Principles of Bank Operation

Principles of Bank Operation BNKG 1303 Session 10 - Measuring and Reporting Financial Performance

Lecture Notes:

Imagine for a minute - going to the doctor - not for a specific complaint, but for your annual checkup. Are you nervous about it? Isn't there always some nagging concern that the Doctor might find something wrong with you - something that you may have suspected but didn't really want to know about.

In the case of a business - any business - but your bank in particular - the Financial Performance review - is just about the same as going to the Doctor. Even as the medical profession as specialized - so has the area of Financial Reporting.

Bankers have an obvious need to understand financial reporting. Not only do you need to know about the health - or problems - in your own organization, but financial reporting is the tool that is most used to help you understand about your customers borrowing needs - and their financial strength. And, even though - your business is one of money - and theirs is manufacturing or selling some other commodity - there are many similarities in understanding the financial reports. Just as there are similarities - there are differences - not so much in the ratios used - but the application of those ratios - AND the 'benchmarks' that are used for comparison.

The liquidity ratio for a bank - should be (better be!) much higher than for that of a manufacturing firm. A bank MUST maintain a higher percentage of its assets in the form of CASH - since it is responsible for paying not only its own obligations - but through customer checking accounts - the obligations of the customer as well.

Every company - banks or other types of financial institutions - have other entities to which they are responsible for financial reporting. A national bank - that is publicly traded stock - is responsible for reporting to the FDIC, the Federal Reserve, the Comptroller of the Currency, the SEC, (possibly the New York Stock Exchange, if that is where their stock is traded) and THEIR STOCKHOLDERS. All of these require sound accounting practices - and consistency in reporting styles. Much of the reporting currently required by the financial regulators - is done in the manner they prescribe - so that the same information may be reported to different users in different formats.

The personnel who deal with the customer - whether it be new accounts, tellers or loan officers are very important to the institution. This is because the customer is the lifeblood of the organization.

At the same time - the job performed by the financial management team - is also of vital importance. The financial management team will consist of not only those departments that are responsible for investing excess funds - and determining interest rates - but also those that are responsible for reporting on the financial activities of the bank.

Much like my earlier comparison to visiting the Doctor - the review of the financial activities is a report on the health of the organization. This review is some vital to the ongoing health of your organization - that regulations and sound business practices - require that the banks financial activities be review by both internal staff - and external specialists, in the form of both bank examiners and Certified Public Accountants.

After examining the processes of Financial Reporting - and the absolute need to be able to rely on the information provided - it is easier to understand why - accounting is the "language of banking" (and for that matter - the language of business.)

Back to the Top

Chapter Notes:

Ratio analysis is one of the foremost tools used by regulators to identify potential situations. Ratios are used for a number of reasons - but primarily because they can utilize the computer to rapidly analyze large numbers of financial institutions. Additionally, ratios can be utilized, to some extent, to analyze both large and small institutions in much the same manner. These rations should not be used for any definitive action - but merely to identify which institutions from a regulatory standpoint should be scrutinized further.

Each of the ratios listed has a specific purpose in the process. However, some of the ratios should also be considered from multiple viewpoints. For example, the Capital/Assets ratio is a measure of the bank's overall financial strength. While the statement "The higher the percentage, the healthier the institution" is true, it is also true that the higher the percentage, the less earnings are being returned to the investors (of a bank) and the member/owners (of a credit union). As with other financial ratios, it is the responsibility of management to balance both considerations. Certainly, it is true that regulators want that ratio to be as high as possible and continue to grow - where investors and members would be just as happy with a more reasonable ratio.

Ratios are calculated using either end of period balances or end of period balances divided by average (beginning of period + end of period divided by two). For example, the Loans to Assets ratio is the year-end Loans divided by the year-end Assets, while Return on Assets is the year-end Earnings divided by the average of the beginning of the year and the end of the year Assets.

Consider the following examples: 12/31/98 Earnings = $875,000; 12/31/98 Assets = $90,000,000; 12/31/99 Assets = $100,000,000. Average Assets then, is $90 million + $100 million divided by 2 = $95 million. Return on Assets is $875,000 divided by $95 million or 0.921%.

Net Worth Ratio of the bank above with end of year total capital of $11,450,000 is 11.45%.

Back to the Top

ASSIGNMENT:
Determine what is the difference between an income statement and a balance sheet. (Hint - one is one time snap shot it time, the other is more of a video camera view that tells a story over a period of time.)

Back to the Top

Please review one or more of the following questions for your learning experience.

Why is the budgeting process important for organizations/entities?

Back to the Top

Sessions Home Page

BNKG 1303 Home Page

Internet Resources

Ratio analysis is one of the foremost tools used by regulators to identify potential situations. Ratios are used for a number of reasons - but primarily because they can utilize the computer to rapidly analyze large numbers of financial institutions. Additionally, ratios can be utilized, to some extent, to analyze both large and small institutions in much the same manner. These rations should not be used for any definitive action - but merely to identify which institutions from a regulatory standpoint should be scrutinized further.
Each of the ratios listed has a specific purpose in the process. However, some of the ratios should also be considered from multiple viewpoints. For example, the Capital/Assets ratio is a measure of the bank's overall financial strength. While the statement "The higher the percentage, the healthier the institution" is true, it is also true that the higher the percentage, the less earnings are being returned to the investors (of a bank) and the member/owners (of a credit union). As with other financial ratios, it is the responsibility of management to balance both considerations. Certainly, it is true that regulators want that ratio to be as high as possible and continue to grow - where investors and members would be just as happy with a more reasonable ratio.
Ratios are calculated using either end of period balances or end of period balances divided by average (beginning of period + end of period divided by two). For example, the Loans to Assets ratio is the year-end Loans divided by the year-end Assets, while Return on Assets is the year-end Earnings divided by the average of the beginning of the year and the end of the year Assets.
	Consider the following examples: 12/31/98 Earnings = $875,000; 12/31/98 Assets = $90,000,000; 12/31/99 Assets = $100,000,000. Average Assets then, is $90 million + $100 million divided by 2 = $95 million. Return on Assets is $875,000 divided by $95 million or 0.921%.
	Net Worth Ratio of the bank above with end of year total capital of $11,450,000 is 11.45%.