Part C. Banks' Financial Reporting Lectures 6&7. Banks Balance Sheet (II)

Transcription

1 Part C. Banks' Financial Reporting Lectures 6&7. Banks Balance Sheet (II) Lecture 7

2 Outline Banks' Assets 6.2. Banks' Liabilities

3 3 For bank liabilities, the ranking positions is reversed compared to non-financial firms: first are nominated debts and subsequently equity capital Compared to non-financial firms typically banks are highly leveraged and thus hold a lower proportion of equity to assets

4 4 Capital structure: Manufacturing firms versus Banks

5 5 Capital structure: Manufacturing firms versus Banks

6 6 Banks' Liabilities are found in the following main forms: Customer deposits Borrowings from nondeposit sources Subordinated debt Equity capital

7 7 Customer deposits Financial claims held by individuals/firms/governments in current accounts (checking accounts), sight deposits, time deposits (saving deposits). The largest share is attributed to time deposits (higher interest rate), while the lower to current accounts (usually no interest). The largest proportion of bank liabilities is in the form of deposits that are typically made by individuals and firms Individuals (retail banks) Business firms (corporate banks)

8 8 Customer deposits For commercial banks, deposits are the main source of capital. For banks more oriented towards capital markets (investment banks, mortgage banks), deposits are a secondary source of capital, sometimes even negligible.!!! In general small banks, or those focusing on local or regional activities, are oriented towards attracting resources as customer deposits, rather than loans from other financial institutions.

9 9 Customer deposits Deposit institutions must hold minimum reserve requirements against specified deposit liabilities. Usually central banks sets the minimum fraction of customer deposits that each bank must hold as reserves

10 10!!! Banks are required to make mandatory contributions to the Deposit Guarantee Fund. Deposit Guarantee Schemes reimburse a limited amount of deposits to depositors whose bank has failed. In Romania & EU the guarantee ceiling is of EUR, equivalent in RON, per depositor, per bank. Example: if a depositor holds a savings account worth EUR and a current account with EUR at the same bank, he will receive only the equivalent in RON of EUR. From the depositors point of view, this protects a part of their wealth from bank failures. From a financial stability perspective, this promise prevents depositors from making panic withdrawals from their bank, thereby preventing severe economic consequences.

11 11 Borrowings from nondeposit sources Borrowings from other banks/financial in the form of repurchase agreements (repo). Usually, banks rely on other local banks, borrowings being denominated in in national currency. (! Robor) In case of banks owned by large foreign banking groups, it appears the position loans from foreign banks, mostly denominated in euro or US dollars. For the latter, the interest rate is based on money market rates (Euribor, Libor)

12 12 Advantages Funds are raised for longer periods and from a small number of banks avoiding contractual relationships with a large number of small savers who prefer short maturities (1M, 3M ) and often manifest an unpredictable behavior No reserve requirement, the funds attracted are left entirely to the bank No mandatory contributions to the Deposit Guarantee Schemes

13 13 Disadvantages When financial markets are faced with periods of uncertainty and volatility may occur sharp liquidity crisis, during which banks become more cautious to lend to other banks. Excess demand for funds may lead to substantial increases in the interest rate, so that if a bank needs urgent refinancing will have to accept a reduction in its profit margin just to access the funds it needs. In extreme situations, it is possible that even large banks do not have enough liquidities to lend other banks through the inter-bank market. In such circumstances, banks can turn to loans the central bank as lender of last resort.

14 14 For banks which rely mainly on loans from other banks are very important their reputation and image in the market. Depending on the bank s credit rating (as it is perceived in the banking system) varies the cost of credit and even the probability to obtain it in crisis. Overall, it is estimated that as a bank is more dependent on refinancing from short-term loans, the risk of a liquidity crisis increases, and, also the probability to become insolvent

15 Banks' Liabilities ROBOR evolution during crisis

16 Banks' Liabilities EURIBOR evolution during crisis

17 17 Subordinated debt - debt which ranks after other debts if the bank falls into liquidation or bankruptcy. the debt providers (the lenders) have subordinate status in relationship to the normal debt. subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, and ranks below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. debt instruments with the lowest seniority are known as subordinated debt instruments.

18 18 Subordinated debt Banks are among the largest issuers of subordinated debt, especially banks that securitize their loan portfolios (usually mortgages). Frequently, banks contract subordinated debt by issuing convertible bonds. Because subordinated debts are repayable after other debts have been paid, they are more risky for the lender of the money.

19 19 Subordinated debt For example, if a company has debt A that totals $100 and debt B that totals $50, debt A is senior debt and debt B is subordinated debt. If the company needs to file for bankruptcy, it is required to liquidate all of its assets to repay the debt. If the company's assets are liquidated for $125, it first needs to pay off the $100 amount of its senior debt A. The remaining subordinated debt B is only half repaid due to the lack of money.

20 Banks' Liabilities

21 21 Equity capital accounts resources available to the bank's on long-term (unlimited), on which no repayment obligations exist; these resources are formed on the basis of capital increase with cash contributions (through subscriptions by shareholders) or by capitalization of profits.

22 22 Equity capital accounts Shareholders equity Common stock & Preferred stock Retained earnings Reevaluation reserves Other reserves: Statutory reserve Reserve for the general risk

23 23 Equity capital accounts Statutory reserve it is fed by annual transfers of 5% of the bank's net profit until the reserve has reached a level of 20 % of the bank's capital. Reserve for the general risk transfers are made from the gross profit by levying 1% in value of risky assets (bank specific risk-bearing )

24 24 Equity capital accounts Compared to non-financial firms typically banks hold a lower proportion of equity to assets if in the first case Equity/TA is about 50 %, for banks the percent range from 8 % to15 %. For this reason, banks are very vulnerable to credit risk relatively low NPLs of 10 % -15 % can lead to financial losses enough to completely erode the bank's own capital.

25 25 Capital reduce the risk of failure by providing protection against operating and any other losses, in five ways by: 1) providing a cushion for firms to absorb unanticipated losses with enough margin to inspire confidence and enable the bank to remain solvent; 2) protecting uninsured depositors (depositors not protected by a deposit insurance scheme that covers small depositors) in the event of insolvency and liquidation; 3) protecting bank insurance funds and taxpayers; 4) providing ready access to financial markets and thus guarding against liquidity problems caused by deposit outflows; and 5) limiting risk taking.

26 26 Equity capital accounts!!! Post crisis regulation is characterized by stringent capital adequacy ratios a higher share of equity capital reported to total risk weighted assets. => The Basel III Accord

27 27 Examples: BCR Deutsche Bank JP Morgan