FINM3006 w3 (1,2)

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Off balance sheet activities- We've mainly talked about on balance sheet but there is heightened importance of off-balance sheet items. a lot of the banking business especially today occurs off balance sheet. it doesn't have to be recorded on the balance sheet because there are only contingent liabilities and assets (if contingent event occurs, this is value of asset/liability-> think insurance)Adjustments had to be made to regulations when they realised the extent of off balance sheet activities. One is trading of derivatives e.g. NAB made losses on FOreign exchange trading and wasn't part of their regular trading book

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The financial statements of banksNumber of reasons why reports are important- We should be able to read and write an analysis report and make it coherent. WHO uses the information? Analysts, decision makers, financial media, academics and regulatorsBank Financial Statements- Capital requirements by regulators (how much equity held relative to asset base)Liquidity requirements by regulators (short term securities, liquidity securities, liquidity coverage ratio Financial ratios (leverage requirements) used by regulators and investors- profitability of a bank

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Report of Condition- AssetsReport of Condition- LIabilitiesEquity also known as owner's equity, capital.acts as a buffer If house values fall then loan values fall and something must fall for the equation to hold so equity goes first (premium because you're first to experience losses

Loan Accounts- The 'loan loss allowance account' contra asset account. A percentage of loans will default. This is due to credit risk. If banks can predict credit risk then they can predict credit loss. Provisioning by bank impacts current income. So if you look at ratios like return on equity (net profit/equity) net profit changes for a bunch of reason one of which includes the level of provisioning Allowance for loan losses: Beginning ALL+ Provision for loan loss (income statement)=adjusted allowance for loan losses- actual charge-offs+recoveries from previous charge-offs= ending allowance for loan lossesNon-performing loans are loans greater than 90 days past due Off balance-sheet items Largely split into two groups 'derivative activity' (classed into exchange traded and over the counter, the key difference of which is counter party risk which exists in OTC but in exchange, in case of default, exchange will pay) and 'liquidity support facilities' Notional values are attached to contingent liabilities 'how much it would be worth if some even occurred' 

During a crisis, supply of credit shrinks, corporations in the US had multiple line of credits with multiple banks so corporations tried to draw line of credits (to get funding) but banks had so many commitments that they couldn't fulfil-> example of credit risk. until you draw line of credit it won't appear on banks balance sheet but does generate revenue

Standby letter of credit-> guy can't pay him until he sells the shoes so usually there is information asymmetry and transaction can't occur. The payment might be promised in 60 days but the guy wants the shoes today and so unless A knows B really well they may not want to pursue transaction. So B would ask for letter of credit 'in event that B defaults, this guy will pay A' so B pays bank fee for letter of credit and gives A letter of credit

THe Volcker rule- things to come out post current crisis and prohibits propriety trading. prohibits banks trading with their own money, most of banks trade in is derivatives and obviously the off balance sheet items will shrink. Moving forward we should see a trend int he size of derivative transactions. So it won't go to zero but the fall in trading would lead to a reduction of the off-balnace sheet items

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Report of income- Banks have two sources of income-> 1.non interest (fees) 2. interest (loans) 3.non interest expenses (e.g. salaries and other fees) 4. interest expense (the banks' borrowings i.e. deposits)

Regal Neil Act reversed the prohibition of interest branching-> lead to mergers and explains some of the regulation structure change that took place along with the FInancial Modernisation Act in 1999. There was a massive increase in number of branches

Assessing Performance with Ratios- We can value a firm using the discounted cash flows. When you're using income statement and balance sheet information then you need to know what their cash flows might look like and approximation for what 'r' or riskiness of entity might look like.

ROE Breakdown- DuPont Analysis ROE is most common= net income/equity capitalROA- (net income/total assets). Usually they're considered as proxies for profit-higher is better. But banks can manage their income through their provisioning. For banks, net income can increase due to an increase in growth or reduction in cost or reduction in provisions.ROE (what shareholders usually care about- return on equity) can increase if leverage increases. If you look at ROE, it can increase if net income increases or if equity falls and if equity falls generally debt has increased. These are things you have to be aware of. 

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