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Risk Analysis and Bank Financial Statements. Hennie van Greuning World Bank Treasury FirstRand Board of Directors. Outline – key messages. Discuss the common causes of financial crisis and failure. K ey lessons learned from the financial crisis

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risk analysis and bank financial statements

Risk Analysis and Bank Financial Statements

Hennie van Greuning

World Bank Treasury

FirstRand Board of Directors

outline key messages
Outline – key messages

Discuss the common causes of financial crisis and failure.

Key lessons learned from the financial crisis

Proposed regulatory reforms and risk enhancements as a result of the financial crisis.

Basic risk analysis

1 credit crises common causes
1. Credit Crises – Common Causes

“…all consequential events in human history have come from unexpected, rare occurrences” Nassim Nicholas Taleb

Unusual Times

1 financial banking sector crises common causes
1. Financial / Banking Sector Crises – Common Causes

Business strategies flawed

Poor governance oversight & risk management

Balance sheets structurally weak

Excessive gearing

Excessive credit risk

  • Weak credit terms
  • Risky products

Liquidity risk not well understood

Risks taken at lower levels not understood by senior management

Recent bank failures – generic causes

1 financial crises common causes
1. Financial Crises – Common Causes

Global imbalances have built up over years

CA balances

Financial

1 financial crises common causes6
400%

350%

300%

250%

200%

150%

100%

50%

0%

1916

1926

1936

1946

1956

1966

1976

1986

1996

2006

1. Financial Crises – Common Causes

US Private Sector Debt to GDP

  • “Debt can be viewed as sustainable as long as the debt to GDP ratio is non-increasing”*

Source: US Federal Reserve

*Nouriel Roubini (2001) Debt Sustainability: How to Assess Whether a Country is Insolvent, Stern School of Business, NYU

1 financial crises common causes7
1. Financial Crises – Common Causes

US Housing Market Fundamentals

  • Source: OFHEO and US Federal Reserve
1 financial crises common causes8
1. Financial Crises – Common Causes

Unrestrained asset (derivative) growth – CDS market growth

Source: ISDA, The World Bank, US Bureau of Economic Analysis and US Treasury

1 financial crises common causes9
1. Financial Crises – Common Causes

South Africa’s macro economic imbalances monitor

Current account balance

Household debt to disposable income

House prices

Inflation

1 financial crises common causes10
1. Financial Crises – Common Causes

Consequences of macro economic imbalances

Global macroeconomic crisis

Global financial sector crisis

Bank share prices

Global growth

financial crises common causes
Financial Crises – Common Causes

Bank Failures Statistics

2010 began with a whimper for Bank Failures as the first week almost gave us the illusion that maybe and just maybe, the problem might just have solved itself as zero failures were reported. It was never going to be that easy, was it?

As the graph, shows,  a few weeks into 2010, the number of failures curve has already picked up steam and we see the red curve blasting away.

May 20

Failures – 72 so far this year

Problems - 775 institutions with aggregate assets of $431 billion

8,384 FDIC insured banks

Source: http://investingcontrarian.com/global/us-1800-bank-failures-tsunami-on-horizon/

key lessons learned
Key Lessons Learned

“I spent too much time out of the office with clients and trusted other people to manage the risk – I am sorry.” Dick Fuld, ex-Lehman CEO.12 September 2009

“We strive to have a balance in our team and I will use the analogy of the soccer team. A balanced team has good forwards, sweepers, backs and a goalie. If too many goals are let in, you must strengthen your defense. However to score goals you must have good strikers. You can’t win matches with 11 goalies and nor can you win with 11 strikers. We have improved our defensive line but not at the expense of our forward line.” SA banker - September 2009

Remember, models are only as effective as the assumptions on which they’re built and the inputs they’re provided

“Human beings, who are almost unique in having the ability to learn from the experience of others, are also remarkable for their apparent disinclination to do so.” Douglas Adams

What did management learn?

key lessons learned13
Key Lessons Learned

If things appear too good to be true, they probably are (“If something cannot go on forever, it won’t”) – know where profits come from

Back to basics – use common sense approach to risk management: Risk management is about quality of people, experience, judgment and coordination

Pro-active, holistic and forward looking analysis, through e.g. robust stress testing and a combination of quantitative and qualitative risk information

Align risk, capital, funding and strategy – and incorporate it in a dynamic risk appetite process

Escalate clearly and early – to avoid surprises

“The last time anybody made a list of the top hundred character attributes of New Yorkers, “common sense” snuck in at number 79.” Douglas Adams

“Nothing travels faster than the speed of light with the possible exception of bad news, which obeys its own special laws.” Douglas Adams, "The Hitchhiker's Guide to the Galaxy"

slide15
Disconnect between risk and controls: “These are stories of what happens when the desire for excess returns overrides risk controls”.

The person in charge (in each case) showed excellent results in the beginning, and thus was allowed to transact without proper supervision and controls.” Beware of star performer who is unconstrained by lack of supervision.

If returns are too good to be true, there is likelihood of elevated risk

Poor understanding of business and investment strategies by senior management and Board

Fractured (and not always competent) oversight mechanisms: internal and external

GREED

History: Analysis from Kidder Peabody to the present crisis

3 regulatory reform17
3. Regulatory Reform

Some emerging market countries way ahead of the governance & regulatory curve – already implemented many items the world is still debating

The crisis provides a unique opportunity to make significant internal improvements in organizations

Good time to foster a culture of risk and transparency

Flexibility: Those better able to adapt have an advantage in the market going forward

Building-up infrastructure and capacity takes commitment and resources.

Not everything is bad news...

4 risk information not directly reflected in afs20
4. Risk information not directly reflected in AFS

Risk in the context of a Bank Balance Sheet

Assets

High level allocation to key risk types

Liquidity risk

Market risk + Banking book hedges

Credit risk +Interest Rate in the banking book +Liquidity

Investment risk + Liquidity risk + Market risk

Liabilities

Liquidity & Funding risk + Interest rate in the banking book

Market risk + Banking book hedges

Market risk

Funding risk

Capital risk

Note: figures are provisional

financial analysis principles
Financial Analysis – Principles

Questions to consider…

What is the purpose of the analysis?

What level of detail will be needed?

What factors or relationships (context) will influence the analysis?

What are the analytical limitations, and will these limitations have the potential to impair the analysis?

What data is available?

How will data be processed?

What methodologies will be used to interpret the data?

How will conclusions and recommendations be communicated?

financial analysis principles22
Financial Analysis – Principles

What happened?

Why did it happen?

What is the Impact of event?

Action plan going forward

  • Accountability
  • Target date

What is Financial Analysis?

4 regulatory returns analytical value
4. Regulatory Returns Analytical Value

Composition of Assets : Structural Change & Growth

4 regulatory returns analytical value26
4. Regulatory Returns Analytical Value

Asset Growth Over Time

SARB -2008 Annual Bank Supervision Report

financial analysis tools and techniques27
Financial Analysis – Tools and techniques

Trend analysis – Asset Growth: cumulative from a base period

Source: 2009 ABACUS

6 financial analysis tools and techniques
6. Financial Analysis – Tools and techniques

Trend analysis: Total Assets, Gross Loans and Advances

SARB – 2008 Annual Bank Supervision Report

financial analysis tools and techniques29
Financial Analysis – Tools and techniques

Common Size Analysis - “Vertical” Analysis

slide30
Assets

Income

Regulatory Returns Analytical Value

Assets Vs Income: Energy Applied Vs Income Earned

cost to income ratios of individual banks categorized by asset value of each bank
Cost-to-Income Ratios of Individual banks Categorized by Asset Value of Each Bank

4. Regulatory Returns Analytical Value

SARB – 2008 Annual Bank Supervision Report

slide32
Regulatory Returns Analytical Value

Composition of Income Statement - Multi Year Trend

SARB – 2006 Annual Bank Supervision Report

financial analysis tools and techniques33
Financial Analysis – Tools and techniques

Ratio Analysis: Liquidity statistics

250%

200%

150%

100%

50%

0%

Period 1

Period 2

Period 3

Period 4

Current Period

Customer loans as % of customer deposits

Interbank loans as % of interbank deposits

Readily marketable assets as % of total assets

Volatile liabilities as % of total liabilities

Volatility coverage (readily marketable assets as % of volatile liabilities)

Bank run (readily marketable assets as % of all deposits type)

financial analysis tools and techniques34
Financial Analysis – Tools and techniques

Correlation: Total Banking-Sector Assets to GDP

SARB – 2008 Annual Bank Supervision Report

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