FINANCIAL MANAGEMENT

FINANCIAL STATEMENTS
 Financial Statements

Understanding the financial health of

a business by reviewing its financial
statements is also important to the
financial manager, whose goal is to
determine how to increase the value
of the firm.
 Basic Financial Statements
The accounting and financial regulatory authorities mandate that firms provide the
following four types of financial statements:
1. Income Statement—includes the revenues the firm has earned, the expenses it
has incurred to earn those revenues, and the profit it has earned over a specific
period of time, usually monthly, a quarter of a year or a full year.

2. Balance Sheet—contains information as of the date of its preparation about the

firm’s assets (everything of value the company owns), liabilities (the company’s
debts), and stockholders’ equity (the money invested by the company owners). As
such, the balance sheet is a snapshot of the firm’s assets, liabilities, and
stockholders’ equity for a particular date.

3. Cash Flow Statement—reports cash received and cash spent by the firm over a
specific period of time, usually monthly, a quarter of a year or a full year.

4. Statement of Shareholders’ Equity—provides a detailed account of activities in

the firm’s common and preferred stock accounts and its retained earnings account
and of changes to shareholders’ equity that do not appear in the income statement
 Why Study Financial Statements?
Analyzing a firm’s financial statements can help managers carry out three important
tasks: assess current performance, monitor and control operations and plan and
forecast future performance.

1. Financial statement analysis. The basic objective of financial statement

analysis is to assess the financial condition of the firm being analyzed. In a
sense, the analyst performs a financial analysis so he or she can see the firm’s
financial performance the same way an outside investor would see it.

2. Financial control. Managers use financial statements to monitor and control the
firm’s operations. The performance of the firm is reported using accounting
measures that compare the prices of the firm’s products and services with the
estimated costs of providing them to buyers. Moreover, the board of directors
uses these performance measures to determine executives’ bonuses. In addition,
the company’s creditors use performance measures based on the firm’s financial
statements to determine whether or not to extend loans to the company. For
example, a common restriction included in loan agreements prohibits firms from
borrowing more than a specific percentage of their total assets as reflected in
their financial statements.
 Why Study Financial Statements?
Analyzing a firm’s financial statements can help managers carry out three important
tasks: assess current performance, monitor and control operations and plan and
forecast future performance.

3. Financial forecasting and planning. Financial statements provide a universally

understood format for describing a firm’s operations. Consequently, financial
planning models are typically built using the financial statements as a prototype.
 What Are the Accounting Principles Used to
Prepare Financial Statements?
Accountants use three fundamental principles when
preparing a firm’s financial statements: the revenue
recognition principle, the matching principle, and the
historical cost principle. Understanding these principles
is critical to a full and complete understanding of what
information is reported in a firm’s financial statements and
how that information is reported. Much of the accounting
fraud that has occurred in the United States can be traced
back to violations of one or more of these basic principles
of accounting.
 What Are the Accounting Principles Used to
Prepare Financial Statements?
1. The revenue recognition principle.

This principle provides the basis for deciding what revenues—the cumulative
dollar/peso amount of goods and services the firm sold to its customers during
the period—should be reported in a particular income statement. The principle
states that revenues should be included in the firm’s income statement for the
period in which (a) its goods and services were exchanged for either cash or
accounts receivable (credit sales that have not yet been collected) or (b) the
firm completed what it had to do to be entitled to the cash. As a general rule, a
sale can be counted only when the goods sold leave the business’s premises en
route to the customer. The revenue recognition principle guides accountants
when it is difficult to determine whether revenues should be reported in one
period or another
 What Are the Accounting Principles Used to
Prepare Financial Statements?
2. The matching principle.

This principle determines what costs or expenses can be attributed to a specific

period’s revenues. Once the firm’s revenues for the period have been determined, its
accountants then determine the expenses for the period by letting the expenses
“follow” the revenues, so to speak. For example, employees’ wages aren’t recognized
when the wages are paid or when their work is performed but when the product
produced as a result of that work is sold. Therefore, expenses are matched with the
revenues they helped to produce
 What Are the Accounting Principles Used to
Prepare Financial Statements?
3. The historical cost principle.

This principle provides the basis for determining the dollar/peso values the firm reports
on the balance sheet. Most assets and liabilities are reported in the firm’s financial
statements on the basis of the price the firm paid to acquire them. This price is called
the asset’s historical cost. This may or may not equal the price the asset might bring if it
were sold today.
 The Income Statement
An income statement, also called a profit and loss statement, measures the
amount of profits generated by a firm over a given time period (usually a month or
year or a quarter). In its most basic form, the income statement can be expressed
as follows:

Revenues (or Sales) - Expenses (Costs) = Profits (Net Income)

Revenues represent the sales for the period. Profits are the difference between
the firm’s revenues and the expenses it incurred in order to generate those
revenues for the period. Recall that revenues are determined in accordance with
the revenue recognition principle and expenses are then matched to these
revenues using the matching principle.
 The Income Statement
H.J. Boswell, Inc.
Income Statement
For the Year Ended December 31, 2016
(in $ Millions)
 The Income Statement
1. Revenues (or Sales). Boswell’s revenues totaled $2,700 million for the 12-month period ended
December 31, 2016.

2. Cost of Goods Sold. Next, we see that the various expenses the firm incurred in producing
revenues are broken down into various subcategories. For example, the firm spent $2,025 million on
cost of goods sold, the cost of producing or acquiring the products or services that the firm sold
during the period.

3. Gross Profit. Subtracting cost of goods sold from revenues produces the firm’s gross profit of
$675 million.

4. Operating Expenses. Next, we examine Boswell’s operating expenses (this includes the salaries
paid to the firm’s administrative staff, the firm’s electric bills, and so forth). One of the operating
expense categories is depreciation expense ($135 million for Boswell in 2016). Depreciation expense
is a noncash expense used to allocate the cost of the firm’s long-lived assets (such as its plant and
equipment) over the useful lives of these assets. For example, suppose that, during 2016, Boswell
built a new distribution facility in Temple, Texas, at a cost of $10 million. The firm would not
expense the full $10 million against 2016 revenues; instead, it would spread out the costs over many
years to match the revenues created with the help of the facility.

5. Net Operating Income. After deducting $292.50 million in operating expenses, Boswell’s net
operating income is $382.50 million. The firm’s net operating income shows us the firm’s ability to
earn profits from its ongoing operations—before it makes interest payments and pays its taxes. For
our purposes, net operating income will be synonymous with earnings before interest and taxes
(EBIT)
 The Income Statement
6. Interest Expense. To this point, we have calculated only the profit resulting from
operating the business, without regard for any financing costs, such as the interest
paid on money the firm might have borrowed. In this instance, Boswell incurred
interest expense equal to $67.50 million during 2016.

7. Earnings Before Taxes. Now we can subtract Boswell’s interest expense of $67.50
million from its net operating income of $382.50 million to determine its earnings
before taxes (also known as taxable income). Boswell’s earnings before taxes are $315
million.

8. Income Taxes. Next, we determine the firm’s income tax obligation. We will show
how to calculate the tax obligation later in this chapter. For now, note that Boswell’s
income tax obligation is $110.25 million.

9. Net Income. The income statement’s bottom line is net income, which is calculated
by subtracting the firm’s tax liability of $110.25 million from its earnings before taxes
of $315 million. This leaves net income of $204.75 million
 Constructing an Income Statement

STEP 1: Picture the problem The income statement can be visualized as a

mathematical equation using Equation as follows: Revenues - Expenses = Profit
Constructing an Income Statement
Constructing an Income Statement
FINANCIAL MANAGEMENT
 The Balance Sheet
The income statement reports the cumulative results from operating the business
over a period of time, such as one year. By contrast, the balance sheet is a snapshot
of the firm’s financial position on a specific date. In its simplest form, the balance
sheet is defined by the following equation:

Total Assets = Total Liabilities + Total Shareholder’s Equity

Total liabilities represent the total amount of money the firm owes its creditors
(including the firm’s banks and suppliers). Total shareholders’ equity refers to the
difference in the value of the firm’s total assets and the firm’s total liabilities
recorded in the firm’s balance sheet. As such, total shareholders’ equity refers to
the book value of their investment in the firm, which includes both the money they
invested in the firm to purchase its shares and the accumulation of past earnings
from the firm’s operations. The sum of total shareholders’ equity and total liabilities
is equal to the firm’s total assets, which are the resources owned by the firm
 The Balance Sheet
H.J. Boswell, Inc.
Balance Sheet
December 31, 2015 and 2016
(in $ Millions)
 The Balance Sheet
Legend:
Assets: The Left-Hand Side of the Balance Sheet
Current Assets. Assets that the firm expects to convert to cash in 12 months or less.
Examples include cash, accounts receivable, inventories, and other current assets.
• Cash. Every firm must have some cash on hand at all times because cash
expenditures can sometimes exceed cash receipts.
• Accounts Receivable. The amounts owed to the firm by its customers who
purchased on credit.
• Inventory. Raw materials that the firm utilizes to build its products, partially
completed items or work in process, and finished goods held by the firm for eventual
sale.
• Other current assets. All current assets that do not fall into one of the named
categories (cash, accounts receivable, and so forth). Prepaid expenses (prepayments
for insurance premiums, for example) are a common example of an asset in this catch-
all category.
Gross Plant and Equipment. The sum of the original acquisition prices of plant and
equipment still owned by the firm.
Accumulated Depreciation. The sum of all the depreciation expenses charged against
the prior year’s revenues for fixed assets that the firm still owns.
Net Plant and Equipment. The depreciated value of the firm’s plant and equipment
 The Balance Sheet
Legend:

Liabilities and Stockholders’ Equity: The Right-Hand Side of the Balance Sheet
Current Liabilities. Liabilities that are due and payable within a period of 12 months or less. Examples
include the firm’s accounts payable, accrued expenses, and short-term notes.
• Accounts payable. The credit suppliers extended to the firm when it purchased items for its
inventories.
• Accrued expenses. Liabilities that were incurred in the firm’s operations but not yet paid. For
example, the company’s employees might have done work for which they will not be paid until the
following week or month. The wages owed by the firm to its employees are recorded as accrued wages.
• Short-term notes. Debts created by borrowing from a bank or other lending source that must be
repaid in 12 months or less.

Long-Term Debt. All firm debts that are due and payable more than 12 months in the future. A 25-year
mortgage loan used to purchase land or buildings is an example of a long-term liability. If the firm has
issued bonds, the portion of those bonds that is not due and payable in the coming 12 months is also
included in long-term debt.

Common Stockholders’ Equity. Common stockholders are the residual owners of a business. They
receive whatever income is left over after the firm has paid all of its expenses. In the event the firm is
liquidated, the common stockholders receive only what is left over—but never lose more than they
invested—after the firm’s other financial obligations have been paid
The Balance Sheet
Constructing a Balance Sheet
Constructing a Balance Sheet
Constructing a Balance Sheet
Financial Statement
Analysis
Financial Statement Analysis
Horizontal Analysis
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Vertical Analysis
Vertical Analysis
CASE 2

• Perform Vertical Analysis

for the balance sheet of
QRC Corporation:
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Ratio Analysis
Liquidity Ratios
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Banking Regulations
Introduction
Banks in the Philippines are classified into
1. Universal banks
2. Commercial banks
3. Thrift banks
4. Rural banks
5. Cooperative banks
6. Islamic banks
7. Government-owned banks
8. Other banks as may be classified by the Bangko Sentral ng Pilipinas (BSP)
 Introduction
 Universal and commercial banks are the dominant groups,
representing approximately 70 per cent of the resources of the
banking system.
 Under the General Banking Law of 2000 (GBL), a universal bank is
defined as a commercial bank with the additional authority to
exercise the powers of an investment house and invest in non-
allied enterprises. An ordinary commercial bank does not have
that authority.
 There are branches, subsidiaries and affiliates of foreign banks in
the Philippines that are licensed either as universal or commercial
banks. Others have offshore banking units with more limited
functions.
 The BSP, which is the Philippine central bank, acting through its
Monetary Board, is mandated by law to ensure that the control of
60 per cent of the resources or assets of the banking system is held
by domestic banks that are at least majority-owned by Philippine
nationals.
Minimum Capitalization Requirement by Bank
Type in the Philippines
 Classification of Banks in the Philippines
PRIMARY STATUTES AND REGULATIONS THAT GOVERN THE BANKING
INDUSTRY – organization, ownership, capitalization, and powers
1. UNIVERSAL BANKS - THE GENERAL BANKING LAW

2. COMMERCIAL BANKS – THE GENERAL BANKING LAW

3. THRIFT BANKS – THE THRIFT BANKS ACT

4. RURAL BANKS – THE RURAL BANKS ACT

5. COOPERATIVE BANKS – THE PHILIPPINE COOPERATIVE CODE

6. ISLAMIC BANKS – THE CHARTER OF AL-AMANAH ISLAMIC

INVESTMENT BANK OF THE PHILIPPINES

7. GOVERNMENT OWN BANKS

General Banking Law can apply to the thrift banks and rural banks as long as
there is no conflict with the provisions stated in the laws governing such banks.
 Classification of Banks in the Philippines
PRIMARY STATUTES AND REGULATIONS THAT GOVERN THE
BANKING INDUSTRY – organization, ownership,
capitalization, and powers
8. OTHER BANKS – DIGITAL BANK

a. Overseas Filipino (OF) by Land Bank

b. Tonik Digital Bank

c. Unobank

d. Union Digital Bank

 Classification of Banks in the Philippines
PH will only have 6 digital banks for now — Diokno
Published October 4, 2021, 12:48 PM
by Lee C. Chipongian

 PH will only have 6 digital banks for now — Diokno

 Bangko Sentral ng Pilipinas (BSP) Governor Benjamin E. Diokno said on
Monday, Oct. 4, that only six digital banks are authorized to operate after all
following the cancellation of the seventh slot for neobanks due to non-
complying applicants.
 “We approved six digital banks and it will remain six because the seventh slot
–which was supposed to be competed among the nine additional applicants —
failed to submit the complete documentation for the request. So, we will
keep it at six,” said Diokno in a forum organized by the Financial Executives
Institute of the Philippines (FINEX).
 With only six neobanks, the BSP chief said they will be able to closely monitor
the development of the digital bank market and make sure that there is
healthy competition among the digital banks and the existing traditional
banks.
 Classification of Banks in the Philippines
PH will only have 6 digital banks for now — Diokno
Published October 4, 2021, 12:48 PM
by Lee C. Chipongian

 For now, there are only six digital banks approved to operate in the
Philippines. These are Overseas Filipino Bank (OF Bank) of Land Bank of the
Philippines (its license was approved on March 25, 2021); Tonik Bank of
Singapore (June 3); UNObank of Singapore (June 3); UnionDigital of Union
Bank of the Philippines (July 15): GOtyme of Robinsons Bank Corp. (Aug. 12);
and Maya Bank, owned by PayMaya of PLDT Inc. (Sept. 16).
 Of the six, only OF Bank and Tonik Bank are already operating as digital banks
while the rest are expected to fully set up their operations within six months
or less.
 “We’ll give them three years to operate but some are really ready and they
have huge networks (and some) will be online pretty soon, maybe in less than
six months,” said Diokno in the FINEX forum.
 Classification of Banks in the Philippines
PH will only have 6 digital banks for now — Diokno
Published October 4, 2021, 12:48 PM
by Lee C. Chipongian
 “As you know, digital banking is different from the traditional banking, we
only require them to have one headquarter, no branches, no light branches
even, and so they will be operating at lower costs (and) adopting new
technology,” he added.
 The approved digital banks are given a year to complete pre-operating
requirements and commence banking operations. Existing banks converting to
digital banks should complete the transition within three years from date of
acquiring a Monetary Board approval.
 The BSP is limiting the number of digital banks to allow them the space to
closely monitor the performance and impact of digital banks to the banking
system and their contribution to the financial inclusion agenda. Diokno has
said that BSP needs to ensure that there is healthy competition among banks
to encourage the development of innovative and competitive financial
products and services.
 Classification of Banks in the Philippines
PH will only have 6 digital banks for now — Diokno
Published October 4, 2021, 12:48 PM
by Lee C. Chipongian

 Digital banks, which are required at least P1 billion capitalization, have

minimal or zero-reliance on physical touchpoints but will have to set up one
office as central hub in the Philippines to receive and resolve customer
complaints.
 The BSP issued Circular No. 1105 last Dec. 2020 on the establishment of
digital banks. It is the BSP’s seventh bank category.
 Diokno said last week that BSP could reopen the window for digital bank
license applications anytime or even within a year if they have assessed that
the digital bank market needs to expand.
 The Regulatory Regime Applicable To Banks
 The GBL governs universal and commercial banking. Special laws or
charters regulate the operations of the other banks, but the GBL still
applies to them insofar as it is not in conflict with those laws or
charters. In fact, the Philippine Cooperative Code of 2008 recognizes
the primacy of the GBL in the regulation of cooperative banks.

 The rules implementing the various banking laws are embodied in the
Manual of Regulations for Banks issued by the BSP. From time to time,
additional circulars and other issuances are promulgated by the BSP to
regulate new matters, if not to amend, repeal or otherwise modify
existing rules.

 The New Central Bank Act, which is the BSP charter, is applicable as
it contains provisions on banking regulation in line with the mandate
of the BSP as the primary overseer of banks in the Philippines.
Relevant too is the Charter of the Philippine Deposit Insurance
Corporation (PDIC), the insurer of bank deposits.
 Prudential Regulation
Relationship with the Prudential Regulator
 An effective prudential regulator is central to a safe and sound
banking system.
 In the Philippines, that role is fulfilled entirely by the BSP.
 Section 4 of the GBL expressly states that the 'operations and
activities of banks shall be subject to supervision of the Bangko
Sentral'.
 Supervision, as defined in Section 4, not only contemplates the
promulgation by the BSP of rules of conduct and standards of
operations for banks (now set out in the Manual of Regulations for
Banks, as supplemented or modified by the BSP from time to time),
but also visitorial powers; that is, the conducting of examinations and
investigations of the activities of banks with a view to determining
their compliance with those rules and standards, and enforcing
prompt and corrective action in cases of breaches of the same.
 Ultimately, the aim is to ensure the continued solvency and liquidity
of banks.
 Prudential Regulation
 As a rule, the BSP conducts regular investigations of banks not more than once
a year. However, the Monetary Board, by an affirmative vote of five members,
may order a special examination of a bank. In this regard, the BSP is required
to immediately address findings of irregularities or deficiencies. When
examining a bank, the BSP also has the authority to examine an enterprise
that is wholly or majority-owned by the bank.
 Under the PDIC Charter, the PDIC can also examine banks once a year with the
prior approval of the BSP. To avoid the overlapping of efforts, the PDIC has to
maximise the efficient use of relevant reports, information and findings of the
Bangko Sentral which it shall make available to the [PDIC].
 Under the amendments to the PDIC Charter made by Republic Act No. 10846,
if the PDIC has submitted to the Monetary Board a report of examination
asking that corrective action be taken against a bank determined by the PDIC
to be conducting unsafe and unsound banking practices, and no corrective
action is taken by the Monetary Board within 45 days of submission of the
report, the PDIC can, motu proprio, institute the necessary corrective action
and thereafter inform the Monetary Board of the action taken.
 Prudential Regulation
Management of banks
 The management of a locally incorporated bank (such as a subsidiary of a
foreign bank) is vested in a board of directors with 5 to 15 members, at least
two of whom must be independent directors. Foreign nationals may become
directors to the extent of the foreign equity in the bank concerned.
 The Monetary Board has prescribed the criteria for individuals to be elected
as bank directors, in line with the fit and proper rule, to maintain the quality
of bank management, and better protect depositors and the public in
general. Here, the Monetary Board considers the integrity, experience,
education, training and competence of the individual concerned. The
election of bank directors must be confirmed by the Monetary Board.
 Board meetings may be conducted via teleconferencing or
videoconferencing. Accordingly, directors of a bank need not all be physically
present in one room to hold a valid meeting. A bank director must, however,
participate in at least 50 per cent of all board meetings every year and
physically attend at least 25 per cent of all such meetings.
 Prudential Regulation
 As in other domestic corporations, all corporate powers of a locally
incorporated bank are exercised by its board of directors. After the
election of the directors, the shareholders can participate in the
management of the bank only in certain fundamental matters, such as the
amendment of the articles of incorporation or by-laws of the bank, its
dissolution, or its merger or consolidation with another bank.
 The BSP published the Handbook on Corporate Governance 'to improve
corporate governance in the Philippine banking system'. The BSP also
issued the rules of procedure on administrative cases involving directors
and officers of banks. It is also aligning its rules with international best
practices that foster good corporate governance in the banking sector,
such as the Principles for Enhancing Corporate Governance promulgated by
the Basel Committee on Banking Supervision.
 In this regard, the BSP has required each bank to appoint a full-time chief
compliance officer to manage a compliance system designed to identify
and mitigate business risks that may erode the franchise value of the bank.
 Prudential Regulation
 To protect the funds of the depositors and creditors of banks, the Monetary
Board may regulate the payment of compensation, allowances, fees,
bonuses, stock options, profit-sharing and fringe benefits to bank directors
and officers, in exceptional cases and when circumstances warrant, such as
when a bank is under comptrollership or conservatorship, when it is found
to be conducting business in an unsafe and unsound manner, or when it is in
an unsatisfactory financial condition.
 Towards this end, the Monetary Board requires that the total amount of
unbooked valuation reserves and deferred charges be deducted from the
net income of the bank in the event of profit sharing.
 Further, when the total compensation package (including salaries,
allowances, fees and bonuses) of directors and officers is significantly
excessive when compared with peer group averages, the Monetary Board
may order a reduction of the package to a more reasonable level. It must
also be noted that the compensation of directors in general is regulated by
Section 29 of the Revised Corporation Code, which mandates that the total
annual compensation of directors must not exceed 10 per cent of the bank's
net income before tax during the preceding year.
 Prudential Regulation
 Philippine branches of foreign banks are bound by the pertinent provisions
of the GBL and the Manual of Regulations for Banks, except those providing
for (1) the creation, formation, organization or dissolution of corporations,
and (2) the fixing of the relations, liabilities, responsibilities or duties of
shareholders, directors or officers of corporations.
 These excluded matters will be governed by the applicable law in the
jurisdiction of the foreign bank. Apart from the aforementioned in items (1)
and (2), branches of foreign banks are required to conduct their operations
subject to the same standards required of domestic banks.
 A branch does not have a board of directors. It is usually managed by an
individual appointed by the head office, and his or her authority is normally
set out in a power of attorney from the head office.
 Prudential Regulation
Regulatory Capital and Liquidity
 Section 34 of the GBL enjoins the BSP to conform the 'minimum ratio which
the net worth of a bank must bear to its total risk assets' to 'internationally
accepted standards, including those of the Bank of International
Settlements relating to risk-based capital requirements’.
 In the case of non-compliance by a bank with the prescribed minimum
ratio, the Monetary Board may, until that ratio is met or restored by the
bank:
a. limit or prohibit the distribution of net profits by the bank, and require
that those profits be used, in full or in part, to increase the capital
accounts of the bank;
b. restrict or prohibit the acquisition of major assets by the bank; and
c. restrict or prohibit the making of new investments by the bank, with
the exception of purchases of readily marketable evidence of
indebtedness of the government and the BSP, and other evidence of
indebtedness or obligations, the servicing and the repayment of which
are fully guaranteed by the government
 Prudential Regulation

 Universal and commercial banks are subject to the capital adequacy

standards under Basel III. The Basel Committee on Banking
Supervision had outlined a staggered implementation of Basel III up to
the end of 2018 to allow internationally active banks time to raise
capital organically.
 However, the BSP decided to adopt Basel III-based capital standards in
full on 1 January 2014 on a non-staggered basis. This is in recognition
of the strong capital position of the Philippine banking industry.28
 Under the rules, the risk capital ratio, expressed as a percentage of
qualifying capital to risk-weighted assets, is 10 per cent for solo bases
(head office plus branches) and consolidated bases (parent bank plus
subsidiary financial allied undertakings, but excluding insurance
companies).
 Prudential Regulation

 The Common Equity Tier 1 (CET1) ratio is 6 per cent,

while the Tier 1 capital ratio is 7.5 per cent.

 Moreover, there is a capital conservation buffer of 2.5

per cent, composed of CET1 capital.

 In addition, the BSP subjects domestically systematically

important banks to a higher loss absorbency by requiring
them to have a higher share of their balance sheets
funded by instruments that increase their resilience as a
going concern.
 Prudential Regulation
 To restrict the build-up of leverage, banks must meet a leverage ratio
of not less than 5 per cent on both a solo and consolidated basis.
 Finally, there is a required liquidity coverage ratio, which is the ratio
of high-quality liquid assets to total net cash outflows. As a minimum,
the stock of liquid assets should enable the bank to withstand
significant liquidity shocks that last 30 calendar days, which would
give time for corrective actions to be taken by the bank management
or the BSP, or by both.
 Thrift banks, rural banks and cooperative banks, which are not
subsidiaries of universal and commercial banks, are covered by a
separate risk-based capital adequacy system labelled by the BSP as the
Basel 1.5 framework – a simplified version of Basel II that takes into
account the simple operations of those banks.
 Prudential Regulation
Recovery and resolution
 Under Section 29 of the New Central Bank Act, the Monetary
Board may appoint a conservator for a bank that is in a 'state of
continuing inability or unwillingness to maintain a condition of
liquidity deemed adequate to protect the interest of depositors
and creditors'. The conservator will:
a. have such powers as the Monetary Board deems necessary to
take charge of the assets and liabilities of the bank;
b. manage the bank or reorganize its management;
c. collect all monies and debts due to the bank; and
d. exercise all powers necessary to restore its viability.
 Prudential Regulation
 The conservator must be competent and knowledgeable in bank
operations and management. There is a one-year limit to conservatorship.
 The Monetary Board will terminate the conservatorship when the bank can
continue to operate on its own. Termination is also an option if the
Monetary Board determines that the continuance in business of the bank
would involve probable loss to the depositors and other creditors of the
bank, in which case Section 30 of the New Central Bank Act would apply.
 Under Section 30, the Monetary Board may summarily forbid a bank from
doing business and designate the PDIC as a receiver of the bank if that
bank 'has insufficient realisable assets, as determined by the Bangko
Sentral, to meet its liabilities'. The appointment of a receiver is also
warranted without prior hearing in the event that the Monetary Board
finds that a bank is unable to pay its liabilities as they become due in the
ordinary course of business; cannot continue in business without involving
probable losses to its depositors or creditors; or has wilfully violated a
final BSP cease-and-desist order involving acts or transactions that amount
to fraud or dissipation of bank assets.
 Prudential Regulation

 The receiver must determine, as soon as possible but not

later than 90 days after the takeover, whether the bank may
be rehabilitated or otherwise placed in a condition that would
permit it to resume business with safety to its depositors and
other creditors, and the general public.
 Any such determination for the resumption of business is
subject to prior Monetary Board approval.
 Prudential Regulation
 In the event that the receiver determines that the bank cannot be
rehabilitated or permitted to resume business, the Monetary Board will
notify the board of directors of the bank accordingly, and instruct the
receiver to liquidate the bank.

 The receiver will then file an ex parte petition in court for assistance in
the liquidation of the bank pursuant to a liquidation plan adopted by the
PDIC for general application to all closed banks and convert the assets of
the bank to money, disposing of the same to creditors and other parties,
for the purpose of paying the debts of the bank in accordance with the
rules on concurrence and preference of credits under the Civil Code of the
Philippines, and institute actions to collect and recover accounts and
assets of, or defend any action against, the bank.
 Prudential Regulation
 The actions of the Monetary Board taken under Section 30 of the New
Central Bank Act are final and executory, and may not be restrained or set
aside by a court, except for on petition for certiorari on the ground that
the action in question was in excess of jurisdiction or done with such
grave abuse of discretion as to amount to lack or excess of jurisdiction.

 Under the amended PDIC Charter, a bank ordered to be closed by the

Monetary Board will no longer be rehabilitated. The PDIC, as the
designated receiver, will proceed with the takeover and liquidation of the
closed bank, without the consent of the stockholders, board of directors,
depositors and the other creditors of the closed bank.
 Conduct of Business

 Section 2 of the GBL requires banks to exercise 'high standards of

integrity and performance'.
 A breach of this fiduciary duty could make the erring bank liable for
damages to its customers, and result in the conduct of banking business
in an unsafe and unsound manner that may lead to a bank run and
eventual insolvency.
 To minimise this systemic risk, prudential measures have been put in
place in the GBL and the Manual of Regulations for Banks.
 Apart from the capital adequacy discussed earlier, these measures
include the reserve requirement, single borrower's limit (SBL), the
directors, officers, stockholders and related interests (DOSRI) limit,
loan-loss provisioning and equity investment limit.
 Conduct of Business
 The BSP is also reinforcing prudential measures to minimise systemic
risk, as exemplified by its adoption of a stress test for the real estate
exposures of local banks.
 Further, Part Ten of the Manual of Regulations for Banks sets forth the
minimum standards of consumer protection in the areas of disclosure
and transparency, confidentiality of client information, fair treatment,
effective recourse and financial education.
 BSP-supervised financial institutions must adhere to the highest service
standards in their dealings with their customers.
 They are required to have a consumer protection risk management
system whereby they are able to identify, measure, monitor and
control consumer protection risks inherent in their operations.
 The BSP considers consumer protection as a core function
complementary to its prudential regulation and supervision, and to its
agenda for financial stability, inclusion and education.
 Conduct of Business
Reserves
 Banks are required to maintain reserves against their deposit and
deposit-substitute liabilities.
 The reserve requirements are not static, as they may be varied from
time to time by the Monetary Board.
 The BSP imposed a unified reserve (initially at 18 per cent) for the
deposit and deposit-substitute liabilities of universal and commercial
banks.
 These reserves, aside from being an instrument of monetary policy of
the BSP, have a prudential purpose, since they serve as a ready source
of funds that will respond to an unusually large number of withdrawals
of deposits taking the shape of a bank run.
 Under manageable circumstances, the reserves and other funds at the
bank's disposal should stem the run.
 Conduct of Business
Single Borrowers Limit (SBL)
 The SBL serves to allocate bank resources to different sectors of the
economy.
 It prevents banks from making excessive loans and other credit
accommodations to a single borrower or corporate group.
 Thus, banks are prohibited from placing all their eggs in the basket of
a single client, thereby safeguarding them from too large a risk
exposure to a single client.
 Currently, the SBL is 25 per cent of the net worth of a bank.
 There could be an incremental SBL of 10 per cent of the net worth of
the bank, provided that the additional liabilities of the borrower are
adequately secured by documents of title to goods that are readily
marketable, non-perishable and fully insured.
 Conduct of Business
Directors, Officers, Stockholders and Related Interests (DOSRI) Limit
 The general policy behind the DOSRI limit is to level the lending field
between insiders (namely, directors, officers, stockholders and their
related interests) and outsiders.
 The rules require that loans and other credit accommodations to DOSRI are
to be in the regular course of business and upon terms no less favourable to
the bank than those offered to those outside the DOSRI circle.
 The aim is to prevent banks from becoming a captive source of finance of
the DOSRI.
 The existing DOSRI rules have three ceilings: an individual ceiling, an
aggregate ceiling and a ceiling on unsecured loans.
 The individual ceiling relates to the total allowable outstanding direct
credit accommodation to a DOSRI, which is an amount equivalent to the
individual's unencumbered deposits in the lending bank plus the book value
of the paid-capital contribution therein. It is also required that the
unsecured credit accommodations must not exceed 30 per cent of the total
DOSRI credit accommodations.
 Conduct of Business
Directors, Officers, Stockholders and Related Interests (DOSRI) Limit
 On the other hand, the aggregate ceiling refers to the total credit
accommodations to DOSRI: this is 15 per cent of the total loan portfolio of
the bank or 100 per cent of its net worth, whichever is lower.
 Before a bank can extend a DOSRI loan, a specific resolution must be passed
by the board of directors, without the participation of the interested
director.
 The resolution must be entered into the records of the bank, and a copy of
the entry must be transmitted to the BSP within 20 banking days of board
approval.
 Conduct of Business

Loan-loss Provisioning
 Appendix 15 to the Manual of Regulations for Banks contains the
basic minimum guidelines for setting up allowances for credit losses
(ACL) in respect of banks 'with operations that may not economically
justify a more sophisticated loan loss estimation methodology or
where practices fell short of expected standards'.
 Loans and other credit accommodations with unpaid principal or
interest are to be classified (as pass, especially mentioned,
substandard, doubtful or loss, as the case may be) and provided with
ACL based on the number of days of missed payments.
 Conduct of Business
Equity investment limit
 There are limits as to how much universal and commercial banks can invest in
equities of enterprises. Under Section 24 of the GBL, the total investment by a
universal bank in equities of allied and non-allied enterprises must not exceed
50 per cent of its net worth, while its equity investment in any one enterprise is
not to exceed 25 per cent of its net worth.41
 On the other hand, the total investment by a commercial bank in equities of
allied enterprises must not exceed 35 per cent of its net worth, while the
individual limit is 25 per cent of its net worth.
 It must be stressed that only universal banks can invest in non-allied
enterprises. In all cases, the approval of the Monetary Board is required.
 Conduct of Business
 A breach of any of the foregoing prudential measures would constitute a
violation of the GBL or the Manual of Regulations for Banks. Under
Section 36 of the New Central Bank Act, any person responsible for a
breach or violation may be criminally prosecuted, and if convicted may
be punished with a fine ranging from 50,000 to 2 million Philippine pesos,
with imprisonment for a period ranging between two and 10 years, or
with a combination of a fine and imprisonment, at the discretion of the
court.
 Further, whenever a bank persists in carrying on its business in an
unlawful or unsafe manner, the Monetary Board may take action under
Section 30 of the New Central Bank Act for its receivership and
liquidation, without prejudice to the penalties provided above and the
administrative sanctions provided in Section 37 of the New Central Bank
Act, namely:
a. fines in amounts determined by the Monetary Board, but in no case to
exceed 1 million pesos for each transactional violation or 100,000 pesos
per calendar day for violations of a continuing nature;
 Conduct of Business
b. suspension of rediscounting privileges or access to BSP credit
facilities;
c. suspension of lending or foreign exchange operations or authority to
accept new deposits or make new investments;
d. suspension of interbank clearing privileges; and
e. suspension or revocation of quasi-banking or other special licenses.
 Conduct of Business
 The bank is subject to certain confidentiality obligations. Any information
relating to the funds or properties of clients of a bank are to be kept
confidential by that bank and its directors, officers, employees and agents.
 Under Subsection 55.1(b) of the GBL, this information cannot be disclosed to
any unauthorised person without a court order. However, under Section 11 of
the Anti-Money Laundering Act of 2001, no court order is required if:
a. the funds or property involved consist of investments (other than those
in bonds issued by the government or its political subdivisions and
instrumentalities, as those are governed by the Secrecy of Bank Deposits
Law mentioned below); and
b. the said investments are related to:
o kidnapping for ransom;
o unlawful activities under Sections 4, 5, 6, 8, 9, 10, 12, 13, 14, 15 and
16 of the Comprehensive Dangerous Drugs Act of 2002;
o hijacking and other violations under Republic Act No. 6235; and
o destructive arson and murder, including that perpetrated by terrorists
against non-combatants and similar targets.
 Conduct of Business
 The term 'unauthorised person' in Subsection 55.1(b) of the GBL does not include
BSP officials involved in the periodic or special examination of a bank, or other
persons authorised by the bank to undertake certain activities on its behalf (e.g.,
a service provider under an outsourcing arrangement allowed under Subsection
55.1(e) of the GBL).
 It must also be noted that the persons entitled to protection under Subsection
55.1(b) are 'private individuals, corporations, or any other entity'. Thus, the
protection would not extend to non-private persons, such as public officials.
 With regard to bank deposits in pesos (as well as investments in bonds issued by
the government or its political subdivisions and instrumentalities), the Secrecy of
Bank Deposits Law applies.
 Under this Law, those deposits and investments may not be examined, enquired
about or looked into by any person, government official, bureau or office,
except:
a. upon written permission of the depositor or investor;
b. in cases of impeachment;
c. upon an order of a competent court regarding bribery;
d. for dereliction of duty by public officials; or
e. where the money deposited or invested is the subject of the litigation.
 Conduct of Business
 The following cases are additional exceptions to the Secrecy of Bank Deposits
Law:
a. prosecution for unexplained wealth under Republic Act No. 3019, as
amended (otherwise known as the Anti-Graft and Corrupt Practices Act);
b. upon order of a competent court in cases of violation of the Anti-Money
Laundering Act of 2001 when it has been established that there is
probable cause that the deposits or investments involved are in any way
related to an unlawful activity or a money laundering offence under the
said Act, except that no court order is required in cases of:
o kidnapping for ransom;
o unlawful activities under Sections 4, 5, 6, 8, 9, 10, 12, 13, 14, 15 and
16 of the Comprehensive Dangerous Drugs Act of 2002;
o hijacking and other violations under Republic Act No. 6235; and
o destructive arson and murder, including that perpetrated by terrorists
against non-combatants and similar targets;
 Conduct of Business
 the BSP's enquiry into or examination of deposits or investments with any
bank when the enquiry or examination is made during the course of the
BSP's periodic or special examination of a bank;
 an enquiry by the Commissioner of Internal Revenue into the deposits of a
decedent for the purpose of determining the gross estate of the
decedent; and
 disclosure of certain information about bank deposits, which have been
dormant for at least 10 years, to the Treasurer of the Philippines in a sworn
statement, a copy of which is posted in the bank premises
 On the other hand, deposits in foreign currency deposit units of banks may
be examined in any of the following instances:
a. upon the written permission of the depositor;
b. upon an order of a competent court in cases of violation of the Anti-
Money Laundering Act of 2001, when it has been established that
there is probable cause that the deposits involved are in any way
related to an unlawful activity or a money laundering offence under
the said Act, except that no court order is required in cases of:
 Conduct of Business
▪ kidnapping for ransom;
▪ unlawful activities under Sections 4, 5, 6, 8, 9, 10, 12, 13, 14,
15 and 16 of the Comprehensive Dangerous Drugs Act of 2002;
▪ hijacking and other violations under Republic Act No. 6235; and
▪ destructive arson and murder, including that perpetrated by
terrorists against non-combatants and similar targets;
c. an enquiry by the Commissioner of Internal Revenue into the
deposits of a decedent for the purpose of determining the gross
estate of the decedent;51 and
d. the BSP's enquiry into or examination of deposits with any bank
when the enquiry or examination is made during the course of the
BSP's periodic or special examination of the bank.
 Conduct of Business
 Notwithstanding the provisions of the Secrecy of Bank Deposits Law,
the Foreign Currency Deposit Act and Subsection 55.1(b) of the GBL,
the BSP and the PDIC may enquire into or examine deposit accounts
and all information related thereto in cases where there is a finding of
unsafe or unsound banking practices.
 Further, under the Terrorism Financing Prevention and Suppression Act
2012, the Anti-Money Laundering Council is authorised, in connection
with an investigation of financing of terrorism, to enquire into or
examine deposits and investments with any bank and any of its
subsidiaries or affiliates without a court order.
 Funding
 Funding for banks comes from equity contributions from its shareholders,
and from loans and credit accommodations from the BSP and other
lenders.
 The BSP has prescribed certain minimum levels of capitalization for
banks. For instance, a universal bank (with more than 100 branches)
must have a minimum paid-in capital of 20 billion pesos at the time of its
establishment, while a commercial bank (with the same number of
branches) must have 15 billion pesos. Furthermore, the risk-based capital
adequacy ratio of universal and commercial banks has continued to be
above the BSP's minimum ratio of 10 per cent and the Basel Accord's
standard ratio of 8 per cent, despite global financial uncertainties.
 The BSP, for its part, provides rediscounting and other credit facilities to
banks, including loans for liquidity purposes and emergency loans during
periods of financial panic that directly threaten monetary and banking
stability.
Control of Banks and Transfers of Banking Business
Control regime
 Under Section 122 of the Manual of Regulations for Banks, the
shareholdings of an individual or a corporation in any bank are subject to
the following limits:
a. foreign individuals and non-bank corporations may collectively own or
control up to 40 per cent of the voting stock of a domestic bank;
b. qualified foreign banks may own or control up to 100 per cent of the
voting stock of a domestic bank;
c. a Filipino individual and a domestic non-bank corporation may each
own up to 40 per cent of the voting stock of a domestic bank, but
there is no ceiling on the aggregate ownership by such individuals and
corporations in a domestic bank; and
d. an individual and corporations wholly or majority-owned by him or
her can own or control only up to a combined 40 per cent of the
voting stock of a domestic bank.
Control of Banks and Transfers of Banking Business
Transfers of banking business
 The prior approval of the Monetary Board is required for transactions involving
voting shares of a bank if they will result in ownership or control of more than
20 per cent of voting shares of stock of a bank by any person (whether natural
or juridical), or will enable that person to elect or be elected as a director of
the bank; or effect a change in the majority ownership or control of the
voting shares of stock of the bank from one group of persons to another.
Foreign individuals and non-bank corporations may collectively own or control
up to 40 per cent of the voting stock of a domestic bank;

 The transaction will not be approved by the Monetary Board unless the bank
concerned immediately complies with the prescribed minimum capital
requirement for new banks.
Control of Banks and Transfers of Banking Business
Transfers of banking business
 Under the Philippine Competition Act, a bank merger or consolidation
whose value exceeds 1 billion pesos is to be notified to the Philippine
Competition Commission. However, a favorable or no-objection ruling
by the Commission will not dispense with the Monetary Board and PDIC
approvals for a merger or consolidation. Further, without PDIC consent,
no insured bank can assume another bank's liability to pay deposits.
Financial Statement
Analysis for Banks
Why do banks exist?
In an ideal world:
However…
Information Asymmetry
 Availability
of information is not the same for
transacting parties.
Adverse selection
 Situation: undesirable results occur because two parties in
the transaction have asymmetric information (before the
transaction)

 In Business: Managers of the business know the potential

returns and risk of the investments; investors
(shareholders) do not.
 In Lending: Borrowers know their ability to pay a loan
(whether they can pay the proposed amount or not);
Lenders do not know them.
Solutions to adverse selection

 Information collection.
 Free rider problem
 Government required disclosures (annual report, F/S)
 Screening
Moral Hazard
 Situation: One party takes an excessive amount of risk or
reckless behavior because it knows another will bear the
burden of such. (this happens after the transaction)

 In Business: Investors (shareholders) prefer to take in risky

project upon borrowing funds from lenders (bondholders).
 In Lending: Borrowers gamble away the money lent by
lenders.
Solutions to moral hazard
 Compensating balance.
 Restrictive covenants.
Why do banks exist?
In the real world:
Banks
 Takes deposits from parties with
excess funds.
 Gives loans to parties who need funds.
 Creates money.
How do banks create money
 Through the fractional reserve banking system…

Res. 10 Depo 100

Loan R 90
How do banks create money
 Through the fractional reserve banking system…

Res. 10 Depo 100 Res 9 Depo 90

Loan R 90 Loan R 81
How do banks create money
 Through the fractional reserve banking system…

Res. 10 Depo 100 Res 9 Depo 90 Res 8.1 Depo 81

Loan R 90 Loan R 81 Loan R 72.9

How do banks create money
 Through the fractional reserve banking system…

Res. 10 Depo 100 Res 9 Depo 90 Res 8.1 Depo 81

Loan R 90 Loan R 81 Loan R 72.9

Will this ever end?
If so, when?...
Bank Financial Statement Analysis
Common ratios for banks.
Return on Net income
Equity Average Equity

Efficiency Non-interest Expense Loan to De-

Ratio Total loans
Interest Revenue posit Ratio Total Deposits
Non- Nonperforming loans Capital
performing Capital
Total loans Adequacy Risk-weighted
loans Ratio Ratio assets
Return on Net Income
Equity Average Equity
P560,000
(P17M +P19M)/2

3.11%
Efficiency Non-interest Expense
Ratio Interest Revenue
P300,000
P1,800,000

16.67%
 Non- Nonperforming Loans
performing Total loans
loans Ratio
P10,000,000
P123,000,000

8.13%
Loan to De- Total Loans
posit Ratio Total Deposits
P123,000,000
P127,000,000

96.85%
Capital Adequacy Ratio
 measures a bank's available capital expressed as a
percentage of a bank's risk-weighted credit exposures.
 Purpose: to protect depositors

Capital Capital
Adequacy Risk-weighted
Ratio assets
 Capital
Capital Risk-weighted assets
Adequacy
Ratio P19,000,000
Risk-weighted
P69,500,000

27.34%
Basel Accords
 Basel I Risk-based capital
 Basel II Internal risk based approach
 Basel III Capital conservation buffer
BSP Circular no. 781 s.2013
Capital
Debt
Preferred Shares
Common Equity
Bank Regulation
 Government Policy:
Bank Regulation
 BSP – via monetary board: Oversight and examination
Bank Regulation
 Consumer Protection Standards:  Fair treatment
 Disclosure and Transparency  Effective Recourse
 Protection of Client information  Financial Education
Bank Regulation
Reserve Requirement Ratio
12%

Bank Regulation
Bank Regulation