im02 - Chapter 3 Analyzing Bank Performance: Using the UBPR...

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Chapter 3 Analyzing Bank Performance: Using the UBPR Chapter Objectives 1. Introduce bank financial statements, including the basic balance sheet and income statement, and discuss the interrelationship between them. 2. Provide a framework for analyzing bank performance over time and relative to peer banks. Introduce key financial ratios that can be used to evaluate profitability and the different types of risks faced by banks. Focus on the trade-off between bank profitability and risk. 3. Identify performance measures that differentiate between small independent banks (specialty banks) and larger banks that are part of multibank holding companies. 4. Distinguish between types of bank risk; credit, liquidity, interest rate, capital, operational, and reputational. 5. Describe the nature of and meaning of regulatory CAMELS ratings for banks. 6. Provide applications of data analysis to sample banks’ financial information. 7. Describe performance characteristics of different-sized banks. 8. Describe how banks can manipulate financial information to ‘window-dress’ performance. Key Concepts 1. Bank managers must balance banking risks and returns because there is a fundamental trade-off between profitability, liquidity, asset quality, market risk and solvency. Decisions that increase banking risk must offer above average profits. The more liquid a bank is and the more equity capital used to fund operations, the less profitable is a bank, ceteris paribus. 2. Banks face five basic types of risk in day-to-day operations: credit risk, liquidity risk, market risk, capital/solvency risk, and operational risk. Market risk encompasses interest rate risk, foreign exchange risk and price risk. Each type of risk refers to the potential variation in a bank's net income or market value of stockholders’ equity resulting from problems that affect that part of the bank's activities. 3. Banks also face risks in the areas of country risk associated with loans or other activity with foreign government units and off-balance sheet activities, which create contingent liabilities. More recently, banks have focused on reputation risk. For example, in 2002 Citigroup found that even though it continued to report strong profits, the firm experienced strong criticism for 1) its role in facilitating strategies to disguise Enron’s true financial status, 2) problems in its sub-prime lending programs via the Associates and its own internal finance company activities, and 3) problems with its Salomon Smith Barney subsidiary with analyst conflicts between stock reports and the firm’s investment banking relationships. For much of 2002, Citigroup’s stock price reflected the continued barrage of reputation problems more than the firm’s reported earnings. 4. A bank's return on equity (ROE) can be decomposed in terms of the duPont system of financial ratio analysis. This
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im02 - Chapter 3 Analyzing Bank Performance: Using the UBPR...

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