Chapter
INTRODUCTION
1
The purpose of this chapter is to acquaint the reader with the
concept of bank fund management and also the content, structure
and purpose of bank financial statements and to help bank managers
understand how information from bank financial statements can be
used as tools to reveal how well their banks are performing.
Copyright © 2002 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
❑ An Overview of Bank Fund Management
❑ Sources and Uses of Bank Fund
❑ Bank’s Balance Sheet Identity
❑ Off-Balance Sheet Activities
❑ Income Statement
❑ Fund Flow Statement and
❑ Comparison of Different Sources of Bank Fund.
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Bank Fund
◼ The amount of money in the bank is recorded on the
right side or liabilities of the bank balance sheet.
◼ The money is a fund for banks because the money is
used to finance bank products and activities.
◼ Bank funds in the form of bank profits, paid up capital
by bank owners, public deposits and bank provide
these funds as loans to other parties.
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Bank Fund
◼ According to the source, bank funds are divided into
two:
◼ Funds originating from within a bank
◼ Known as First party fund: owner’s own deposit/capital
◼ Funds originating from outside the bank:
◼ Second party funds: interbank loans
◼ Third party funds: public savings/deposits
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Bank Fund Management
◼ In narrow sense, Bank Fund Management is a series of bank
activities in raising funds which include:
◼ Plans for raising funds
◼ Organization of raising funds
◼ Carrying out fund raising
◼ Supervising fund raising
◼ But do not include the use, investment and placement of funds
and
◼ Do not take into account the profit and loss after the funds are
collected.
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Bank Fund Management
◼ In broader sense, Bank Fund Management is a series of bank
activities in collecting funds which include:
◼ Plans for raising funds
◼ Organization of raising funds
◼ Carrying out fund raising
◼ Supervising fund raising
◼ Planning the use or placement of funds and
◼ Investing bank funds that have been collected so that the bank can
form the expected profit plan including planning for public funds
refund if requested in accordance with the time period.
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How To Collect Bank Fund?
◼ Passive ways, namely how to raise funds without any
activities that encourage people to save their funds.
Effort in the form of promotion, advertence and appeal.
◼ The active way, namely the way of raising funds
preceded by certain activities by banks that specifically
direct the public to save their funds in the bank.
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Bank Financial Statements
◼ Report of Condition – Balance Sheet
◼ Report of Income – Income Statement
◼ Sources and Uses of Funds Statement – Fund Flow
Statement
◼ Statement of Stockholders’ Equity
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Report of Condition
The Balance Sheet of a Bank Showing its
Assets, Liabilities and Net Worth
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C + S + L + MA = D + NDB + CA
C = Cash Assets
S = Security Holdings
L = Loans
MA = Miscellaneous Assets
D = Deposits
NDB = Non-deposit Borrowings
CA = Capital Accounts
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Cash Assets
◼ Account is Called Cash and Deposits Due from Bank
◼ Includes:
◼ Vault Cash
◼ Deposits with Other Banks
◼ Cash Items in Process of Collection
◼ Reserve Account with the Federal Reserve
◼ Sometimes Called Primary Reserves
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Security Holdings
◼ Investment Securities – Secondary Reserves
◼ Investment Securities – Income Generating
◼ Taxable Securities - government bonds and notes,
securities issued by various federal agencies, and
corporate bonds and notes.
◼ Non-taxable Securities - state and local government
(municipal) bonds.
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Security Holdings
◼ TradingAccount Securities-provide short term profits
from short term price movements.
◼ Held for Resale Only
◼ Valued at Market Value
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Loan Accounts
◼ GrossLoans – Sum of All Loans
◼ Allowance for Possible Loan Losses
◼ SpecificReserve
◼ General Reserve
◼ NetLoans
◼ Nonperforming Loans
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Types of Loans
◼ Commercial and Industrial Loans
◼ Consumer Loans
◼ Real Estate Loans
◼ Financial Institution Loans
◼ Foreign Loans
◼ Agriculture Production Loans
◼ Security Loans
◼ Leases
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Miscellaneous Assets
◼ Unearned Income
◼ Net Premises and Equipment
◼ Other Real Estate Owned (OREO)
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Deposit Accounts
◼ Noninterest-Bearing Demand Deposits
◼ Savings
Deposits
◼ NOW (Negotiable Order of Withdrawal) Accounts
◼ It
is an interest-bearing demand deposit
◼ The bank retain the right to require 7 days advance
written notice.
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Deposit Accounts
◼ Money Market Deposit Accounts (MMDA)
◼A money market deposit account (MMDA) is a type of
savings account that offers higher interest rates than a
traditional savings account, with some checking account
features like check-writing privileges and a debit card.
However, MMDAs typically have higher minimum
balance requirements and may impose restrictions on
withdrawals to avoid fees.
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Deposit Accounts
◼ Time Deposits
◼ Key Characteristics
◼ Fixed Term: Money is deposited for a specified duration, such as
months or years.
◼ Maturity Date: There is a predetermined date when the deposit and its
accumulated interest become available to the depositor.
◼ Higher Interest Rates: Time deposits typically offer higher, fixed
interest rates than savings accounts.
◼ Limited Access: Funds cannot be withdrawn at any time without
penalty.
◼ Penalty for Early Withdrawal: If funds are withdrawn before the
maturity date, a penalty or forfeiture of interest may apply.
◼ No Extra Deposits: Typically, you cannot make additional deposits
into a time deposit account after the initial placement.
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Non-deposit Borrowings
◼ Fed Funds Purchased
◼ Banks lend and borrow reserves from each other, usually
for periods of 24 hours, to meet their reserve
requirements.
◼ Securities
Sold Under Agreement to Repurchase
(Repurchase Agreements)
◼ This is a short-term borrowing method where a financial
institution sells securities with an agreement to buy them
back at a later date at a slightly higher price.
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Non-deposit Borrowings
◼ Borrowing from Central Bank
◼ Banks can borrow funds directly from their central bank,
such as the Federal Reserve.
◼ Commercial Paper (CP)
◼ Thisis a short-term, unsecured debt instrument issued by
large corporations and financial institutions to finance
short-term needs.
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Non-deposit Borrowings
◼ Eurocurrency Borrowings
◼ Bankscan obtain funds by borrowing in foreign currency
markets, often called the Eurocurrency deposit market.
◼ Long-term Debt
◼ Banks can also issue longer-term debt instruments like
capital notes or bonds to raise longer-term funds.
◼ Subordinated Debt (Notes and Debentures)
◼ Thiscategory includes limited-life preferred stock
◼ noncollateralized borrowings.
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Capital Accounts
◼ Common Stock
◼ Every new financial firm begins with a minimum amount of
owners' capital.
◼ Their equity (owners’) capital accounts normally represent
less than 10 percent of the value of their total assets.
◼ Common Stock Outstanding
◼ total par (face) value issued
◼ Capital Surplus
◼ When that stock is sold for more than its par value, the excess
market value of the stock flows into a surplus account.
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Capital Accounts
◼ Retained Earnings (Undivided Profits)
◼ the largest item in the capital account
◼ represent accumulated net income left over each year after
payment of stockholder dividends.
◼ Treasury Stock
◼ Treasury stock refers to shares of a company's own stock that it
has reacquired from the open market, which are then held by the
company rather than being outstanding or available for public
trading. These repurchased shares reduce the total number of
shares on the market.
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Capital Accounts
◼ Contingency Reserve
◼ held as protection against unforeseen losses
◼ Preferred Stock-Perpetual
◼ Unlimited life like common stock
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Report of Condition (Balance Sheet) for BB&T
(Year-End 2008 and 2009)
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Sources and Uses of Bank Fund
◼ Sources of Funds
◼ Liabilities & Equity side of balance sheet (D + NDB + EC)
◼ Deposits (Demand, NOW, money market, savings and time) (D)
◼ Non-deposit borrowings (NDB)
◼ Equity capital from shareholders (stock, surplus, and retained
earnings) (EC)
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Sources and Uses of Bank Fund
◼ Uses of Funds
◼ Assets side of balance sheet (C + S + L + MA)
◼ Cash and deposits in other institutions (Primary Reserves) (C)
◼ Securities to provide liquidity (Secondary Reserves) and for
investment (the income-generating portion) (S)
◼ Loans and leases (L)
◼ Miscellaneous assets (buildings, equipment etc.) (MA)
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Sources and Uses of Bank Fund
◼ One useful way to view the balance sheet identity is to note
that liabilities and equity capital represent accumulated
sources of funds, which provide the needed spending power
to acquire assets.
◼ A bank's assets, on the other hand, are its accumulated uses of
funds, which are made to generate income for its
stockholders, pay interest to its depositors, and compensate
its employees for their labour and skill. Thus, the balance
sheet identity can be pictured simply as:
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Sources and Uses of Bank Fund
Accumulated uses of funds = Accumulated sources of funds
(Assets) (Liabilities and equity capital)
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Off-Balance-Sheet Items
◼ Off-balance sheet (OBS) items are financial assets,
liabilities, or commitments not shown on a company's
balance sheet but are still part of its financial picture.
◼ Some Off-balance sheet (OBS) items are:
◼ Unused Loan Commitments
◼ A lender receives a fee to lend up to a certain amount of
money over a defined period of time.
◼ However, these funds have not yet been transferred from
lender to borrower.
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Off-Balance-Sheet Items
◼ Standby Credit Agreements
◼ A financial firm receives a fee to guarantee repayment of a
loan that a customer has received from another lender.
◼ Derivative Contracts
◼ A financial institution has the potential to make a profit or
incur a loss on an asset that it presently does not own.
◼ This category includes:
◼ Futures Contracts
◼ Options and
◼ Swaps
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Off-Balance-Sheet Items
◼ These derivative contracts can be used to hedge:
◼ Credit risk
◼ Interest rate risk
◼ Foreign exchange (currency) risk
◼ Commodity risk, and
◼ Risk surrounding the ownership of equity securities.
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Off-Balance-Sheet Items
◼ Examples of Derivatives:
◼ Notional Amount of Credit Derivatives
◼Bank is Guarantor
◼ Bank is Beneficiary
◼ Interest rate contracts (i.e., interest-rate swaps, futures,
options)
◼ Foreign exchange rate contracts (i.e., currency swaps,
commitments to purchase, and currency options)
◼ Contracts on other commodities and equities (i.e., other
swaps, futures, and options on commodities and equities)
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Report of Income
The Statement of Revenues, Expenses and
Profits for a Bank
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Net Income
◼ Net Income = Total Revenue items – Total Expense items
◼ Total Revenue Items:
◼ Cash assets × Average yield on cash assets
◼ Security investments × Average yield on security investments
◼ Loans outstanding × Average yield on loans
◼ Miscellaneous assets × Average yield on miscellaneous assets
◼ Income from fees and trading account gains
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Net Income
◼ Total Expense items:
◼ Total deposits × Average interest cost on deposits
◼ Non-deposit borrowings × Average interest cost on non-deposit
borrowings
◼ Owners' capital × Average cost of owners' capital
◼ Employee salaries, wages, and benefits expense
◼ Overhead expense
◼ Provision for possible loan losses
◼ Miscellaneous expenses
◼ Taxes owed
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Net Interest Income =
Interest Income – Interest Expenses
Interest Income Interest Expenses
◼ Interest and fees on loans ◼ Deposit interest costs
◼ Taxable securities revenue ◼ Interest on short-term debt
◼ Tax-exempt securities revenue ◼ Interest on long-term debt
◼ Other interest income
**Net Interest Income is often referred to as the
Interest Margin.
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Provisions for Possible Loan Loss (PLL)
◼ This provision is a non-cash expense.
◼ Its purpose is to shelter a portion of current earnings from
taxes to help prepare for bad loans.
◼ Calculation methods of Loan Loss Deduction:
◼ Experience Method
◼ Specific Charge-Off Method
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Net Non-interest Income =
Non-interest Income – Non-interest Expenses
Non-interest Income Non-interest Expenses
◼ Service Charges on Customers ◼ Wages and Salaries
Deposits ◼ Other Personnel Expenses
◼ Online banking charge ◼ Premises & Equipment
◼ Fees on different card related Expense
services ◼ Small Expense Items (legal
◼ Commission on A-Challan, fees, office supplies, and repair
Savings certificate, Pay order, costs)
Bank draft issue ◼ Other Operating Expenses
◼ Trust Department Income
◼ Other Operating Income
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Income Statement
Net Interest Income
(-) Provision for Loan and Lease Losses
(+/-) Net Non-interest Income
Net Income Before Tax
(-) Taxes
Net Income
(-) Dividends
Undivided Profits
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Report of Income (Income Statement) for BB&T
(2008 and 2009)
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Income Statement (Example)
◼ Given,
Interest Income = Tk. 8,192
Interest Expenses = Tk. 6,024
Non-Interest Income = Tk. 1,888
Non-Interest Expense = Tk. 1,188
Provision for Loans & Lease Losses = Tk. 519
Provision for Tax (Including Deferred Tax) = 45%
Profit after Tax (Net Income) = ?
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Income Statement (Math Problem)
◼ Answer:
Net Interest Income = Interest Income - Interest Expenses
= (8,192 - 6,024)
= Tk. 2,168
Net Non-Interest Income = Non-Interest Income - Non-Interest Expense
= (1,888 - 1,188)
= Tk. 700
Net Income Before Tax = Net Interest Income + Net Non-Interest
Income - Provision for Loans & Lease Losses
= (2,168 + 700 - 519)
= Tk. 2,349
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Income Statement (Math Problem)
Tax Amount = Net Income Before Tax × Tax Rate
= 2,349 × 45%
= Tk. 1,057
So, Profit after Tax (Net income) = Net Income Before Tax - Tax
= (2,349 - 1,057)
= Tk. 1,292
(Ans.)
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Fund-Flow Statement
◼ Also Known as the Sources and Uses of Funds Statement
◼ A fund flow statement is a statement that compares the
two balance sheets by analysing the sources of funds (debt
and equity capital) and the application of funds (assets)
and its reasons for any differences.
◼ These statements portray the flow of funds - or the
sources and applications of funds over a particular period.
◼ It asks Two Questions
◼ Question-1: Where did the funds come from?
◼ Question-2: How were those funds used?
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Fund-Flow Statement
◼ Answer to the Q-1
◼ Funds provided to the banks over a specific period
of time (sources of fund):
◼ Net Income
◼ Noncash Expenses
◼ Decrease in Assets
◼ Increase in Liabilities
◼ Increase in Capital Accounts
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Fund-Flow Statement
◼ Answer to the Q-2
◼ Funds used by the banks over a specific period of
time (uses of fund):
◼ Net Loss
◼ Dividends
◼ Increase in Assets
◼ Decrease in Liabilities
◼ Decrease in Capital Accounts
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Statement of Stockholders’ Equity
Report Showing the Changes in the Make
Up of the Bank’s Capital Account
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Statement of Stockholders’ Equity
Beginning Capital Account Balance
(+/-) Net Income (Loss) for Period
(-) Preferred Stock Dividends
(-) Common Stock Dividends
(+) New Shares of Stock Issued
(-) Purchases of Treasury Stock
= Ending Capital Account Balance
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Statement of Stockholders’ Equity
Stockholders' equity = Total Asset (TA) – Total Liability (TL)
Stockholders' equity = Share Capital + RE – Treasury Shares
◼ Example
Assume a company has $500,000 in ending stockholders' equity,
issued $100,000 in stock, purchased $20,000 in treasury stock,
earned $200,000 in net income and paid $30,000 in cash dividends
during the year. Find out the beginning stockholders' equity.
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Statement of Stockholders’ Equity
◼ Answer:
Ending stockholders' equity = Beginning stockholders' equity + Net
income - Cash dividends + New shares
of stock issued - Purchases in treasury
stock
Beginning stockholders' equity = Ending stockholders' equity - Net
income + Cash dividends - New shares
of stock issued + Purchases in treasury
stock
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Statement of Stockholders’ Equity
= 500,000 - 200,000 + 30,000 - 100,000 + 20,000
= $250,000
So, the Beginning stockholders' equity was $250,000.
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Comparison of Different Sources of Bank Fund
◼ Deposit:
◼ Meaning: Funds collected from the public, customers, or
institutions, repayable on demand or after a fixed time.
◼ Examples: Savings deposits, Current deposits, Fixed deposits,
Recurring deposits.
◼ Source: Public/customers.
◼ Repayment: On demand/maturity.
◼ Nature: Primary liability of banks and financial institutions.
◼ Cost: Generally, carries interest (except current deposits).
◼ Role: Main liability/funding.
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Comparison of Different Sources of Bank Fund
◼ Non-Deposit Borrowings:
◼ Meaning: Funds raised by banks/financial institutions from
sources other than public deposits.
◼ Examples: Borrowings from the central bank, Inter-bank
borrowings, Borrowings from financial institutions (e.g., bonds,
debentures, commercial papers, term loans)
◼ Source: Central bank, other banks, financial markets.
◼ Repayment: As per borrowing terms.
◼ Nature: Secondary source of funds, used when deposits are
insufficient or for liquidity management.
◼ Cost: Usually higher than deposits, depends on market rates.
◼ Role: Supplementary funding.
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Comparison of Different Sources of Bank Fund
◼ Capital:
◼ Meaning: Owners’ funds or shareholders’ contribution, plus
retained earnings. It represents the bank’s net worth.
◼ Examples: Equity capital (shareholders’ funds), Preference
capital, Reserves and surplus (retained earnings).
◼ Source: Owners/shareholders.
◼ Repayment: Not repayable (permanent).
◼ Nature: Permanent source of funds, not repayable like
deposits/borrowings.
◼ Cost: Dividend (depends on profits).
◼ Role: Financial strength & loss-absorbing buffer.
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