Financial Reporting 1

Analysis
 Ratio Analysis of Banks
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What is Bank?
 A bank is a financial institution licensed to receive deposits and make loans.
Banks may also provide financial services such as currency exchange and safe
deposit boxes
Who Provide the License to Bank?
 Government Authority
 In case of Pakistan, State Bank of Pakistan has the authority to regulate the banks
 Ratio Analysis of Banks
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History of Banking System?
 Banking has been around since the first currencies were introduced and wealthy people
wanted a safe place to store their money.
 Ancient empires also needed a functional financial system to facilitate trade, distribute
wealth, and collect taxes. Banks were to play a major role in that, just as they do today.
 Ratio Analysis of Banks
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History of Banking System?
 Religious temples became the earliest banks because they were seen as a safe
place to store money.
 Before long, temples also got into the business of lending money, much like
modern banks.
 Based on the theories of economist Adam Smith, some 18th century
governments gave banks a relatively free hand to operate as they pleased.
 However, numerous financial crises and bank panics over the decades eventually
led to increased regulation
 Ratio Analysis of Banks
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Important Fact
 "Banca Monte Dei Paschi di Siena” is the oldest surviving bank in the world.
 It was founded in 1472 in the Siena, Italy, which at the time was a republic.
 Ratio Analysis of Banks
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Deposits of Banks
 Bank deposits consist of money placed into banking institutions for safekeeping.
 These deposits are made to deposit accounts such as current accounts and savings
accounts
 The account holder has the right to withdraw deposited funds, as set forth in the terms
and conditions governing the account agreement.
Loans of Banks
 A bank loan is when a bank offers to lend money to consumers for a certain time period.
 As a condition of the bank loan, the borrower will need to pay a certain amount of
interest per month, or per year.
 Ratio Analysis of Banks
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Assets of Banks
 The asset portion of a bank's capital includes cash, government securities, and interest-
earning loans.
Total Capital
 Bank capital is the difference between a bank's assets and its liabilities, and it
represents the net worth of the bank or its equity value to investors.
 Ratio Analysis of Banks
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Interest margin
 Interest Margin = Interest income - Interest expenses
 In finance, net interest margin is a measure of the difference between interest paid and
interest received, adjusted for the total amount of interest-generating assets held by the
bank.
 Interest Income
 Interest income is the amount paid to an entity for lending its money or letting another
entity use its funds. 
 On a larger scale, interest income is the amount earned by an investor's money that he
places in an investment or project.
 Ratio Analysis of Banks
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 Interest Expense
 An interest expense is the cost incurred by an entity for borrowed funds.
 It represents interest payable on any borrowings such as bonds, loans
 Ratio Analysis of Banks
Main Ratios 10
Loans to Total Deposits
 Loans to Total Deposits = Loans/ Total Deposits *100
 The loan-to-deposit ratio (LDR) is used to assess a bank's liquidity by comparing a
bank's total loans to its total deposits for the same period.
 The LDR is expressed as a percentage.
 If the ratio is too high, it means that the bank may not have enough liquidity to cover
any unforeseen fund requirements.
 Conversely, if the ratio is too low, the bank may not be earning as much as it could be.
 Ratio Analysis of Banks
Main Ratios 11
Loans to Total Deposits
 Loans to Total Deposits = Loans/ Total Deposits *100
 If the loan to deposit ratio is 60 percent, it means bank is giving 60 percent loan to its
customers (who need money) out of 100 percent deposits from customers (who put
savings in banks).
 A loan-to-deposit ratio shows a bank's ability to cover loan losses and withdrawals by
its customers. 
 Investors monitor the LDR of banks to make sure there's adequate liquidity to cover
loans in the event of an economic downturn resulting in loan defaults.
 Ratio Analysis of Banks
Main Ratios 12
 Capital funds to total assets
 Capital funds to total assets = Capital funds/Total assets *100
 A low “Capital funds to total assets ratio” means that the company primarily used debt
to acquire assets, which is widely viewed as an indication of greater financial risk. 
 “Capital funds to total assets ratio” with higher value generally indicate that a
company’s effectively funded its asset requirements with a minimal amount of debt.
 Interest margin to average total assets 13

 Formula = Interest margin/average total assets *100

 The net margin measures how successful an investment manager or company is at
making investment decisions or investing its resources.
 If this ratio is a negative figure, then it indicates that the firm or company has not
been made effective investment decisions. In other words, the company lost money
on its investments and “earned” a negative margin.
 A positive figure, on the other hand, means that the investment decisions were
successful and the fund manager or the company was profitable.
 Total Deposits Times Capital 14

 Total Deposit Times Capital = Average Total Deposit/Average Total Capital

 To some extent, it is a type of debt/equity ratio, indicating a bank’s debt
position.
 Like the debt-to-equity ratio, the debt-to-capital ratio indicates the amount of
debt possessed by a bank concerning its total capital.
 This ratio is usually higher for a bank because of its operations, creating
higher exposure to loans
 Although a very high D/E ratio is generally undesirable, banks tend to have a
high debt-to-equity because they carry huge amounts of debt on their balance
sheet.
Foundations of Ratio and Financial Analysis
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Long-term debt and solvency analysis
 Loans to Total Deposits 16
 Loans to Total Deposits = Loans/ Total Deposits *100
 2010
 Loans to Total Deposits = 13,200,000/20,000,000 *100 = 0.66 *100 = 66%
 Interpretation: In 2010, the “McEttrick” bank issued loan of 66% out of its deposit of
100 percent. It means “McEttrick” has still 34% deposit to meet sudden economic crisis
or sudden withdrawal. The ratio between 60 to 75 percent is considered reasonable.
 2011
 Loans to Total Deposits = 16,000,000 / 24,000,000 *100 = 0.66 *100 = 66.66%
 Interpretation: In 2011, the “Loans to Total Deposits ratio” of “McEttrick” bank
further increased to 66.66%. It means in 2011, “McEttrick” bank still maintain healthy
loans to deposit ratio
 Total Deposit Times Capital 17

 Total Deposit Times Capital = Average Total Deposit/Average Total Capital

 2010
 Total Deposit Times Capital = 20,000,000/1,600,000 = 12.50 times
Interpretation = In 2010, the amount of deposit or debt was 12.50 times as compared to
amount of capital (equity). Although this ratio generally considered higher and risky,
it is not cause of concern because banks takes a lot of deposit (debt)
 2011
 Total Deposit Times Capital = 24,000,000/1,850,000 = 12.97 times
Interpretation = In 2011, the “Total Deposit Times Capital” ratio further increased to
12.97 time. It indicates the increased dependency of “McEttrick” bank on debt.
 Capital funds to total assets 18
 Capital funds to total assets = Capital funds/Total assets *100
 2010
 Capital funds to total assets = 1,600,000/22,000,000 *100 = 0.0727 *100 = 7.27%
 Interpretation = 7.27% of “McEttrick” bank total assets are financed through equity capital.
It shows that “McEttrick” bank has less reliance on equity capital and more of its assets are
finance through debt
 2011
 Capital funds to total assets = 1,850,000/ 26,000,000 *100 = 0.071 *100 = 7.1%
 Interpretation = In 2011, the dependency of “McEttrick” bank on equity capital further
decreased to 7.1%
 Interest margin to average total assets 19
 Interest margin to average total assets = Interest margin/average total assets *100
o Interest Margin = Interest income - Interest expenses
 2010
 Interest margin to average total assets = Interest margin/average total assets *100
 Interest Margin = Interest income - Interest expenses
 Interest Margin = 1,650,000 - 1,512,250 = 137750
 Interest margin to average total assets = 137750 / 22,000,000 *100 = 0.0062 *100 = 0.62%
 Interpretation = The value of this ratio should be positive. More the positive value means the
investment decisions were successful. 0.62 percent means the “McEttrick” bank earned 0.62
percent (In shape of interest) on its assets.
 Interest margin to average total assets 20

 Interest margin to average total assets = Interest margin/average total assets *100
o Interest Margin = Interest income - Interest expenses
 2011
 Interest margin to average total assets = Interest margin/average total assets *100
 Interest Margin = Interest income - Interest expenses
 Interest Margin = 1,750,000 - 1,615,000 = 135000
 Interest margin to average total assets = Interest margin/average total assets *100
 Interest margin to average total assets = 135000/26,000,000 *100 = 0.0051*100 = 0.5192%
 Interpretation = In 2011, the ratio of “Interest margin to average total assets” reduced to 0.5192%. It
means year 2011 proved to be less profitable for “McEttrick” bank (In terms of interest income) as
compared to year 2010