This means that it can take the form of a customer loan, but contains full banking risk.

Another example of such a risk is that a bank provides a commercial or documentary letter of credit to its customer.

The Basel Accord determines the degree of risk for the three main types of off-balance sheet items. These risk indicators are used to translate off-balance sheet risk into asset-related risk. For example, a guarantee has a risk index of 100%. This means that it can take the form of a customer loan, but contains full banking risk.

According to the analysis of the bank’s capital, a rating is established according to the following criteria:

1. Rating 1 {strong):

banks whose solvency and capital adequacy ratios far exceed 8% and 4%, respectively; banks with better capital ratios than all other banks; banks that, according to inspections, have excellent asset quality.

2. Rating 2 {satisfactory):

banks in which the solvency and capital adequacy ratios are higher than 8% and 4%; banks that are the best among the banks of their group in terms of capital; banks that, according to on-site inspections, have a satisfactory asset quality or at least an average asset quality.

3. Rating 3 {mediocre):

banks in which the indicators of fixed and total capital meet the established standards; banks that occupy an intermediate place among other banks in terms of capital; banks with at least mediocre asset quality as determined by on-site inspections.

4. Rating 4 {marginal):

banks that meet at least one of the two established standards; banks located in the last third or quarter of the banks of their group in terms of capital; banks that show weakness or have problems with the quality of assets as a result of on-site inspections.

5.Rating 5 {unsatisfactory):

banks that violate the established standards or have negative capital ratios (capital deficit); banks whose capital ratios are the worst among other banks in the group; banks in which, according to on-site inspections, the quality of assets is marginal or unsatisfactory.

Asset quality analysis

Poor asset quality is the most common problem for fragile and poorly managed banks, although this is not the only reason for their financial weakness. The purpose of the analysis of the quality of the bank’s assets is a tree grows in brooklyn chapter 17 summary to determine their viability and the correctness of their value in the bank’s reporting. In order to most accurately analyze the quality of assets, a system of classification of loans, other types of assets and off-balance sheet items is used.

Assets that are considered satisfactory (standard) are not subject to classification.

Assets with which the bank has clear problems and for which final repayment is not guaranteed are classified as substandard.

Assets whose losses are almost certain but whose size cannot yet be determined are classified as doubtful.

Assets that will certainly not be repaid and thus are not viable assets of the bank are classified as unprofitable.

If necessary, we can identify another category of assets – “especially mentioned” which includes assets that are not satisfactory, but do not cause such serious concern to be included in the category of substandard. However, this approach is not always used when analyzing asset quality.

The risk weighting for each asset classification is as follows:

Therefore, during the analysis, all assets (as well as off-balance sheet items, if any) are multiplied by the appropriate risk ratio. The total amount of risk-weighted assets is the weighted average value of classified assets.

The weighted average value of classified assets by category becomes the numerator when determining the quality of assets. The denominator in determining the quality of assets, as a rule, is the bank’s capital with the following adjustment:

if the bank has made special deductions for loan losses, these deductions are deducted from the value of the asset before its classification; if the bank has total reserve deductions that can be used to recover possible future losses, this amount is added to the amount of capital.

The quality of assets is determined by this ratio. Weighted average value of classified assets / Bank capital * 100%.

The overall rating of asset quality is determined by the following indicators:

Revenue analysis

The bank’s income and profitability are important indicators that characterize the efficiency of the bank and its overall financial condition. Therefore, the analysis of these indicators is of great importance to ensure the stability of the banking system.

The bank must have a sufficient amount of income (profits) to ensure its development. In other words, it must direct sufficient profits to maintain or increase its capital. If the bank’s capital ratios tend to deteriorate, it indicates that the bank’s profit is low, or that its insufficient profits remain undistributed. This, in particular, may be in the case of payment of too large a share of profits in the form of dividends to the owners of the bank.

During the financial analysis of the bank, it is important to determine the relationship between income and asset quality. A bank that has problems with the quality of assets will be forced to recognize losses and reduce the value of problem assets (those that are subject to classification). These losses will reduce the bank’s income or even result in the bank incurring losses from its core business.

Issues are closely related to asset quality reliability of revenue data. For example, if a bank does not recognize its bad loans in terms of accounting, ie does not make reserve deductions, its receipts may seem sufficient, but in reality they are overstated, while problem assets are accounted for at an overestimated value.

The inaccuracy of income data may be evidenced by the accrual of interest on profits before they are received.

Interest on loans can be:

earned; collected (received).

If the loan payments are overdue and the bank continues to accrue interest earned but not received, it actually overstates its interest income. After all, it may happen that they will never be paid.

Therefore, the bank must immediately suspend the accrual of interest as soon as the non-payment of the debt reaches the appropriate period (usually 90 days).

In addition, other factors must be taken into account when analyzing revenue, in particular:

the established practice of depreciating assets that lose their value over time; the correctness of the calculation of tax arrears; reflection in the account of the sums paid to owners of bank in the form of dividends after payment of taxes.

If a bank pays high interest rates on net income as dividends, it will not be able to use a sufficient portion of its profits to increase capital.

The level of income is calculated as the rate of return according to the formula: Net profit after taxes, but before dividends / average value of all assets * 100%.

Revenue analysis is performed on the basis of annual and quarterly data after adjustment for tax payments.

The overall rating of the quality of revenues is set depending on the profitability ratio:

Liquidity analysis

The analysis of the bank’s liquidity makes it possible to identify whether it is able to meet its obligations in a timely manner and without losses.

The simplest method of the bank’s activity is to keep the relevant part of its assets in liquid form, ie in the form of cash, balances on correspondent accounts with the National Bank, as well as in other banks, government securities (if possible quickly convert them into cash).

However, there is a corresponding relationship between liquidity and receipts. It is that liquid assets tend to give a lower interest rate than illiquid ones (especially loans), and banks that hold a significant portion of their assets in liquid form will have lower returns. Therefore, banks that pursue an aggressive policy of maximizing profits try to keep liquid assets at a minimum allowable level.

Proper liquidity management requires maintaining a sufficient level of liquidity so that the bank can meet its obligations on time and without losses. In exceptional circumstances, if it is necessary to raise liquid funds as soon as possible, the bank’s management may sell assets at a loss for itself only to meet its obligations, although this will adversely affect the profitability of the banking institution.

Banks must determine the amount of liquidity required, taking into account two factors:

You need to know whether the bank will meet its obligations with respect to borrowed funds in the near future or in the more distant future. This usually depends on the terms of deposits and other liabilities and involves an analysis of the amount of deposits that are likely to remain in the bank (basic deposits), and those deposits and other liabilities that will be withdrawn from the account or urgently paid. It is important to find out how the bank will be forced to meet its future loan obligations. For example, if a bank has committed to provide a loan to its customer in the future, it must take this obligation into account in liquidity management.

With the development and expansion of the financial market, banks have more opportunities to manage their liquidity.