CS Professional · Banking and Insurance - Laws and Practice

Analysis of Financial Statements of Banks: formula sheet

Full chapter guide

Key formulas

Statutory basis: Section 29 + Third Schedule → Form A (Balance Sheet) and Form B (Profit and Loss Account); State this first in any answer. Section 29 is the provision requiring the accounts to be prepared in these forms.
Balance sheet identity: Capital and Liabilities total = Property and Assets total; Both sides must agree. Contingent liabilities are shown below the line and are not added in.
Liabilities side schedules: Sch 1 Capital; Sch 2 Reserves and Surplus; Sch 3 Deposits; Sch 4 Borrowings; Sch 5 Other Liabilities and Provisions; Remember the order: Capital, Reserves, Deposits, Borrowings, Other Liabilities.
Assets side schedules: Sch 6 Cash and Balances with RBI; Sch 7 Balances with Banks and Money at Call and Short Notice; Sch 8 Investments; Sch 9 Advances; Sch 10 Fixed Assets; Sch 11 Other Assets; Assets are shown in order of liquidity, most liquid first.
Profit and loss schedules: Sch 13 Interest Earned; Sch 14 Other Income; Sch 15 Interest Expended; Sch 16 Operating Expenses; Schedule 12 is Contingent Liabilities in the common format. Schedules 17 and 18 are accounting policies and notes to accounts.
Profit and loss result: Net profit = (Interest earned + Other income) − (Interest expended + Operating expenses + Provisions and contingencies); Appropriations such as transfer to statutory reserve come after net profit.
Net interest income: Net interest income = Interest earned − Interest expended; A useful analytical figure, though not a line in Form B.
Balance sheet identity: Total assets = Capital + Reserves and surplus + Deposits + Borrowings + Other liabilities and provisions; Both sides of the bank balance sheet must always be equal.
Net interest income (NII): NII = Interest earned − Interest expended; Measures the core spread earned from lending and investing.
Net interest margin (NIM): NIM = NII ÷ Average earning assets × 100; A percentage. Earning assets mean advances, investments and interest-bearing balances. Use the average where data allows.
Total income: Total income = Interest earned + Other income; Form B shows these as two main heads.
Operating profit: Operating profit = Total income − Interest expended − Operating expenses; This is before provisions and contingencies.
Net profit: Net profit = Operating profit − Provisions and contingencies (including tax); Provisions include those for bad loans, investment depreciation and tax.
Cost to income ratio: Cost to income = Operating expenses ÷ (NII + Other income) × 100; Shows how much of net income is spent on running the bank. Definitions of the denominator vary, so state yours.
NPA test (term loans): Interest or instalment of principal overdue for more than 90 days → NPA; The count is of days overdue. Exactly 90 days is not yet an NPA; the account must be overdue for more than 90 days.
Sub-standard asset: NPA for a period not exceeding 12 months; Starts from the date the account became an NPA.
Doubtful asset: Asset that has remained sub-standard for 12 months; Provision rises with the age of the doubtful status (up to one year, one to three years, more than three years).
Loss asset: Asset identified as uncollectable by the bank, internal or external auditors or RBI inspection, but not written off in full; Needs 100% provision of the outstanding.
Income recognition: Standard asset: accrual basis. NPA: cash basis (income only when actually received); Interest already booked but unrealised on an account turning NPA must be reversed.
Provision on standard assets (general rule): 0.40% of outstanding is the general rate for standard assets. Direct agriculture and SME: 0.25%. Commercial real estate: 1%. Commercial real estate - residential housing: 0.75%; These are the main rates only. Other categories of standard assets carry different rates, so check the latest RBI Master Circular. Quote the rate given in the question.
Provision on sub-standard assets: 15% of the secured portion; 25% of the unsecured portion (ab initio). Infrastructure loan accounts with the specified escrow structure carry a lower rate of 20% on the unsecured portion; The general provision is 15% of the total outstanding, with an additional 10% on the unsecured exposure, which gives 25% on that part. Split the outstanding into secured and unsecured parts and apply each rate to its own part. Use the rate stated in the question if it differs.
Provision on doubtful assets: Secured part: 25% up to 1 year, 40% for 1 to 3 years, 100% above 3 years. Unsecured part: 100%; Total provision is the secured-portion provision plus 100% of the unsecured portion.
Provision on loss assets: 100% of outstanding; Even if the asset is not yet written off.
CRAR: CRAR = (Tier 1 capital + Tier 2 capital) ÷ Total RWA × 100; Total RWA = credit RWA + market RWA + operational RWA. Capital must be after regulatory deductions.
Risk-weighted asset for one exposure: RWA = Exposure amount × Risk weight; Use the exposure after any permitted credit risk mitigation. Add all exposures to get total RWA.
Tier 1 ratio: Tier 1 ratio = (CET1 + AT1) ÷ RWA × 100; CET1 ratio = CET1 ÷ RWA × 100.
RBI minimum capital ratios (Basel III, India): CET1 5.5%; Tier 1 7%; Total capital 9%; plus Capital Conservation Buffer 2.5% in CET1; The buffer is held in CET1, so CET1 must be at least 8%. The Tier 1 figure of 9.5% and the Total figure of 11.5% follow from it and are derived targets, not separate buffers. AT1 is at least 1.5% of RWA. Check the latest RBI master direction for changes.
Provision for substandard assets: Secured portion: 15%; Unsecured portion: 25% (20% for unsecured exposures in infrastructure loan accounts where certain safeguards such as escrow accounts are available); A substandard asset is one that has been NPA for up to 12 months. Split the outstanding into the secured portion (covered by the realisable value of the security) and the unsecured portion, and apply the rates to the two parts separately.
Provision for doubtful assets: Secured portion: 25% (doubtful for up to 1 year), 40% (doubtful for 1 to 3 years), 100% (doubtful for over 3 years); Unsecured portion: 100%; An asset becomes doubtful when it has stayed substandard for 12 months. The periods in the formula are counted from the date the asset became doubtful. The secured portion is the amount covered by the realisable value of the security; the rest is the unsecured portion. Apply the rates to the two parts separately.
Provision for loss assets: 100% of outstanding; Loss assets are identified as uncollectible but not yet written off.
Net NPA: Net NPA = Gross NPA − Provisions held against NPAs (and similar permitted deductions); Net NPA ratio = Net NPA ÷ Net advances × 100.
Capital to risk-weighted assets ratio (CRAR): CRAR = (Tier 1 capital + Tier 2 capital) ÷ Risk-weighted assets × 100; Measures capital strength. Compare with the minimum set by RBI under Basel III norms. Use the figure given in the question if a benchmark is stated.
Gross NPA ratio: Gross NPA ratio = Gross NPAs ÷ Gross advances × 100; Shows the share of loans that have turned bad before provisions.
Net NPA ratio: Net NPA ratio = (Gross NPAs − Provisions) ÷ (Gross advances − Provisions) × 100; Use the provisions held against NPAs. Net NPA is lower than gross NPA when provisions exist.
Provision coverage ratio (PCR): PCR = Provisions held against NPAs ÷ Gross NPAs × 100; Shows how much of the bad loans is already covered by provisions.
Net interest margin (NIM): NIM = (Interest earned − Interest expended) ÷ Average earning assets × 100; Core measure of lending profitability. Use average earning assets if both opening and closing figures are given.
Return on assets (ROA): ROA = Net profit ÷ Average total assets × 100; Shows profit earned per rupee of assets.
Return on equity (ROE): ROE = Net profit ÷ Average shareholders' equity × 100; Shows return to shareholders. Higher leverage can raise ROE and risk together.
Cost-to-income ratio: Cost-to-income = Operating expenses ÷ (Net interest income + Other income) × 100; Lower is better. It shows operating efficiency.
Credit-deposit (CD) ratio: CD ratio = Total advances ÷ Total deposits × 100; A very high ratio can strain liquidity. A very low ratio means funds are not being lent.
Business per employee: Business per employee = (Total deposits + Total advances) ÷ Number of employees; A management efficiency measure.

Quick revision

A bank's balance sheet is in the prescribed format with schedules for capital, reserves, deposits, borrowings, other liabilities, assets and contingent liabilities.
Loans and advances are a bank's main assets and deposits are its main liabilities.
Interest earned is usually the largest income item, and interest expended is the largest cost.
Income on a non-performing asset is not recognised as accrued; it is booked when actually received.
Assets are classified as standard, substandard, doubtful or loss, based on days overdue and security condition.
Provisioning rises as an asset moves to a worse category.
Capital adequacy compares a bank's regulatory capital with its risk-weighted assets.
Learn the capital components: Common Equity Tier 1, Additional Tier 1 and Tier 2.
CAMELS stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk.
Always state the norm first, then apply it to the facts, then conclude.
Disclosures in notes and the auditor's report support users in judging a bank's real position.

Common mistakes

Applying Schedule III of the Companies Act, 2013 to a bank. Fix: Remember that banking companies follow the Third Schedule of the Banking Regulation Act, 1949, under Section 29.
Mixing the order of heads, such as putting Advances before Investments. Fix: Learn the asset order as Cash, Bank balances, Investments, Advances, Fixed assets, Other assets, and the liabilities as C-R-D-B-O.
Treating deposits as an asset because the bank holds the money. Fix: Deposits are owed to customers. They are a liability. The bank's asset is the loan or investment made from them.
Confusing interest earned with interest expended. Fix: Take the bank's point of view. Interest on loans and investments is earned. Interest on deposits and borrowings is expended.
Treating an account as an NPA at exactly 90 days overdue. Fix: Write 'more than 90 days' in your answer. Day 91 onwards is NPA.
Booking interest on an NPA on accrual basis. Fix: Remember the two-line rule: standard on accrual, NPA on cash. Also reverse interest already booked but unrealised.
Dividing capital by total assets instead of risk-weighted assets. Fix: CRAR always uses RWA in the denominator. A total-assets ratio is the leverage ratio, a separate measure.
Stating the minimum CRAR as 11.5% without explaining the buffer, or as 9% without the buffer. Fix: Say: minimum 9% total capital, plus 2.5% capital conservation buffer in CET1, giving 11.5% effectively.
Using total loans in the denominator of the NPA ratio without checking whether gross or net advances are needed Fix: Gross NPA ratio uses gross advances. Net NPA ratio subtracts provisions from both the numerator and the denominator.
Using total assets instead of earning assets for NIM Fix: NIM uses net interest income over average earning assets. ROA uses net profit over average total assets.

Exam tips

Begin every answer with Section 29 and the Third Schedule. It shows the examiner you know the source.
Reproduce the heads in prescribed order. A neat two-column list of liabilities and assets earns marks quickly.
In case-based questions, identify the head under which a given item falls, then explain why in one line.
Mention notes to accounts and accounting policies. Many students leave them out.
If you cannot recall a schedule number, give the schedule name. A correct name is safer than a wrong number.
In theory answers, list items in the order of Form A and Form B. It shows you know the format.
For every figure, state the side (asset or liability, income or expense) before using it.
Write the formula before substituting. Method marks are given in a written paper.