Analyzing Financial

Performance and Standing

of Commercial Banks
Naveed Ahmad
Joint Director
BSD – 3 , SBP
 CAPITAL
• Financial institutions are fundamentally different from
other firms.
• The overall effects of failure an industrial corporation
are limited to direct stakeholders (shareholders,
bondholders, & other creditors).
• In contrast, the failure of a financial institution can be
much more harmful. Thus the primary threat is
systemic risk.
• The added risk is primarily due to exuberantly
leveraged business model of banks.
• Capital acts like a financial cushion against losses
 CAPITAL ADEQUACY

• All banks/ DFIs are required to comply with the

capital adequacy framework which comprises the
following three capital standards:
– Minimum Capital Requirement (MCR):
The MCR standard sets the nominal amount of
capital banks/ DFIs are required to hold. No bank/
DFI shall commence and carry on its business in
Pakistan unless it meets the nominal capital
requirements prescribed by SBP from time to
time.
 CAPITAL ADEQUACY
– Capital Adequacy Ratio:
The Capital Adequacy Ratio (CAR) assesses the capital
requirement based on the risks faced by the banks/
DFIs. The banks/ DFIs are required to comply with the
minimum requirements as specified by the State Bank of
Pakistan on standalone as well as consolidated basis.
– Leverage Ratio
The Tier-1 Leverage Ratio of 3% was introduced in
response to the Basel III Accord as the third capital
standard, which is simple, transparent and
independent measure of risk.
 Minimum Capital Requirements
Type of Banking Institution MCR
Commercial Banks (locally incorporated) 10 B
Foreign bank’s branches: upto 5 branches 3B
Foreign bank’s branches: upto 6-50 branches 6B
Microfinance Banks (MFBs):
i. licensed to operate in a specified district: 300 M
ii. licensed to operate in a specified region: 400 M
iii. licensed to operate in a specified province; 500 M
iv. licensed to operate at national level: 1,000 M
Development Financial Institutions (DFIs) 6B
Exchange Companies 200 M
Islamic Banking Fund for Islamic Banking Branches 500 M
Islamic Finance Fund for Shariah Compliant Business by DFIs 150 M
 CAPITAL ADEQUACY

• The total regulatory capital will consist of sum of

the following categories:
• 1. Tier 1 Capital
– i. Common Equity Tier 1
– ii. Additional Tier 1
• 2. Tier 2 Capital
 CAPITAL ADEQUACY
Sr.
Tier 2015 2016 2017 2018 2019 Current^
No.

1 CET 1 6% 6% 6% 6% 6% 6%

2 Tier 1 7.5% 7.5% 7.5% 7.5% 7.5% 7.5%

ADT 1
3 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%
(Max)
Total
4 10% 10% 10% 10% 10% 10%
Capital

5 CCB* 0.25% 0.65% 1.275% 1.90% 2.50% 1.50%

Total
Capital + 10.25% 10.65% 11.275% 11.90% 12.50% 11.50%
CCB
* CCB stands for Capital Conservation Buffer consisting of only CET 1.
^ Reduced for time being under COVID 19 relief package for banking industry
 CAPITAL ADEQUACY
Capital Adequacy Ratio (CAR):
CAR is a risk sensitive measure of capital adequacy
and is computed as the ratio of Total Eligible
Capital (TEC) to Total Risk Weighted Assets
(TRWAs).

CAR = Total Eligible Capital (TEC)

Total Risk Weighted Assets (TRWAs)
Where:
TRWAs = Total Credit, Market and Operational Risk
Weighted Assets
 Leverage Ratio

The current regulatory requirement for minimum

Tier I leverage ratio is 3%.
 Evaluation of Capital

• Overall Financial Condition of the bank

• Banks use capital is used to absorb losses and
remain solvent
• Analysis of problems in other areas e.g Asset
Quality, Earnings etc
 Assets and Allied Risks
Total Assets
• Make Horizontal Analysis
• Increase in Gross or Net Assets- How ?
• Decrease in Gross or Net Asset- Why?
• In order to answer the question, have to
analyze each component of Assets on the
Balance sheet
 Assets and Allied Risks

Major Categories of Asset

Cash
Balance with other banks
Loan and Advances
Investment
Other Assets
Contingent Assets/Liabilities (off-balance
sheet)
 Assets and Allied Risks
Cash & Balances with Treasury Bank
• Bank should have cash necessary to meet the
obligations but not the excess cash.
• Excess cash- Cash mismanagement- losing return-
could be invested in profitable avenue
• Monitoring the regulatory requirement related to
CRR
• Check other components trend
• Particular Date- Quarter end analysis also needed.
 Assets and Allied Risks
Current CRR requirements:
• Balances in bank’s current account maintained with
SBP
• Reserve Maintenance Period is 2 weeks starting
from Friday and ending on Thursday of subsequent
• Average of 6% of total of demand liabilities and time
deposits with tenor of less than 1 year, during the
reserve maintenance period
• However it is subject to a daily minimum
requirement of 4%.
 Assets and Allied Risks
Balances with Banks
• Increase in Balances to be analyzed.
• Business Need
• Other options available with high return. Why with
banks?
• Could be having higher return. But Why other bank
is offering? Systemic risk?
• Encumbrance / lien over any balances especially in
NOSTROs?
 Assets and Allied Risks
Lending to Financial Institutions

• What are the components ?

• Types of Lending ?
• Rating of counter banks?
• Cross currency and sovereign risks in cross boarder
placements?
 Lending To FIs
Increase in Lending
– Find out Source- Check on the other side of the BS
• Increase in Deposits or Increase in Borrowings
• If borrowings increases at the same time with almost
equal, have to check cost of borrowings and
lendings.
Decrease in Lending
– Check the liquidity position
– Any major deposits withdrawal?
 Investments
Increase in Investments
– Trend of growth
– Vertical analysis with total assets
– Change in asset mix.
– If its at the cost of advances – is it a Strategic Decision or
inability to lend.
– Check increase in nature of investment. (Disclosure is given in
the notes)
• Govt. Securities- Overall share
• TFCs or Shares
• Listed or unlisted (Risk Point of view)
• Strategic Investments
– Source of increase in Investment
 Investments
If decrease in advance
– Analyze bank’s strategy and risk appetite
– Need to check in consonance with changes in capital
adequacy- Not able to generate risk weighted assets.
– Tend of NPLs status
– Not able to market and bring new business
– Products limitation
– Contribution in economy- credit growth- financial
inclusion
– Adverse taxation impact; can significantly hamper
PAT
 Investments
Monitoring of Statutory Liquidity
Requirements (SLR)
– SLR to be maintained in cash (excluding the CRR)
and unencumbered approved securities.
– SLR for conventional banks and Islamic Banking
Institutions is 19% and 14%respectively ofdemand
liabilities and time deposits with tenor of less than
one year
– Combined monitoring of SLR as CRR+SLR. i.e SBP
monitors liquid asset requirement @ 25% and 20%
for conventional banks and IBIs respectively.
 Advances
•Horizontal and Vertical
•Advances Mix (Corporate, Commercial, SME, Consumer, Agriculture)
•Increase in gross advances and net advances
–Increase in both gross and net- Good or Bad ?

•Increase in Gross but Decrease in Net or increase in gross greater

than increase in Net
–Need to check Provision (Disclosure/detail in Notes)
–NPLs, Unable to recover, FSV benefit depletes
 Advances
• Industry wise trend- NPLs
• Peer Analysis
• Concentration- Industry (Textile, Energy,
Communication, PSEs)
• Related Party Transaction.
– Regulatory limits per party 7.5% and group 15% of last
audited equity
• If Increases
– have to see arms length.
– Proper Disclosure
 Advances
• Have to see provision B/up in Notes
– If Sub Standard increase- Fresh Lending is not of
quality, Poor disbursement or lax evaluation/selection
– If DF or Loss Increases- Mgt unable to recover, benefit
of collateral/FSV depletes, relaxation no more
available.
• Notes regarding Relaxation needs to be reviewed for further analysis.
• Provision Required Vs Provision Held.
– Increase in classification but provision remains same or
decrease
 Advances
• General Provision against Consumer
 ADVANCES

• Classification and Provisioning

– Loans can be classified on both subjective
and objective basis
Subjective Criteria:
Subjective factors like Cash flows,
repayment behaviour, operation in a/c
and value of security, position of industry,
are taken into account.
Objective Criteria:
loans are classified on time-frame basis.
 R-8: Classification and Provisioning
Classification Category
Segment / PRs
OAEM SS DF Loss
Corporate and DPDs 90 180 1 year
N/A
Commercial Provision 25% 50% 100%
DPDs 90 180 1 year 1.5 years
SME (Small Enterprise)
Provision 10% 25% 50% 100%
SME (Medium DPDs 90 180 1 year
N/A
Enterprise) Provision 25% 50% 100%
DPDs 90 1 year 1.5 & 2 years 2 & 3 years
Agri Finance
Provision Nil 20% 50% 100%
Consumer Finance DPDs 90 180 1 year
N/A
(Excl Credit Card) Provision 25% 50% 100%
Consumer Finance DPDs 180
N/A N/A N/A
(Credit Card) Provision 100%
Infrastructure Project DPDs 90 180 1 year 2 years
Finance Provision Nil 25% 50% 100%
DPDs 90 180 1 year 2 years
Housing Finance
Provision Nil 25% 50% 100%
– Trade Bills to be classified loss after 180 days
 SPECIAL MENTION CATEGORY

• A special mention credit is defined as having potential

weaknesses that deserve management’s close attention.
If left uncorrected, these potential weaknesses may, at
some future date, result in the deterioration of the
repayment prospects for the credit or the institution’s credit
position. Special mention credits are not considered as
part of the classified extensions of credit category and do
not expose an institution to sufficient risk to warrant
classification.

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 Other Assets
• M/up Accrued- To be recovered
• Non Banking Assets
• Advance Payments
• Others of Others
 Asset Quality

• Credit related key financial ratios

• Total Provision Against Advances/ Financing

• Net Non-Performing Assets to Total Assets
• Net NPLs to Net Advances/Financing
• NPL to Gross Advances / Financing
• Provision Coverage
 Asset Quality

• Investment related key financial ratios

• Investment in Government Securities to Total
Investments (in percentage)
• Investment in Equities to Total Investments
• AFS portfolio to Total Investments
• HFT portfolio to Total Investments
• Market Risk related indicators e.g. Duration,
VaR, Variance etc
 Evaluation of Asset Quality

Asset quality is evaluated in relation to

• Level, trend, and severity of non-performing assets
• Adequacy of provisions (general and/or specific)
• Management’s demonstrated ability to identity, monitor,
administer, and collect problem advances and other such
assets.
• Quality of other assets (including investments), as well as
the quality of off-balance-sheet items are assessed.
• Degree of concentration of credits, investments, and
other assets.
• Level and quality of related party transactions
 Evaluation of Asset Quality

• Concentration of credit, investments and

other assets
 Any undue concentration of credit
• Quality of Insider Credit Extended
 Credit to insiders defined as directors,
executive officers which are not in terms of
employment
• Effectiveness of Lending Policies and
Credit Administration
 EARNINGS
• Continued viability of bank depends on appropriate ROA
• Earnings are essential to :
• Absorb losses
• Fund its expansion
• Support to Capital Internally
• Attract investors to supply capital.
• Profitability vs Safety
• Risk & Return
• Balance the expectations of shareholders, depositors
& regulators
 EARNINGS
• Level & Trend of Profit
• Potential Overstatement
• Coverage of Losses and Buildup of Capital
• Adequacy of Provision
 Adjustment for inspection findings i.e. Short fall in provisions
 Adjusted profit & ROA
• Support of Present & Future Operations
 Reference to sufficiency of Earnings to support future capital
needs in line with Balance Sheet growth
• Any Policy/Treatment which may Affect the Future
Earnings
 EARNINGS
• Quality of Earnings - Core Earning &
Recurring Nature
• Reliance on Unusual Items, Tax Effects
 Adjusted ROA on the basis of only Core Earning
• Plans to Correct Earnings Deficiency
 Any other future plans, budget/target
 Assumptions used for the plan & its adequacy
 Possibility of achieving the target
 Earnings

• Interest Income
– Break up- Advances
– Investments
– Lending
• Increase in gross Assets but Income Decrease ???
– Low Rates
– Assets composition- where deployed funds
– Increase in NPLs
– Shift in Strategy- Low risky Assets
– Investment in non interest bearing instruments
 Earnings

• Interest Expense to be reviewed in line with

the deposit mix, growth, type of deposits,
Fixed, institutional.
• Lending and borrowing rates.
• During the period under review, any change
in the interest rates ?
• Net Interest Income Trend. Income from core
function of the bank.
• Calculation of Net Interest Margin
 Earnings
• Key financial ratios
• Return on Assets
• Return on Equity
• Net Mark-up / Profit Margin (aka NIM)
• Net mark-up Income to Gross Income
• Non markup Income to Gross Income
• Non-mark-up Expense to Gross Income
• Non markup income/ Average total assets
• Non-markup expense / Average total assets
• Yield on Advances / Finances
• Yield on Investments
• Cost of Deposits and Cost of Borrowing
 Liquidity

Can the company meet its short-term

obligations
using the resources it
currently has in hand?

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 Liquidity

Liquidity of the bank is assessed in relation

with:
• Overall effectiveness of asset and liability
management
• Compliance with regulatory Requirement
• Structure and stability of deposits
• Degree and trend of reliance on borrowed
funds, including SBP facilities
 Liquidity

• Management of advances portfolio with

regard to maintaining adequate liquidity
levels
• Ability to raise liquidity quickly through
asset conversion or access to funding
facilities
• Adequacy of and compliance to written
internal liquidity and funding policies.
 Liquidity
• Key financial ratios
• Liquidity Coverage Ratio (LCR)
• Net Stable Funding Ratio (NSFR)
• Liquid Assets to Total Deposits & Borrowings (unsecured)
• Net Loans (ex. refinance from SBP) to Total Deposits
• Net Loans (ex. refinance from SBP) to Total Deposits +
Borrowings (unsecured)
• Net Loans (excluding. refinance from SBP) to Customers'
Deposits
• GAP (Assets- Liabilities) within 3 months to Total Assets
• GAP (Assets- Liabilities) within 3 months to 1 year to Total
Assets
 Deposits
Types of Deposits
• Remunerative
• Non remunerative
• Individual
• Institutional
• Local
• Foreign
• Core and Non Core
• Current , Savings and Fixed
 Deposits
• Trend
• Increase in Current- Good
• Increase in Fixed, Institutional- High cost ,
Volatile, Rate sensitive.
– Interest margin would decrease.
– Competition, Innovative products.
• Decrease in deposit- Liquidity Issue,
– Not able to retain (Rate, Services).
 Deposits
• Concentration of Deposits
– Top 20, 50 ,100
• Mobilized on Preferential Rates- Additional
information from mgt.
• Withdrawal of deposits; reasons to be explored.
Trend to be studied, quarterly and six years trend in
financials, industry and peer analysis
• Window Dressing- Could not be detected from FSA
but clues could be taken. i.e. increase in advances
and deposits vs Markup earned and expensed.
 Deposits
• Key financial ratios
• Concentration of Deposits (Top 20, 50 and 100 to Total
Deposits)
• Total Deposits
• Customer Deposits to Total Deposits
• CASA as a % of Total Deposits
• Cost of Deposits
 Evaluation of Liquidity
• In response to the global financial crises, the Basel
Committee on Banking Supervision (BCBS) has
introduced two liquidity standards under its Basel III
reforms i.e. Liquidity Coverage Ratio (LCR) and Net
Stable Funding Ratio (NSFR).
• The objective of LCR is to promote the short-term
resilience of the liquidity risk profile of banks by ensuring
that they have an adequate stock of unencumbered
high-quality liquid assets (HQLA) to survive a significant
stress scenario lasting for 30 calendar days.
• Stock of High Quality Liquid Assets (HQLA) ≥ 100% Total
net cash outflows over the next 30 calendar days
 Evaluation of Liquidity
• NFSR: The objective is to reduce funding risk over a one
year horizon by requiring banks to fund their activities
with sufficiently stable sources of funding
• The NSFR limits overreliance on short-term wholesale
funding, encourages better assessment of funding risk
across all on- and off-balance sheet items
• The ratio is defined as the amount of available stable
funding (“ASF”) relative to the amount of required stable
funding (“RSF”).
• The ratio should be equal to at least 100% on an
ongoing basis.