The Arab Investment & Export Credit Guarantee Corporation
“DHAMAN”
Bank’s Risk Assessment
AMAN UNION
5th April 2011
Dubai – U.A.E.
Introduction to Banks’ Risk Assessment
WORKSHOP OUTLINE
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What is a bank?
Sources of information
Types of banks (Function)
Practical steps to Bank Assessment
Matters to Keep in mind
Bank’s Balance Sheet & Income Statement
CAMELS framework
What Does Bank Mean?
In simple terms,
• A bank is a commercial institution
• Licensed as a receiver of deposits
• Mainly concerned with making and receiving payments
• Supplying financing to individuals & corporate
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Sources of Information on Banks
Financial Information may be obtained through:
• Bank’s Web Page
• Annual Report (Hard Copy)
• Bankers Almanac database (fee based – by subscription)
• Bankscope database (fee based – by subscription)
• Fitch rating
• CI Rating
• Others
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Types of Banks (Function)
Banks can be both private or public in nature. The most common
forms / types are:
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Retail banks
Commercial banks
Investment banks
Specialized banks
Savings & Loans
Development banks
Central Banks – Regulators
Online banks
Retail Bank
• A bank that works with consumers, otherwise known as 'retail
customers'.
• Provides basic banking services to the general public, including:
 Checking and savings accounts
 CDs
 Safe deposit boxes
 Mortgages and second mortgages
 Auto loans
 Unsecured and revolving loans such as credit cards
 Payment and Collection processing
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Commercial Banks
• A bank that works with businesses.
• Handles banking needs for large and small businesses,
including:
 Basic accounts such as savings and checking
 Lending money for real and capital purchases
 Lines of credit
 Trade Finance / Letters of credit & Letters of guarantee
 Collection Services services
 Payment and transaction processing
 Foreign exchange
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Investment Banks
• Some large investment banks serve as commercial banks or
retail banks
• Work primarily in the investment markets
• Help organizations use investment markets through raising
money by issuing stocks or bonds
• Consult on mergers and acquisitions
• Specialized investment banks usually do not take customer
deposits
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Specialized Banks
• Usually owned by the State
• Established for economic development of the country, with a
focus on certain sectors
• Operate like commercial banks
• Rely on the State for funding rather than on deposits
• Target specific sectors, such as:
 Agriculture
 Industrial
 Real Estate
 Others
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Savings & Loans (S&L’s)
• Specialized
banks
created
to
promote
affordable
homeownership.
• Encouraged people to save their money
• Capitalization & deposit funds are used by S&L’s to lend
through long term mortgages
• Affordable monthly payment.
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Development Banks
• Multilateral institutions / supranational institutions.
• Provide financing for development needs of a regional group of
countries.
• Rely on capital contributions from member countries
• Examples include:
 The World Bank / IMF
 Islamic Development Bank
 African Development Bank
 Asian Development Bank
 American Development Bank
 European Bank for Reconstruction & Development
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Online Banks
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Primary or exclusive use on the Internet
Allow to have more choice and flexibility
Direct use of own computer\
Often get more competitive rates
Online banks allow you to do everything online, including
Open accounts
Fund accounts
Transfer money between accounts
Use online bill pay services
Buy CDs
Get loans
Access overdraft lines of credit
Access cash in the real world with a debit card
Central Banks
Main Characteristics:
• Public institution / government authority
• Named either as central bank, reserve bank, or monetary
authority.
• Usually independent, operating under rules usually free from
political interference.
• Roles are similar in different countries, but they may have
different objectives.
• Enjoy supervisory powers
• Regulatory body for the banking sector in the country
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Central Banks
• They usually have three primary goals:
 Conduct monetary policy
Issue currency
Regulate the money/credit supply
Control the interest rates in a country
 Supervise and regulate financial Institutions
 Provide financial services
 Act as a lender of last resort to the banking sector during times
of financial crisis.
Hold the reserves of other banks
Sell new issues of securities for the government
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Banking Regulations
Bank regulations are a set of certain requirements,
restrictions and guidelines imposed by the financial
regulatory authority within a country usually in view of
international banking regulations set forward by
recognized regulatory bodies.
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Practical steps to Bank Assessment
Practical steps to Bank Assessment:
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Get the correct name of the bank
Look at the Economic performance & major economic indicators
Look at the banking sector in the country
Check out the bank’s ranking in the country in terms of asset size,
equity size and deposit base size.
5. Check bank’s history (date established, mergers & acquisitions)
6. Check ownership
7. Define bank’s Activities
8. Start reading the bank’s balance sheet & Income statement
9. Start looking at the ratios
10.Write down the analysis
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Practical steps to Bank Assessment
1. Get the correct name of the bank
– Names can be confusing, specially when translated.
– Examples:
• National Bank of Egypt vs. Alwatany Bank
• National Bank of Kuwait vs. Al Ahli Bank
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Practical steps to Bank Assessment
2. Look at the economic performance & major economic
indicators
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How well is the economy performing
Economic & political reforms
Impact of macro economic variables on performance
Sources for generating foreign currency (Exports)
Trade Balance
Foreign Direct Investments (FDÍ)
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Foreign Currency Reserves
Foreign Currency Debt
Practical steps to Bank Assessment
3. Look at the banking sector in the country
• How well is the banking sector regulated
• Competitive and structural issues of the banking system.
• Banking sector reforms
• Foreign banks operating in the country
• Foreign ownership
• Central Bank acting as a lender of last resort
• Historical performance
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Practical steps to Bank Assessment
4. Check out the bank’s ranking & rating
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Country Ranking in terms of total assets, equity and deposit
base.
– World Ranking
– Bank Rating if available in terms of financial strength & foreign
currency
 Local rating
 International Rating
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Practical steps to Bank Assessment
5. Check bank’s history/Profile
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Date established
Mergers & acquisitions
What went on
Undergoing & Future plans
Practical steps to Bank Assessment
6. Check ownership
• Change in ownership
• Full government ownership
• Part government ownership
• Semi government ownership (through
• Privately owned
 Listed
 Closed
 Major business groups vs. individuals
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Practical steps to Bank Assessment
7. Define bank’s activities/type
– Specialized sector
– Trade finance
– Regular commercial
– Etc..
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Practical steps to Bank Assessment
8. Start reading the bank’s figures
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Latest figures – interim & year-end, not exceeding 15 months
Audited figures – Audit Report
Trend between 3 to 5 years
Check movements up/down more than 5%
Stable growth vs. abrupt jumps
Capital injections vs. Diminishing Equity
Loan portfolio break-down (Short vs. Long term; Provisions)
Deposit base break-down (Current, Savings & Term)
Asset Mix / Asset distribution
Practical steps to Bank Assessment
9. Start looking at the ratios
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Asset Quality
Capital Adequacy
Profitability / Performance
Liquidity
The Analysis
• Backstage preparation is done
• Proceed with the story.
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Keep in Mind
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There is no one mold for banks’ financial statements
Diverse financial reporting
Different disclosures & terminology
Know what's behind the numbers (in terms of bank
type/specialization, Islamic vs. conventional, etc.)
• Notes to the Financial Statements are essential and are integral
part of the financial statements. Take these notes seriously.
• Auditor's Report
Clean opinion/green light
Qualified Opinion – red flag
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Keep in Mind
• Look for Consolidated Financial Statements (parent &
majority-owned subsidiaries (50%+ or "effective control")
• Evaluations differ significantly by country, bank size, stage of
development, economic conditions, etc..
• Look at Non-Financial Statement Information, i.e. Information
on the state of the economy, industry and competitive
considerations, market forces, technological change, and the
quality of management.
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Bank’s Balance Sheet
Assets
Earning Assets
• Net Loans
• Other Earning Assets
Non-Earning Assets
Total Assets
Liabilities
• Deposits & Short term Funding
• L.T. Funding
• Other Liabilities
Total Liabilities
Total Equity
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Assets – Earning Assets
Earning Assets
• Net Loans
– Gross Loans
– Consumer/Retail Loans
– Corporate & Commercial Loans
– Provisions
Other Earning Assets
– Loans & Advances to banks
– Trading securities
– Other Investments / Other earning assets
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Assets – Non-Earning Assets
Non-Earning Assets
• Cash & Due from bank
• Fixed Assets
• Other Assets
• Intangibles
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Liabilities
• Total Customer Deposits
– Current Deposits
– Savings Deposits
– Term Deposits
• Deposits from Banks
• Short term Funding
• Long Term Funding
• Other Liabilities
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Equity
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Share Capital/Common Equity
Statutory Reserves
Revaluation Reserves
Retained Earnings (Loss)
Intangibles
Income Statement
• Net Interest Income (Loss)
– Interest Income
– Interest Expense (Cost of Funds)
• Non-Interest Income (Loss)
– Fees & Commissions
– Foreign Exchange
• Other Operating Income (Loss)
• Operating Expenses
• Provisions on Impaired Loans
• Net Operating Income (Loss)
• Net Income (Loss)
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Off Balance Sheet Items
• Obligations that are contingent liabilities of a bank
• Do not appear on bank’s balance sheet
• Items include the following:
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Standby letters of credit
Letters of credit
Risk participations in bankers' acceptances
Sale and repurchase agreements
Asset sales with recourse against the seller
Interest rate swaps
Interest rate options & currency options
CAMELS Framework
• CAMELS is an international bank-rating system where
bank supervisory authorities rate institutions according to
six factors.
• The six factors are represented by the acronym "CAMELS"
1. C - Capital adequacy
2. A - Asset quality
3. M - Management quality
4. E – Earnings
5. L – Liquidity
6. S - Sensitivity to Market Risk
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CAMELS Rating System
• Bank supervisory authorities assign each bank a score on a
scale of one (best) to five (worst) for each factor.
• Banks achieving an average score less than two it is
considered to be a high-quality institution
• Banks with scores greater than three are considered to be
less-than-satisfactory establishments.
• The system helps the supervisory authority identify banks
that are in need of attention.
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Capital Adequacy
• Key drivers of capital:
– Earnings
– Asset Valuation
– Capital injection
• Risk weighted assets. Weight is defined and allocated to different
assets based on Basel I vs. Basel II approach / Basel III
• Key ratios
– Tier One
– Total Capital ratio
– Leverage (Equity to Total Assets)
• Local and international benchmarks
– Internationally set at a Minimum of 8% (capital to equal at least
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8% of its risk-weighted assets.)
Capital Adequacy
• The capital requirement is a bank regulation, which sets a
framework on how banks must handle their capital.
• The categorization of assets and capital is highly standardized
so that it can be risk weighted.
• Internationally, the Basel Committee on Banking Supervision
influence each country's banking capital requirements.
• The current framework is a complex capital adequacy
framework commonly known as Basel II.
• After 2012 it will be replaced by Basel III.
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Capital Adequacy
• The capital ratio is the percentage of a bank's capital to its
risk-weighted assets.
• Weights are defined by risk-sensitivity ratios whose
calculation is dictated under the relevant Accord.
• Each national regulator normally has a very slightly different
way of calculating bank capital, designed to meet the common
requirements within their individual national legal framework.
• Most developed countries implement Basel I and II, stipulate
lending limits as a multiple of a banks capital eroded by the
yearly inflation rate.
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Capital Adequacy
• Risk-weighted asset is a bank's assets weighted according to
credit risk.
• Some assets are assigned a higher risk than others, such as
cash or government securities/bonds.
• Since different types of assets have different risk profiles,
weighing assets based on the level of risk associated with them
primarily adjusts for assets that are less risky by allowing
banks to "discount" lower-risk assets.
• In the most basic application, government debt is allowed a
0% "risk weighting" - that is, they are subtracted from total
assets for purposes of calculating the ratio.
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Asset Quality
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Assessment of the credit risk associated with a particular asset.
These assets are earning assets
Effective Risk Management Policies & Controls
Loan portfolio analysis: uncovering the risk profile of the loan
portfolio; key differences between types of bank
• Loan quality: impaired loans and reserve adequacy
• Off balance sheet exposures: lending commitments and other
special purpose vehicles
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Asset Quality
• Factors pertaining to asset quality:
– Asset portfolio is appropriately diversified
– Bank Policies in place to limit Credit Risks
– How efficiently operations are being utilized.
• Loan quality
– Portfolio analysis
– Impaired loans
– Provisioning levels, charge offs and recoveries
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Asset Quality
• Placements & Advances to banks
• Trading and investments
– Assessing Securities and Derivatives portfolios (use of
value at risk (VaR) models)
– Government bonds and T-bills
• Investment risk: valuation and accounting policies, hidden
reserve or black hole.
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Management Quality
• An act of getting self & people together to accomplish desired
goals and objectives using available resources efficiently and
effectively.
• Comprises planning, organizing, staffing, leading/directing,
and controlling an organization or effort for the purpose of
accomplishing a goal.
• Resourcing encompasses the deployment & manipulation of
human resources, financial resources, technological resources,
and natural resources.
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Management Quality
• Bank management components are:
– Asset management
– Liquidity management
– Liability management
– Capital adequacy management
– Risk management
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Earnings
• Types of income and expense, impact of earnings accrual and
asset impairment policies, core and non core earnings
• Key drivers of earnings
– Net interest margin
– Fees and commissions
– Trading
• Measure quality and diversity of income, cost control,
provision burden
• Major Ratios:
– Return on Equity (ROE) = Net Income / Equity
– Return on Assets (ROA) = Net Income / Total Assets
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Liquidity
• The degree to which an asset can be converted into cash quickly and
with minimal impact to the price received.
• Liquidity is characterized by a high level of trading activity.
• The ability to convert an asset to cash quickly “marketability".
• Assets that can by easily bought or sold, are known as liquid assets.
• Liquid assets need an established market with enough participants to
absorb the selling without materially impacting the price of asset.
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Liquidity
• Relative ease in transfer of ownership and movement of asset
• Relative ease in transfer of ownership and movement of asset
• Easily converted into cash:
deposits, commercial paper, repos, inter-bank lines/ money
market instruments, government bonds. senior and subordinated
bonds, common and preferred stock, also include blue
chip securities
• Funding stability and liquidity for a bank
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Major Liquidity Ratios
• Key drivers of liquidity
– Volatility of Liabilities
– Quality and Liquidity of Assets
– Contingency Funding Needs
• Net Loans / Deposits & Short Term Funding Ratio.
– Should Ideally be at a maximum of 80% for banks.
• Liquid Assets / Deposits & Short Term Funding Ratio
– Should ideally be At 20%
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Sensitivity to Market Risk
• The risk that changes in market conditions that could adversely
impact earnings and/or capital.
• Market Risk encompasses exposures associated with changes in:
– Interest rates
– Foreign Exchange Rates
– Commodity prices
– Equity prices, etc.
• The primary risk in most banks is interest rate risk (IRR)
• IRR is a balancing act between the quantity of re-pricing assets with
the quantity of re-pricing liabilities.
• It varies from one institution to the other
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The Arab Investment & Export Credit Guarantee Corporation
“DHAMAN”
Thank you
The Arab Investment & Export Credit
Guarantee Corporation “Dhaman”
Kuwait
Tel: (+965) 2495 9000
Fax: (+965) 2495 9596
operations@dhaman.org
www. dhaman.org