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1、 33 CHAPTER 4 THE FINANCIAL STATEMENTS OF BANKS AND SOME OF THEIR CLOSEST COMPETITORS Goal of This Chapter:The purpose of this chapter is to acquaint the reader with the content,structure and purpose of bank financial statements and to help managers understand how information from bank financial sta
2、tements can be used as tools to reveal how well their banks are performing.Key Topics in this Chapter An Overview of Bank Balance Sheets and Income Statements The Banks Balance Sheet Bank Assets Bank Liabilities Recent Expansion of Off-Balance Sheet Items The Problem of Book-Value Accounting Compone
3、nts of the Income Statement Chapter Outline I.Introduction:The Statements We Will Review in This Chapter II.An Overview of Bank Balance Sheets and Income Statements A.Financial Inputs and Outputs on Bank Balance Sheets and Income Statements B.The Banks Balance Sheet(Report of Condition)1.The Princip
4、al Types of Accounts on a Banks Report of Condition 2.Bank Assets a.Cash and Due from Depository Institutions b.Investment Securities:The Liquid Portion c.Investment Securities:The Income-Generating Portion d.Trading Account Assets e.Federal Funds Sold and Securities Purchased under Resale Agreement
5、s f.Loans and Leases g.Loan Losses h.International Loan Reserves i.Unearned Discount Income j.Nonperforming(noncurrent)Loans k.Bank Premises and Fixed Assets l.Other Real Estate Owned(OREO)m.Goodwill and Other Intangible Assets n.All Other Assets 3.Bank Liabilities a.Deposits 34 b.Borrowings from No
6、ndeposit Sources c.Equity Capital Accounts 1.Preferred Stock 2.Common Equity 4.Comparative Balance-Sheet Ratios for Different Size Banks 5.Recent Expansion of Off-Balance-Sheet Items in Banking 6.The Problem of Book-Value Accounting in Banking C.Components of the Income Statement(Report of Income)1.
7、The Determinants of a Banks Net Income 2.Financial Flows and Stocks a.Interest Income b.Interest Expenses c.Net Interest Income d.Loan-Loss Expense e.Noninterest Income f.Noninterest Expenses g.Net Income 3.Comparative Income-Statement Ratios for Different-Size Banks D.Other Useful Bank Financial St
8、atements 1.The Funds-Flow Statement(Sources-and-Uses-of-Funds Statement)2.Statement of Stockholders Equity III.The Financial Statements of Leading Nonbank Financial Firms:A Comparison to Bank Statements IV.An Overview of Key features of Financial Statements and Their Consequences V.Summary of the Ch
9、apter Concept Checks 4-1.What are the principal accounts that appear on a banks balance sheet(or Report of Condition)?The principal asset items on a banks Report of Condition are loans,investments in marketable securities,cash,and miscellaneous assets.The principal liability items are deposits and n
10、ondeposit borrowings in the money market.Equity capital supplied by the stockholders rounds out the total sources of funds for a bank.4-2.Which accounts are most important and least important on the asset side of a banks balance sheet?The rank order of assets by dollar volume appearing on U.S.bank b
11、alance sheets are as follows:Rank Order Assets 1 Loans 35 2 Investment Securities 3 Cash 4 Miscellaneous Assets 4-3.What accounts are most important on the liability side of a banks balance sheet?The principal bank liability items from most important to least important are:Rank Order Liabilities and
12、 Equity Capital 1 Deposits 2 Nondeposit Borrowings 3 Equity Capital 4 Miscellaneous Liabilities 4-4.What are the essential differences between demand deposits,savings deposits,and time deposits?Demand deposits are regular checking accounts against which a customer can write checks or make any number
13、 of personal withdrawals.Regular checking accounts do not bear interest under current U.S.law and regulation.Savings deposits bear interest(normally,they carry the lowest rate paid on bank deposits)but may be withdrawn at will(though a bank usually will reserve the right to require advance notice of
14、 a planned withdrawal).Time deposits carry a fixed maturity and the bank may impose a penalty if the customer withdraws funds before the maturity date is reached.The interest rate posted on time deposits is negotiated between the bank and its deposit customer and may be either fixed or floating.A NO
15、W account combines features of a savings account and a checking account,while a money market deposit account encompasses transactional powers similar to a regular checking account(though usually with limitations on the number of checks or drafts that may be written against the account)but also resem
16、bles a time deposit with an interest rate fixed for a brief period(such as weekly)but then becomes changeable over longer periods to reflect current market conditions.4-5.What are primary and secondary reserves and what are they supposed to do?Primary reserves consist of cash,including a banks vault
17、 cash and checkable deposits held with other banks or any other funds that are accessible immediately to meet demands for liquidity made against the bank.Secondary reserves consist of assets that pay some interest(though usually pay returns that are much lower than earned on other assets,such as loa
18、ns)but their principal feature is ready marketability.Both primary and secondary reserves are held to keep the bank in readiness to meet demands for cash(liquidity)from whatever source those demands may arise.4-6.Suppose that a bank holds cash in its vault of$1.4 million,short-term government securi
19、ties of$12.4 million,privately issued money market instruments of$5.2 million,deposits at the Federal Reserve banks of$20.1 million,cash items in the process of collection of$0.6 million,and deposits placed with other banks of$16.4 million.How much in primary reserves does this bank hold?In secondar
20、y reserves?36 The bank holds primary reserves of:Vault Cash+Deposits at the Fed+Cash Items in Collection+Deposits With Other Banks =$1.4 mill.+$20.1 mill.+$0.6 mill.+$16.4 mill.=$38.5 million The bank has secondary reserves of:Short-term Government Securities+Private Money-Market Instruments =$12.4
21、mill.+$5.2 mill.=$17.6 million 4-7.What are off-balance-sheet items and why are they important to some banks and other financial firms?Off-balance-sheet items are usually transactions that generate fee income for a bank(such as standby credit guarantees)or help hedge against risk(such as financial f
22、utures contracts).They are important as a supplement to income from loans and to help a bank reduce its exposure to interest-rate risk.4-8.Why are bank accounting practices under attack right now?In what ways could banks and similar financial institutions improve their accounting methods?The traditi
23、onal practice of banks has been to record the value of assets and liabilities at their value on the day the accounts were originally created and not changing those values over the life of the account.The SEC and FASB started questioning this practice in the 1980s because they were concerned that inv
24、estors on bank securities would be misled about the true value of the bank.Using this historical value accounting method may in fact conceal a bank that is insolvent in a current market value sense.The biggest controversy centered on the banks investment portfolio which would appear to be easy to va
25、lue at its current market price.At a minimum,banks could help themselves by marking their investment portfolio to market.This would give investors an indication of the true value of the banks investment portfolio.Banks could also consider using the lower of historical or market value for other accou
26、nts on the balance sheet.4-9.What accounts make up the Report of Income(income statement)of a bank?The Report of Income includes all sources of bank revenue(loan income,investment security income,revenue from deposit service fees,trust fees,and miscellaneous service income)and all bank expenses(incl
27、uding interest on all borrowed funds,salaries,wages,and employee benefits,overhead costs,loan-loss expense,taxes,and miscellaneous operating costs.)The difference between operating revenues and expenses(including tax obligations)is referred to as net income.37 4-10.In rank order what are the most im
28、portant revenue and expense items on a banks Report of Income?By dollar volume in most recent years the rank order of the revenue and expense items on a banks Report of Income is:Rank Order Revenue Items Expense Items 1 Loan Income Deposit Interest 2 Security Income Interest on Nondeposit Borrowings
29、 3 Service Charges on Deposits Salaries,Wages,and and Other Deposit Fees Employee Benefits 4 Other Operating Revenues Miscellaneous Expenses 4-11.What is the relationship between the Provision for Loan Losses on a banks Report of Income and the Allowance for Loan Losses on its Report of Condition?Gr
30、oss loans equal the total of all loans currently outstanding that are recorded on the banks books.Net loans are equal to gross loans less any interest income on loans already collected by the bank but not yet earned and also less the allowance for loan-loss account(or bad-debt reserve).The allowance
31、 for loan losses is built up gradually over time by an annual noncash expense item that is charged against the banks current income,known as the Provision for Loan Losses.The dollar amount of the annual loan-loss provision plus the amount of recovered funds from any loans previously declared worthle
32、ss(charged off)less any loans charged off as worthless in the current period is added to the allowance-for-loan-losses account.If current charge-offs of worthless loans exceed the annual loan-loss provision plus any recoveries on previously charged-off loans the annual net figure becomes negative an
33、d is subtracted from the allowance-for-loan-losses account.4-12.Suppose a bank has an allowance for loan losses of$1.25 million at the beginning of the year,charges current income for a$250,000 provision for loan losses,charges off worthless loans of$150,000,and recovers$50,000 on loans previously c
34、harged off.What will be the balance in the banks allowance for loan losses at year-end?The balance in the allowance for loan loss(ALL)account at year end will be:Beginning ALL =$1.25 million Plus:Annual Provision for Loan Losses =+0.25 Recoveries on Loans Previously =+0.05 Charged Off Minus:Charge O
35、ffs of Worthless =-0.15 Loans Ending ALL =$1.40 million 38 4-13.What types of information does a Funds-Flow or Sources-and-Uses-of-Funds Statement provide?A banks sources-and-uses-of-funds statement captures changes in its assets and liability items as well as income from bank operations.It shows wh
36、ere the bank has raised its operating funds over a given period of time and how those funds were allocated over that same time period.Generally,increases in any liability item(such as deposits)represent a source of funds,while increases in any asset item are uses of funds.4-14.What does the Statemen
37、t of Stockholders Equity reveal about how well a bank is being managed and what stresses it is under?The Statement of Stockholders Equity Capital reflects any changes that have occurred in a banks equity capital account.The most common items causing changes in a banks equity capital account include
38、the proportion of current profits(net after-tax income)retained in the bank(which,if positive,increases equity capital or,if negative,decreases equity)and changes in the number of shares of stock outstanding.If more stock is sold,the equity capital account increases.4-15.Suppose a bank has an initia
39、l balance in its capital account of$26 million,receives net income during the year of$3 million,pays out stockholder dividends of$2 million,and issues$1 million in new stock during the year.What balance remained in the banks capital account at the end of the year?The balance in the banks capital acc
40、ount at year end will be:Beginning Capital Account Balance =$26 million Plus:Net Income During Year =+3 New Shares of Stock Issues =+1 Less:Stockholders Dividends =-2 Ending Capital Account Balance =$28 million.4-16.Who are bankings chief competitors in the financial-services marketplace and how do
41、their financial statements resemble or differ from bank financial statements?Why do these similarities and differences exist?What major trend is changing the content of bank and nonbank financial statements?The main competitors in the financial services marketplace are thrift institutions like credi
42、t unions and savings associations and financial services firms such as finance companies,insurance companies and mutual funds.Their financial statements increasingly resemble bank financial statements.Among the common features are the heavy use of leverage,the dominance of financial assets over real
43、 assets and the concentration of revenues from making loans and assisting 39 businesses in selling their securities.Due to the increasing similarities in the products that banks and their non-bank competitors offer the resemblance in the makeup of the financial statements does not come as a surprise
44、.Problems 4-1.The missing items from the Report of Condition and Report of Income of Evergreen National Bank are given below:Report of Condition Items Cash and deposits due from Banks$27(550-43-18-10-348-11-6-87=27)Gross Loans 373 (348+6+19=373)Savings Deposits and NOW Accounts 36(440-21-227-49-107=
45、36)Stockholders Equity Capital 50(550-440-41-19=50)Report of Income Items Interest and Fees on Loans$168(180-5-7=168)Service Charges on Customer Deposits 11(39-20-8=11)Wages,Salaries,and Employee Benefits 42(54-5-7=42)Net Interest Income 21(180-159=21)Net Noninterest Income-15(39-54=-15)Net Income A
46、fter Taxes 0(180+39-159-54-4-2=0)4-2.The items requiring calculation and their dollar amounts are:Net Interest Income=Total Interest Income-Total Interest Expense=$271-$205=$66 Net Noninterest Income=Total Noninterest Income-Total Noninterest Expense=$23-$40=-$17 Total Operating Revenues=Total Inter
47、est Income+Total Noninterest Income=$271+$23=$294 Total Operating Expense=Total Interest Expenses+Total Noninterest Expenses+Provision for Loan Loss 40 =$205+$40+$13=$258 Net Income Before Taxes=Total Operating Revenues-Total Operating Expenses=$294-$258=$36 Net Income After Taxes=Net Income Before
48、Taxes-Income Taxes=$36-$5=$31 Increase in Banks Undivided Profits=Net Income After Taxes-Common Dividends=$31-$11=$20 4-3.The items requiring calculation and the dollar figures required are:a.Total Assets=total liabilities+Total Equity capital Total Assets=380+49=429 b.Net Loans=Gross loans (Allowan
49、ce for loan losses+Unearned income on loans)Net Loans=294 (13+5)=276 c.undivided profits=Total Equity capital (perpetual preferred stock +Common stock+Surplus)undivided profits=49 (3+12+19)=15 d.total deposits=Non-Interest Demand Deposits+NOW accounts+Savings Deposit+Money Market Deposits+Time Depos
50、its=270 total deposits=0+10+12+88+160=270 e.demand deposits=Non-Interest Demand Deposits+NOW accounts+Savings Deposit demand deposits=0+10+12=22 f.depreciation=Bank Premises&equipment,gross-Bank Premises&equipment,net depreciation=34 29=5 g.investment securities=Total Assets (Cash and due from banks