Balance Sheet of a Bank
The balance sheet of the bank is different from the balance sheet of the company and it is prepared only by the banks according to the mandate by the Bank’s Regulatory Authorities in order to reflect the tradeoff between the profit of the bank and its risk and its financial health.
Balance Sheet for banks is different from other sectors and companies. There are several characteristics of the bank’s financial statement that highlight how banks balance sheets and income statements are created. Sales are not measured by ratios like sales turnover and receivables turnover. Once investors are comfortable with the terminology and are able to grasp the statements, it becomes very easy for them, to analyze the trends and understand the statements
Banks Balance Sheet Example
Below is the example of Consolidated balance sheet of Goldman Sachs for the year 2017 and 2016 from their Annual 10K
Balance Sheet Assets
source: Goldman Sachs SEC Filings
- We note that the bank’s balance sheet assets are different from what we usually see in other sectors like Manufacturing etc. The classification is not on the basis of current assets, long term assets, inventory, payables, etc.
- The key highlight is that bank assets include securities purchased, loans, financial instruments, etc.
Balance Sheet Liabilities
- The Bank’s balance sheet liability section looks very different from the ordinary liabilities (current liabilities, long term liabilities, etc).
- Here the key terms to note are Deposits, Securities under repurchase agreements, short term and long term borrowings, etc.
Components of Banks Balance Sheet
The main components of the above bank’s balance sheet are
#1 – Cash
- For other sectors, holding a large amount of cash is considered a loss in opportunity cost. But in the case of Banks Balance Sheet, cash is a source of income and is held on deposit. Sometimes banks also hold cash for other banks and one of the major services which banks provide is to provide cash on demand.
- Due to the nature of its business and also as per regulatory norms it is necessary for banks to have a minimum amount of liquid cash. Most often banks keep excess reserves for higher safety Goldman Sachs has a considerable amount of cash balance.
- In 2017 it has ~12% of its balance in cash and equivalents. This is an important focus for the investors, since the chances of receiving a higher amount of dividend or share buyback increases
#2 – Securities
- These instruments are typically short-term in nature and banks generate a yield from these kinds of investments. Banks own US Treasuries and municipal bonds.
- These securities are liquid and can be easily sold in the secondary market and hence are termed as secondary reserves. Goldman has increased its investment in securities in 2017.
#3 – Loans
Lending money and earning interest is the primary business of the bank. This can be termed as bread and butter of the bank.
- From an investors perspective, the increase in loans is an important factor for the growth of the bank. Along with the increase in loans, banks deposits should also be observed. Increase in loans is alone not sufficient. Quality of creditors should be noted. Poor quality of creditors may lead to an increase in default rates and in turn loss for the banks.
- On a broad level banks provide Personal and mortgage loans. Personal loans are given without any security and hence interest for these loans remains high. In the case of mortgage loans, the loan is given against a mortgage and the interest is lower. But if the loan taker defaults on its loan the mortgage is claimed by the bank as per agreement.
- Banks also provide loans for business, real estate loans which include but not limited to residential loans, home equity loans and commercial mortgages, consumer loans, and interbank loans.
#4 – Deposits
- Deposits falls under the liability portion of the banks’ balance sheet and are also mainly the largest liability for the bank. This includes money market, savings, and current account and has both interest and non-interest bearing accounts.
- Deposits are considered as liabilities but they are also important in determining banks ability to lend. If the bank does not have sufficient deposits it will not be able to lend and the loan growth will also be hampered. Bank may have to take on debt to meet the loan growth which would cost them more than the rate they might receive on loans.
- Also, this is not a sustainable way for banks to grow their loans. After a certain point the debt amount will reach to an extent where the bank will not get any credit and if the bank fails to pay on its payments it will lead to a crash.
- Banks use these liabilities to generate more income which earns them additional income. By using these deposits to finance loans for individuals etc. Banks will be able to leverage this additional capital to earn the additional income which they might have otherwise earned through capital
- Banks also have an allowance in the balance sheet for covering losses and the changes in this amount are based on the economic conditions.
Accounting Rules for Valuing Assets in a Bank
Capital is determined by Total Assets less total liabilities (also known as net worth). However, the recent changes have changed this definition and have made it complex to determine the true value of the bank’s net worth.
Post-2009 crisis, the government took certain initiatives to restore faith in the banking system. Financial Accounting Standards Board has allowed Banks to value their assets at a Fair Value. Banks are now also allowed to record income on the income statement if the market value of the debt decreases. This change is because the bank could buy its own debt in the market and reduce the debt amount.
Important Indicators in Banks Balance Sheet Analysis
The word “Default” means failure to meet interest or payment obligations. Usually, banks use a Non-performance ratio which is a percentage indicating the number of loans given on credit is expected to fail. This comparison helps us in understanding if the bank has sufficient funds to meet the future contingencies
Widely used ratios include –
- Non-performing loans / Customer loans
- Non performing loans / Customer loans + collateral
- Non-performing loans / Average total assets
- Own Resources / Average total assets
Non-performing assets or loans to loans ratio is used as a measure of the overall quality of the bank’s entire loan book. Not performing loans are the ones for which interest is overdue for more than 3 months
The third ratio is especially very important for institutions that are already in a bad place. When this ratio crosses a benchmark it is considered as a strong sign of insolvency
The higher fourth the ratio indicates that the bank is highly leveraged and there is lower protection against defaults on the loans mentioned above on the asset side
This has been a guide to Banks Balance Sheet. Here we discuss the main components of the banks’ balance sheet in detail and its analysis along with practical examples, important indicators, and the widely used Ratios. You may learn more about accounting from the following articles –