Key takeaways from the MEMBA 11 session on financial statements of banks

Philip Anegbe Written by Philip Anegbe · 2 min read >

I think the session on the financial statement of banks (using the Union Bank financials) served as a reminder of the learnings I picked up during my training as an analyst. The study and valuation of a bank’s financials differ from those of other companies. For instance, from a relative valuation standpoint, the price-to-book methodology is applied to banks where price-to-earnings, enterprise value to EBITDA, and price-to-sales are often used for non-financials. However, a proper understanding of the income statement is usually the starting and focal point of financial analysis across companies, and that of a bank principally flows through its balance sheet. Simply put, the core income of banks is mainly derived from the assets held, while their most important expenses mostly flow from the liabilities.

On the asset side of a bank’s balance sheet, we have further sub-division into interest-earning and non-interest-earning assets. The interest-earning assets include loans and advances and investment securities (such as financial assets held at fair value through other comprehensive income or at amortised cost). In this sub-segment of a bank’s assets, loans and advances are the most important components as they are one of the primary tools of basic financial intermediation. Returns on interest-earning ‘assets’ are directly related to the yield environment and the volume/size of assets held by banks. All things being equal, the higher the yield and size of the interest-earning assets, the more the associated interest income and vice versa. As inferred from the sub-division, banks also hold non-interest earnings assets such as properties and equipment (which adds to expenses through depreciation) and intangible assets (such as goodwill, which may occasionally be linked to impairment).

On the liability side of a bank’s balance sheet, we have interest-bearing and non-interest-bearing liabilities. The interest-bearing liabilities chiefly include

  • deposits (which happens to be the most important liability of banks),
  • issued bonds (domestic & foreign currency denominated), and
  • placements from other financial institutions.

Deposits can be decomposed into deposits from customers (usually larger and more critical) and deposits from other financial institutions. Customer deposits can be subdivided into savings, current, and term deposits. Typically, the current account is the cheapest deposit to manage as users often net-pay the bank for services enjoyed. This account is closely followed by savings accounts, typically more affordable than term deposits from the bank’s perspective. In Nigeria, savings deposits directly correlate with the monetary policy rate. Hence, the higher the monetary policy rate, the higher the savings deposit. Unlike savings, the term deposit may not be directly pegged to the monetary policy rate, yet it is also positively correlated with the yield environment. In addition, banks are also expected to compensate term deposit investors for opting to part with liquidity for a longer period. However, the investor may choose to break the contractual agreement when a pressing need arises, but this could attract some sanctions or penalties. Generally, banks with a higher proportion of cheaper deposits (i.e. current and savings deposit accounts) usually experience lesser interest expense pressure, all things being equal.

In closing, it is important to point out that the explanations above primarily cover just some aspects of a thorough bank assessment. A comprehensive evaluation of a bank is often done through the CAMELS approach, which is an acronym for capital adequacy, asset quality, management capabilities, earnings, liquidity, and sensitivity to market. The discussion of CAMELS is not included in this blog post. #MEMBA11 #@Philgaps

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