(Percentage Mix of Bank Sources and Uses of Funds for 2001)

Banks
Bank < Between
$100 Million $100 Mill. - Banks > $1
All Banks % % $1 Bill. % Billion %
Cash and Deposits Due from Banks 5.95 5.72 4.64 6.16
Investment Securities 17.96 24.00 22.65 17.02
Fed Funds Sold and Repos. 4.84 5.60 3.57 4.99
Total Loans and Leases (Net) 58.20 60.22 64.04 57.25
Commercial and Industrial 25.20 17.18 17.76 26.77
Consumer 16.19 12.44 10.95 17.21
Real Estate 46.26 58.64 66.10 42.47
To Depository Institutions 3.01 0.00 0.28 3.58
To Foreign Governments 0.19 0.00 0.12 0.23
Agriculture 1.23 10.32 2.96 0.56
Other Loans 3.56 1.03 1.12 4.05
Leases 4.36 0.39 0.71 5.13
Assets Held in Trading Accounts 4.62 0.00 0.00 5.48
Bank Premises and FA (Net) 1.17 1.88 1.81 1.04
Other Assets 7.26 2.58 3.29 8.06
Total Assets 100.00 100.00 100.00 100.00
Interest Bearing Deposits 53.55 71.69 68.77 50.57
Noninterest Bearing Deposits 13.30 13.00 12.80 13.34
Fed Funds Purchased and Repos. 7.66 0.91 2.70 8.66
Other Liabilities 16.40 3.50 6.05 18.44
Total Equity Capital 9.09 10.90 9.68 8.94
Total Liabilities and Equity 100.00 100.00 100.00 100.00

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Off-Balance-Sheet Items
Fee generating services not fully disclosed in the balance
sheet:
 Standby Credit Agreements: Bank promises to guarantee
repayment of a customer’s loan taken from a third party
 Interest Rate Swaps:Bank promises to exchange interest
payments
 Financial Futures and Options Interest-Rate
Contracts:Bank agrees to deliver or take delivery of
securities at a guaranteed price.
 Loan Commitments:Bank pledges to give loan until a
certain period
 Foreign Exchange Rate Contracts: Bank agrees to deliver
or take delivery of foreign currencies

Make the bank more risky than

appeared in the financial statements
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Report of Income

The Statement of Revenues, Expenses

and Profits for a Bank

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 Net Interest Income = 1-17

Interest Income – Interest Expenses

Interest Income Interest Expenses

 Interest and Fees on
Loans
 Taxable Securities
Revenue
 Tax-Exempt Securities
Revenue
 Other Interest Income
 Deposit Interest Costs
 Interest on Short-Term
Debt
 Interest on Long-Term
Debt

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 Net Noninterest Income = 1-18

Noninterest Income – Noninterest Expenses

Noninterest Income Noninterest Expenses

 Service Charges on  Wages and Salaries

Customers Deposits  Other Personnel
 Trust Department Expenses
Income  Net Occupancy
 Other Operating Expenses
Income  Other Operating
Expenses

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Income Statement

Net Interest Income

- Provision for Loan Loss

Net Income After PLL

+/- Net Noninterest Income
Net Income Before Taxes
Taxes
Net Income
- Dividends

Undivided Profits
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Provisions for Possible Loan Loss (PLL)
 Experience Method
 Specific Charge-Off Method

Example: Suppose a bank anticipated loan losses this year of

$10,000 and held $100 thousand already in the ALL account.

Beg. Bal. Allowance for Loan Losses (ALL) = $ 100,000

+ This year’s Provision for Loan losses (PLL) = $ 10,000
Adjusted Allowance for Loan Losses (ALL) = $110,000
-Actual Charge-offs for worthless loans = $ 5000
Net Allowance for Loan Losses = $105,000
+Recoveries from Previously Charged-off Loans = $ 3,000
End. Bal. in the Allow. for Loan Loss Ac.(ALL) = $108,000

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Sources and Uses of Funds Statement

 Also Known as the Funds-Flows Statement

 It asks Two Questions
 Where Do Funds Come From?
 How Were Those Funds Utilized?

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Sources and Uses of Funds

Sources Uses
 Net Income  Net Loss
 Noncash Expenses  Dividends

 Decrease in Assets  Increase in Assets

 Increase in  Decrease in

Liabilities Liabilities
 Increase in Capital  Decrease in Capital

Accounts Accounts

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Statement of Stockholders’ Equity

Report Showing the Changes in the

Make Up of the Bank’s Capital Account

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Statement of Stockholders’ Equity

Beginning Capital Account Balance

+/- Net Income for Period
- Preferred Stock Dividends

- Common Stock Dividends

+ New Shares of Stock Issued

- Purchases of Treasury Stock

Ending Capital Account Balance

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 Financial Statements of Bangladeshi 1-25

Banks
 Bank Companies Act, 1991 Section 38
 Format of Financial Statements

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The Financial Statements of Nonbank Financial Firms

The financial statements of other financial institutions,

in recent years, come closer to bank statements

Finance Company:
•USE: Loan> Receivables:
BS is dominated by loans> Called “Accounts
Receivable”>Business receivables, consumer
receivables, real estate receivables> reflecting
loans made to these customers
•SOURCE: Deposit>Borrowings:
Borrowings from the money market>Borrowings
from banks etc.
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Life/Property Insurance Company:
•USE:Loan> Loans to the business sector
Holding of bonds, stocks and mortgages
•SOURCE: Deposit>Premium
Premium payment, Borrowings in the money and
capital markets

Mutual Funds:
•USE:Loan>
Corporate stocks, bonds, asset backed securities
•SOURCE:
Selling of fund shares

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Problem of Book Value

Accounting

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Fundamental Principles of Accounting

General Principles
Objectivity Principle Financial statement information is supported by
independent, unbiased evidence.

Cost Principle Financial statements are based on actual costs

incurred in business transactions

Going-Concern Principle A business continues operating instead of being

closed or sold.

Monetary Unit Principle Express transactions and events in monetary

units.

Revenue Recognition Principle Revenue is recognized when earned

Proceeds from selling need not be in cash

Revenue is measured by cash plus the value

Business Entity Principle A business is accounted for separately from its

owner or owners

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Discussion Case: Limitations of the Balance Sheet
Historical Cost versus Current Market Value Accounting

Balance sheet figures are based on historical costs instead of current

market values.

• This comes from the cost principle of accounting which states

that, values on the balance sheet should be recorded on their
original cost.
>For example, if an equipment is purchased for $5,000, it should be recorded
as $5,000. No matter whether the equipment is actually worth more or
less than the amount purchased. This may mislead the investors or
creditors regarding the true value of the firms’ assets and also will cause
trouble in replacement of the assets.

• In order to solve this problem, on October 1979 the Financial

Accounting Standard Boards (FASB) issued a ruling that required
large companies to disclose inflation-adjusted accounting data in
addition to their traditional historical cost data. However, with the
fall in the inflation rate this rule is no longer in force.

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Problem of Book Value Accounting

in Banks/FIs

 Assumes that all balance sheet items will be held to

maturity
 Does not show the impact of changing interest rates
and default risk etc.
 Auditors do not guarantee the accuracy of earnings,
but only that statements are a fair financial
representation
 EPS for a company is not a precise figure that is
readily comparable over time or between companies

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Ethics in Banking

 “Window Dressing” or “Creative Accounting”

 Manipulation of Financial Statements to Look

Stronger and More Successful

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