Chapter 7 Commercial bank financial statement Salwa Elshorafa 2009 © 2005 Pearson Education Canada Inc.

3-2 The balance sheet A bank's balance sheet presents financial information comparing what a bank owns with what it owes and the ownership interest of stockholders. Assets indicate what bank owns ; liabilities represent what the bank owes; and equity refers to the owners interest such that Assets = Liabilities + Equity

© 2005 Pearson Education Canada Inc. 3-3 Balance sheet figures are stock values calculated for a particular day or point in time. the balance sheet represent the balance of cash, loans, investments and premises owned by the bank on a particular day. Regulators require that banks report balance sheet and income statement data quarterly, so figures are available publicly for the three month period

© 2005 Pearson Education Canada Inc. 3-4 Bank assets Bank assets fall into one of four general categories: loans, investment securities, noninterest cash and due from banks and other assets : 1) loans :- are the major asset in most banks portfolio and generate the greatest amount of income before expenses and taxes. 2) investment securities :-are held to earn interest, help meet liquidity needs, speculate on interest rate movement, meet pledging requirement 3) noninterest cash and due from banks consists of vault cash, deposit held at federal reserve banks deposits held at other financial institutions, and cash item in the process of collection.

© 2005 Pearson Education Canada Inc. 3-5 Bank assets These assets are held to meet customer withdrawal need and legal reserved requirement, assist in check clearing and wire transfers and effect the purchase and sale of treasury security. 4) Other assets are residual assets of relatively small magnitudes such as bankers, acceptance, equipment and other smaller amounts.

© 2005 Pearson Education Canada Inc. 3-6 Loans : A bank negotiates terms with each borrower that vary with the use of proceeds, source of payment and type of collateral. There are six categories of loans :- 1) real estate loans :- are loans secured by real estate and generally consist either of property loans secured by first mortgage 2) commercial loans: consist of commercial and industrial loans to financial institution. commercial loans appear in many forms but typically finance a firm's working capital needs, equipment purchases. This category also includes credit extended to other financial institutions, security brokers and dealers

© 2005 Pearson Education Canada Inc. 3-7 Loans : 3) Individual loans:- include those negotiated directly with individual for household, family, and other personal expenditure. And those obtained indirectly through the purchase of retail paper 4) Agricultural loans: appear in many forms but typically finance agricultural production and include other loans to farmers 5) Other loans in domestic office : include all other loans and all lease – financing receivables in domestic office 6) International loans :- loan and lease in foreign office

© 2005 Pearson Education Canada Inc. 3-8 Investment A bank's investment include both short – term and long – term investment security:- 1) short –term security:- those with maturity of one years or less – that can be easily sold to obtain cash. *They have maturities ranging from overnight to one year and carry return that vary quickly with changes in money market condition * lower risk * the bank earns significantly less interest than what could be earned on longer –term securities. * short –term security include treasury and agency securities, foreign debt securities, and other securities

© 2005 Pearson Education Canada Inc. 3-9 Investment 2)long –term investment securities : * Consist of notes and bonds that have maturity of more than one year and generate taxable. * Treasury security and obligations of federal agencies represent the bulk of taxable * purchase mortgage- backed security * small amount of foreign * corporate bonds Most of these carry fixed interest rate with maturities up to 20 years

© 2005 Pearson Education Canada Inc Investment 3) Noninterest cash and due from banks:- This asset category of vault cash, deposit held at held federal reserve banks, deposit held at other financial institutions and cash item in the process of collection : Vault cash :- is coin and currency that the bank hold to meet customer withdrawals 2) Deposits held at the federal reserve are demand balances used to meet legal reserve requirement, assist in check clearing and effect the purchase and sale of treasury securities

© 2005 Pearson Education Canada Inc Investment 3) cash item in the process of collection :- Are generally the largest component of cash, representing cash written against other institution and presented to the bank for payment for which credit has not been given. 4) Other assets this category consists of residual assets of relatively small magnitudes including the depreciated value of bank, equipment, customers liability to the bank under acceptance. Commercial banks own relatively few fixed assets.

© 2005 Pearson Education Canada Inc Balance sheet information for PNC banks PNC ( Bank, National, Association ) Dec-03 % of Balance sheetCan %1000$total Asset loans : Real estate loans Commercial loans Individual loans Agricultural loans Other loans in domestic off Loans in the foreign off Gross loans& leases Less: unearned income Net loans & leases Investment:- U.S. treasury & agency securities Municipal securities Foreign debt security All other securities Interest bearing bank balance Fed fund sold & resale Trading account asset Total investment 1.2% -8.4% -4.4% 9.2% 20.5% 15.6% -4.6% 8.0% -5.8% -4.5% 90.6% -46.9% -100% 1.1% 16.4% -54.6% -9.1% 8.7% % 19.2% 4% 0% 4.9% 1.9% 55.2%.1% 1% 54.1% 9% 0% 14.2%.4% 1.8% 1.5% 26.9%

© 2005 Pearson Education Canada Inc Balance sheet information for PNC banks PNC ( Bank, National, Association ) Dec-03 % of Balance sheetCan %1000$total Total earning assets Cash Fixed assets & capital leases Other real estate owned Acceptance and other assets Total assets.5% -6.9% 24.4% 21.8% 252.4% 51.8% 4% % 4.7% 1.7% 0% 12.5% 100%

© 2005 Pearson Education Canada Inc Bank liabilities and stockholders Equity Internal resource :- The payment of capital Retained earning - Reserves - profit are not divided Debenture

© 2005 Pearson Education Canada Inc Bank liabilities and stockholders Equity External resource Deposit - Demand deposit - time deposit - Subject – to- notice deposits - saving account - foreign deposit - domestic deposit

© 2005 Pearson Education Canada Inc The payment of capital Definition Important Regulation

© 2005 Pearson Education Canada Inc Retained Earning Act as part of the equity Means to obtain the money Divided into :- - reserve - profits are not distributed

© 2005 Pearson Education Canada Inc Reserve Definition Internal resource reserve security of deposit Have several forms :- - Secondary reserve - Primary reserve

© 2005 Pearson Education Canada Inc Secondary reserve Keep reserve by him self There is no percent on it To chive some purpose

© 2005 Pearson Education Canada Inc Primary Reserve Central bank demand it there is percent on it Cut from income before divided the profit Named legal, primary or capital reserve

© 2005 Pearson Education Canada Inc profits are not distributed The management of banks don’t distribute all profit

© 2005 Pearson Education Canada Inc Debentures Consist of notes and bonds with maturities in excess of one year. Most meet requirement as bank capital for regulatory purpose. When a bank fail deposit are paid before subordinate debt holders.

© 2005 Pearson Education Canada Inc External resources (Deposits) Demand deposits Are held by individuals, partnership, corporation, and government that pay no interest. Prior to the depository institutions 1980 they reserved as the only legal transactions accounting nationally that could be offered by depository institutions.businesses now own the bulk of existing demand deposit because they are not allowed to own interest – bearing transaction accounts at bank

© 2005 Pearson Education Canada Inc Demand deposits Withdrawal in any time currant account (checking account ) (check - cash - ….) High liquidity Is very important part in the external resource.

© 2005 Pearson Education Canada Inc Time deposit divided into two type:- 1) time deposit * specific period * interest is the highest * broke deposits

© 2005 Pearson Education Canada Inc Time deposit 2) subject – to- notice deposit * interest is lower than time deposit * periodic of money

© 2005 Pearson Education Canada Inc Saving account Contribute a large portion of funding, especially at community banks, passbook saving deposit are small – denomination account that has no set maturity and no check writing deposit.

© 2005 Pearson Education Canada Inc Deposit held in foreign office Refer to the same type of dollar –denomination demand and time deposit discussed above except that the balance are issued by bank subsidiary ( owned by the bank holding the company) located out side the united state.

© 2005 Pearson Education Canada Inc Active deposit :- non consistence process Idle deposit :- consistence process restricted deposit : restricted by individual Active, Idle, or restricted deposit

© 2005 Pearson Education Canada Inc Matching assets and liabilities Unexpected interest – rate fluctuations can hurt financial intermediation with mismatched assets and liabilities Gap analysis :- Estimates the net effect of interest rate on income Gap = ( rate sensitive assets ) - ( Rate sensitive liabilities )

© 2005 Pearson Education Canada Inc Matching assets and liabilities Rate sensitive :- interest rate can change during the coming year) Gap = 40 million – 30 million = 10$ million If interest rate increase by 2% ( 7% to 9% ) income will increase by 2% ( 10,000,000)= 200,000$ Positive gap :- is an important wager that interest rate will increase

© 2005 Pearson Education Canada Inc. 3-32