Management Accounting
Category: Strategy Implementation
The whole bank financial statements
The bank publishes consolidated financial statements, which show audited figures. These figures are then used, internally and externally, to compare one year to another and see the actual trend in the bank risk profile and profitability. The main information is:
Balance sheet and off balance-sheet tables: size, liquidity and maturity of the assets and liabilities are key elements to be analysed.
Profit and loss report: revenue and expenses due to interests (loans, deposits, dividends on securities) are split from commissions, fees and revenues from trading activities.
Risk statement: for the last few years, annual statements of banks, especially in Western countries, have showed more and more qualitative information about the activity, the risk profile and the risk management. In case of a very active trading book, a precise analysis of its risk/return is also done.
Some key ratios:
On asset quality, the amount of loan provision, compared to the total of the net loans, is meaningful. Variations from one year to another and concentrations of provisions have to be analysed carefully.
Operating efficiency, such as measured by the operating expenses compared to the total revenue, is also normally closely monitored by the banks, which determine long-term targets on that ratio.
In terms of off balance-sheet figures, the loan commitments compared to the total assets are also a useful ratio.
ROC (Return On Capital) and RAROC (Risk Adjusted Return On Capital)
What matters is not only the bank’s net profit, after all expenses and taxes, but also its actual return on capital invested and, when the calculation is possible, the return adjusted from the risks taken.
As for the ROC, investors and analysts expect that a specific industrial activity should generate a minimum ROC, considered as a benchmark. For instance, this level can be set at more than 10%. For Western banks, a higher figure (around 15%) has even be recently very often considered as a benchmark. It would be at least more than the risk free rate of an investment: why to put some capital, develop systems and have a huge staff if it is to have a return below the risk free rate (Government securities)?
The need to have a RAROC comes from the rules developed since the 1988 Cook ratio. Banks have to build-up a capital cushion to cover their weighted risks. Depending on the quality and maturity of the assets, the weights are more or less penalising. RAROC takes into account the return on capital adjusted from these types of risks. Normally, banks should integrate this risk weighting in the price of their products. That is why RAROC is today a better measure of the real profitability of a banking institution.
Analysis by product and operational units
All the above analysis should be run by major profit centres (branches, product lines). This is a way to have all these profit centres feeling fully responsible of the overall results of the banks, and being judged on a consistent basis.