Banking: A journalists tool box

Lou UreneckBoston Universitylureneck@bu.edu

Some basic terms, concepts and approaches.

An economy needs banks …

• A safe place for people to keep their money, and maybe even to make it grow.

• A source of credit for consumers and businesses. • Credit is the lubrication for the economy.• An enterprise’s cash flow doesn’t always match its needs for money –

access to credit is necessary for the smooth operation of an enterprise.

An economy needs banks

• A safe place for people to keep their money, and maybe even to make it grow.

• A source of credit for consumers and businesses. • Credit is the lubrication for the economy.• An enterprise’s cash flow doesn’t always match its needs for

money – access to credit is necessary for the smooth operation of an enterprise.

… And consumers need a source of information about their banks, and

banking choices.

• The media is an obvious source of that information: journalism that is objective, informed and without conflict of interest.

Some key terms, concepts and issues

• Business model, and how it applies to banks.• Shadow banking• Debt as an income stream. For banks, debt is an

asset.• Financial scoreboard: the Balance sheet• Key ratios• Asset bubbles• 2008 financial collapse and current problems• Practical advice to journalists

Different banks, different purposes

• Commercial banks• Investment banks• International aid banks• Central banks

New consideration: The shadow banking system. These are the financial “middle men” that do not call themselves banks and are often not regulated or only lightly regulated.

Shadow banking

• Investment banks, Structured Investment Vehicles, hedge funds, money market funds, and even insurance companies

What is a commercial bank?

An business that accepts deposits and makes loans.

It directs savings toward investment.

Like any business, it seeks to make a profit. Like any business, it has a set of financial statements or “scoreboards” that measure performance.

The business model

Banks make their money by borrowing short and lending long.

Depositors on one side; borrowers on the other.

Low interest rates on one side; higher interest rates on other side.

The spread between the two rates is the source of a bank’s revenue.

Yield curve

The business model as a graph.

“Other income”

In addition, banks earn money by services through fees for services. These services can include cash machines, wealth management advice, and sale of financial products such as mutual funds. Banks also make money by buying and selling debt securities.

The money they earn by these means is reflected in their profit and loss statement under “other income.”

A business with a lot of risk

This is why it is so heavily regulated, and why the names of banks often seek to convey stability. The word “Trust” is often employed.

The risks:Liquidity riskCredit riskInterest rate risk

Liquidity risk

The risk that comes from accepting and then investing deposits that customers can withdraw at any time.

“I want my money, and I want it now!”

Liquidity risk

Banks often put 90 percent or more their deposits in investments that are not easily turned into cash. The risk of many customers taking their money out of the bank at one time requires banks to have access to cash.

1.Cash on hand.2.The ability to borrow from other banks as

needed.

Leverage

Using a small amount of money as a “lever” to earn a much larger amount of money.

A bank may be holding only a small percent of the money that has been deposited with it. The rest has been loaned to creditors.

Example of bank run

Credit risk

Credit risk is the risk that a person or business that borrows from a bank will not be able to pay back the loan. This is at the bottom of the problem that many banks in Europe and US are struggling with right now. They made, or purchased, bad loans.

The term that banks use for a bad loan is a “non-performing asset.”

Credit risk

To reduce this risk, banks evaluate a borrower’s ability to pay by examining income and assets.

Banks also try to diversify their loan portfolios. They make different types of loans so that a high proportion of their loans don't go bad at the same time. They also buy and sell loan portfolios from other players.

Example of bad loans

Interest rate risk

Remember, the business model? Accept low-interest deposits and put them in high-interest investments.

Interest rates move up and down. Banks can get caught in a situation where depositors demand high interest rates and investments are providing low returns.

The bank get squeezed. Net interest income is the difference between the two.

Yield curve again

.

Example too many deposits

Evaluating a bank

• CAMEL– Capital– Asset Quality– Management– Earnings– Liquidity

CAMEL

Capital – how much of the bank’s own money is available to meet its needs.

Assets – Typically, the loans. Remember, for banks a loan is an asset.

Management – The quality of the people who manage the bank.

Earnings – The amount of the bank’s profit. Typically, the measure of success in any business.

Liquidity – The bank’s ability to meet depositor demands.

Bank scorecards

• Income statement• Balance sheet

Balance sheet

Assets = Liabilities + Owners’ Capital (equity)

Or,Capital = Assets – Liabilities

Deposits are liabilities

A deposit can be claimed at any time by a customer. “I want my money! I want it now!”

As a result, a deposit is a liability.

A loan is an asset

Each loan is a kind of black box that generates a line of revenue for the bank. The quality of the black box depends on the credit-worthiness of the borrower, the rate of interest and the term of the loan.

As a consequence, a loan (which generates revenue) is considered an asset of the bank.

Leverage

Banks only keep a small percentage of cash available to meet the demands of depositors. Most of the deposits are distributed as loans to earn revenue.

Measuring the degree to which a bank is leveraged is important. Leverage can be deduced from the balance sheet.

Leverage

Simplified

Readily accessible capital (Tier 1 Capital)Loans

Some terms

• Important income statement and balance sheet data:

• Revenue • Costs • Profit• Net interest margin

Income statement

Balance sheet

Key numbers, ratios

• Net Interest Income ratio• Loans to deposits ratio• Leverage ratio

Credit to deposit ratio

This ratio indicates the funds lent out of the total amount raised through deposits.

A higher ratio indicates more optimal utilization of funds. Check the bank's CDR against the industry range.

Non performing assets

Net NPA ratio is a measure of the overall quality of the bank's loan book. A higher ratio reflects rising incidence of bad loans. 

                         Non-performing assetsNPA ratio = ---------------------------------                           Loans

Profitability

Return on equity (RoE) and Return on Assets (RoA) are the standard metrics for checking a bank's profitability.

• Compare to other banks and across time.•  It is easy for a bank to boost its earnings in the short term by under provisioning for bad loans or by leveraging the balance sheet. 

ROA

      

                           Net profits        ROA =          ---------------                        Average total assets 

• .             Net interest income (NII) - operating expensesOPM = ---------------------------------             Total interest income

Net interest margin. 

Net interest margin is the net interest income as a percentage of average earning assets. It shows how profitable a bank's lending and deposit-taking activities are.        

                     NIM =     Interest income - Interest expenses                              Average earning assets

Tracking banks

http://banktracker.investigativereportingworkshop.org/methodology/

Regulation

• Key to the beat. Know the agencies, key reports and the key people. Look for data on

• Market share• Deposits• Types of loans• Nonperforming loans• Make comparisons• Numbers in isolation not helpful. Trends, etc.

Regulation and shadow banking

“Anything that does what a bank does, anything that has to be rescued in

crises the ways banks are, should be regulated as a bank.” Paul Krugman

The 2007/08 crisis

Types of stories

• Examples here.

Practical advice

List of banks: ownership, headquarters, key officers.

Evaluate the banks by the numbers: depostits, profits, share prices, key ratios, ind the lawyers.

Just about every major law firm in town will have banking and finance experts, accountants, consultants, borrowers (businesses)

Sources

Craig Douglas, Boston Business Journal; Paul Krugman, Princeton University; Cornelius Healy, Boston University; Heather Landy, American Banker magazine; Investopedia; Kenneth Rogoff, Harvard University; Lawrence Kotlikoff, Boston University; The New York Times; Michael Lewis; Society of American Business Writers and Editors; Reynolds Institute for Business Journalism.