lO M oARcPS D| 24299217

The Financial Statements of Commercial Banks

Prepared by:

Ayesha Siddika Arshi

Lecturer

Dept of Finance & Banking

Course- FNB 208 Accounting for FI

 lO M oARcPS D| 24299217

▪ Financial statements are literally a "road map" telling us where a financial firm has been
in the past, where it is now, and, perhaps, where it is headed in the future.

▪ They are invaluable guideposts that can, if properly constructed and interpreted, signal
success or disaster.

▪ The two main financial statements that managers, customers and the regulatory authorities
rely upon are

The balance sheet (Report of Condition): The Report of Condition shows the amount and
composition of funds sources (financial inputs) drawn upon to finance lending and
investing activities and how much has been allocated to loans, securities, and other funds
uses (financial outputs) at any given point in time.

The income statement (Report of Income): In contrast, the financial inputs and outputs on
the Report of Income show how much it has cost to acquire funds and to generate revenues
from the uses the financial firm has made of those funds.

The other financial statements prepared by banks at the end of fiscal period:
Statements of Cash Flows.

Statement of Changes in Stockholder’s Equity.

Banks are unique in the special services they offer. Banks use much more financial leverage
(debt) to finance their operations. Thus, bank’s financial statements have several unique
characteristics especially balance sheet and income statement. This chapter introduces these
two important financial statements of commercial banks and a brief description of their items.

Balance Sheet (Report of Condition)

A balance sheet, or report of condition, lists the assets, liabilities, and equity capital (owners’
equity) held by or invested in a bank at a specific point of time. The balance sheet states that:

Total assets = Total liabilities + equity capital

Where liabilities and equity capital represent accumulated sources of funds, which enable the
bank to acquire assets. While a bank’s assets are its accumulated uses of funds which are used
to generate cash flow and income for its stockholders, paying interest to its depositors, paying
wages and salaries and others the balance sheet equation can be expressed simply as:

Accumulated uses of funds = Accumulated sources of funds

(Assets) (Liabilities and equity capital)
 lO M oARcPS D| 24299217

Although the general structure of balance sheets for banks does not differ from that of any other
sector there are significant differences in the sub-classification of accounts. Below is an
example of a bank balance sheet:

Balance Sheet of a Commercial Bank as of 31 Dec 2024

Total Assets:
Cash and due from depository institutions xx
Investment securities xx
Reserve funds sold and securities repurchase agreements xx
Gross loans and leases xx
(less) Loan loss allowance (xx)
Trading account assets xx
Bank premises and fixed assets xx
Other real estate owned xx
Goodwill and other intangibles xx
All other assets xx
Total Assets (A) xxx
Total liabilities and equity capital:
Total liabilities:
Total deposits xx
Reserve funds purchased and securities sold under repurchase agreements xx
Trading liabilities xx
Other borrowed funds xx
All other liabilities xx
Total Liabilities (B) xxx
Equity Capital:
Perpetual preferred stock xx
Common stock xx
Surplus xx
Undivided profits (Retained earnings) xx
Total Equity Capital (C) xxx
Total liabilities and equity capital xxx

A balance sheet of a bank has certain unique items illustrated below.

Assets: Uses of Funds

Assets are resources that are owned or controlled by an economic entity and will provide a
benefit in current and future periods for the business. The assets on the bank’s balance sheet
consist of four major categories:

i. Cash and Due from Depository Institutions which include Cash in the vault and deposits
held at other depository institutions (i.e. central bank or other banks), they represent cash
assets that are designed to comply with the bank’s need for liquidity such as deposit
 lO M oARcPS D| 24299217

withdrawals, customer demands for loans, and other unexpected or immediate cash
demand. They are the most liquid items; they are also referred to as primary reserves.
Banks attempt to keep the size of this account as low as possible, because cash balances
earn little or no interest income.

ii. Investment Securities: they are government and private interest-bearing securities
purchased in the open market. They are another source of liquidity and provide income.
They can be divided into two types:

a) Investment securities (secondary reserve) they are a second line of defense to meet
demands for cash (secondary reserve). They usually include short term government and
private securities and referenced on regulatory reports as “available for sale”.

b) Investment securities (The Income-Generating securities) they are held primarily

for their expected rate of return or yield. They are referenced on regulatory reports as
“held-to-maturity securities”.

iii. Loans and lease financings made available to customers represent the largest asset item in
the balance sheet of banks. They are an important source of income. A bank’s loans can be
classified according to the purpose of borrowing money into commercial loans, real state
purchase loan, consumer or house holding loans and others.

iv. Miscellaneous assets represent fixed assets such as buildings, equipment, investment in
subsidiary firms, income earned on loans but not collected, net deferred tax assets, and all
other assets.

Liabilities: Sources of Funds

Liabilities are pecuniary obligations (opposed to economic entity’s assets) or claims on assets.
Bank’s Liabilities consists of two major categories:

i. Deposits: The principal liability and the first most important source of funds for a bank
is its deposits. Although deposits are financial claims held by economic entities,
households, and governments against the bank, deposits are the backbone or the life
blood of a bank. Deposits characterized by no or low- cost for a bank. There is no
restriction or limit on the number of deposits that banks should have. There are four
major types of deposit:

a. Demand deposits: They are non-interest-bearing deposits. They allow unlimited check
writing for depositors. Due to the increasing competition between banks, many banks introduce
free services (such as paying postage costs) that yield an implicit rate of return for huge demand
deposit accounts.

b. Saving deposits: They are the lowest interest-bearing deposits. They allow depositors to
withdraw at their will or desire. Traditional passbook saving accounts is one of the most
 lO M oARcPS D| 24299217

popular forms of saving deposits.

c. Negotiable Order withdrawals accounts (NOW): they are interest bearing deposits that
permit checks to be written against each account to pay third parties.

d. Time deposit: they are the highest interest-bearing deposit and usually carry a fixed maturity
date.

ii. Borrowings: Borrowings represent the second most important source of bank funds and
the most important non-deposit funding source for banks. Borrowings represent the
temporary borrowings of banks in the money market, mainly from reserves loaned by
other institutions (central bank or other banks) or from repurchase agreements.

Equity capital: Sources of Funds

The equity capital known also as net worth of the bank is the difference between a bank’s assets
and its liabilities. It represents the owners’ (stockholders’) share of the bank. Equity capital
includes stock, surplus (reserves) and retained earnings.

The bank’s balance sheet can be illustrated by the following:

Off Balance Sheet Items:

The balance sheet of a commercial bank does not present all the information about the bank.
To generate fees, banks engage in numerous transactions that are known as off-balance sheet
items. Off-balance-sheet items are contingent assets and liabilities that are expected to affect
the future financial position of bank’s balance sheet. Banks perform these transactions to get
profit. However, many of these transactions do not appear as either assets or liabilities on the
 lO M oARcPS D| 24299217

bank’s balance sheet, even though they may have an important effect on a bank’s profits.
Examples of these off-balance sheet items include:
▪ Unused commitments: in which a lender (bank) receives a fee to lend up to a certain
amount of money over a specified period of time; however, these funds have not yet
been transferred from lender to borrower.
▪ Standby credit agreements: in which a bank receives a fee to guarantee repayment of
a loan that a customer has received from another lender.
▪ Derivative contracts: in which a bank has the potential to generate profit or incur a
loss on an asset that it presently does not own. This may include futures contracts and
options.
The problem with these off-balance-sheet transactions is that they often expose a firm to
substantial risk like credit risk, liquidity risk, or counterparty risk that will not be shown in
conventional financial reports.

Income Statement (Report of Income)

The income statement reports on the amount of revenue received and expenses incurred over a
specific period of time. Net income or net profit is calculated by subtracting total expenses
from total revenues which can be expressed by this accounting equation:
Net Income = total revenues - total expenses
There is usually a close relationship between the main items on the balance sheet of a bank and
its income statement. In more detail, assets on the balance sheet generate most of the bank’s
operating revenues; in contrast liabilities make many of a bank’s operating expenses.
 lO M oARcPS D| 24299217

Income Statement for a commercial bank for the year ended on 31st December
Interest Income:
Interest on (cash items) deposits in other banks xx
Interest on investment securities xx
Interest on trading securities xx
Interest on reserve funds sold and securities purchased under resale xx
agreement
Total interest income (A) xx
(-)Interest expenses:
Interest on deposits xx
Interest on short-term debts xx
Interest on long-term debts xx
Interest on reserve funds purchased and securities sold under repurchase xx
agreements
Interest on subordinate debentures xx
Total interest expenses (B) (xx)
Net interest income (interest margin) A-B xx
(-) Provision for loan loss (xx)
Net interest income after provision for loan loss xxx
Non interest income:
Service charges on deposit accounts xx
Fees from security brokerage xx
Fees from insurance xx
Net gain (loss) from sale of investment securities xx
Other non-interest income xx
Total noninterest income (C) xx
(-)Non-interest expenses
Salaries and wages xx
Pensions and benefits for employees xx
Expenses of buildings and fixed assets xx
Other non-interest expenses xx
Total non-interest expenses (D) (xx)
Net non-interest income (non-interest margin) C-D xxx
Income before taxes and extraordinary items xx
(-) Applicable income taxes (xx)
(+/-) Extraordinary items xx
Net Income xxx

The main components of income statement include:

i. Interest income: Interest income is the most important source of bank revenue. Interest
income represents interest generated by earning assets which includes loans, investment
 lO M oARcPS D| 24299217

securities and deposits held in other banks. Interest income increases by increasing interest
rates, earning assets or both and vice versa.
ii. Interest expenses: Interest expense is the second major item on the income statement of a
bank. It includes interest on deposits (The number one expense item for a bank) and interest
on short term and long-term borrowings (including interest on reserve funds from other
banks, security repurchase agreements and subordinates and notes and debentures
outstanding).
iii. Net interest income: Net interest income also referred to as interest margin. It equals the
total interest income minus total interest expenses. This important item is often referred to
as the interest margin; it is an important tool in determining the bank’s profitability. A
decrease in interest margin will usually lead to a decrease in the bottom line net after-tax
income and the dividend per share as well.
iv. Provision for loan losses: It is a noncash expense that is deducted from current income
before taxes. It is an estimate of potential revenue losses from bad loans. The provision for
loan losses represents allocation to the allowance for loan losses listed on the balance sheet
for the current period.
v. Non-interest income: Noninterest income includes all other income received by a bank
from activities other than loans and securities. It is also known as fee income. It includes
fees earned from activities such as offering trust service and service charges on deposit
accounts. It also includes fees from other-than banking activities such as security brokerage,
insurance services, credit cards fees, gains and losses from the sale of investment securities,
and others non-interest income.

**The sum of interest income and noninterest income is known as total operating income or
total revenue of a bank.

vi. Non-interest expenses: Non-interest expenses include salaries, wages and employee
benefits, expenses of premises and fixed assets such as (utilities, depreciation, and deposit
insurance), legal fees and repair cost. For most banks, noninterest expense is higher than
noninterest income.

Cash Flow Statement

The Cash Flow Statement presents the movement in cash and bank balances over a period. The
movement in cash flow is classified into the following segments:

• Operating Activities: Represents the cash flow from primary activities of a business.
• Investing Activities: Represents cash flow from the purchase and sale of assets other
than inventories (e.g. purchase of a factory plant)
• Financing Activities: Represents cash flow generated or spent on raising and repaying
share capital and debt together with the payments of interest and dividends.
 lO M oARcPS D| 24299217

Problems:
1.1 Classify each item of the following according to whether it appears on a bank’s balance sheet or a
bank’s income statement.

Items Balance Sheet Income Statement

Allowance for loan losses
Depreciation on plant and equipment
Commercial and industrial loans
Customer loans
Common stock
Repayment of credit card loans.
Securities gains or losses
Employee benefits
Provision for loan losses
Interest paid on money market deposits
Retained earnings.
Credit card loans.
Utility expense.
Vault cash.
Deposits due to banks.
Leases of business equipment to customers.
Interest received on credit card loans.
Saving deposits.
Customer liability on acceptances.
Undivided profits.
Mortgage owed on the bank’s buildings.
Service charges on deposits.
Trust department income.
Provision for income taxes.
Demand deposits.
Investment securities.
 lO M oARcPS D| 24299217

1.2 The ABC commercial Bank submitted its balance sheet and income statement to the general
assembly at the end of the year as follows:
 lO M oARcPS D| 24299217

300

Required: Calculate the missing items from the statements shown above (all figures are
in thousands of pounds).
1.3 The following account balances appear in the records of a commercial Bank at the end of
June 2022 (amounts are stated in thousands of pounds)

Required: Calculate the following items:

i. Investment securities.
ii. Total deposits.
iii. Total assets.
iv. Depreciation.
v. Net loans.
 lO M oARcPS D| 24299217

vi. Undivided profits.

1.4 From the following information, prepare an income statement for a commercial bank for
the year ended December 31, 2020. Be sure to arrange the figures in correct sequence to
derive the bank’s report of income.

Interest and fees on loans $3,120

Deposit interest costs $2052
Provision for possible loan losses $1020
Provision for income taxes $32
Service charges on customers deposits $196
Trust department income $164
Other operating non-interest income $476
Interest on short-term debt $404
Interest on long- term debt $120
Securities gains and losses $50
Wages and salaries and other benefits $520
Occupancy and equipment expenses $176
Other operating expenses $540
Other interest income $494
Interest on investment securities $664
Average number of shares outstanding 708,000 shares