Commercial Bank’s Financial Statements and Analysis

Commercial banks have a unique business model—they accept deposits (liabilities) and create loans and investments (assets). Consequently, their financial statements are fundamentally different from non-financial firms. Banks do not hold inventory, accounts receivable, or traditional plant and machinery as primary assets. Instead, their assets are financial claims, and their liabilities are mostly customer deposits. Therefore, standard ratio analysis (e.g., inventory turnover) is irrelevant for banks. Instead, analysts focus on asset quality, capital adequacy, liquidity, and interest rate sensitivity. In India, bank financial statements are prepared according to the Banking Regulation Act, 1949, and follow RBI’s prescribed formats under the Third Schedule of the Act, aligned with Accounting Standard (AS) 30 (now Ind AS 109 for certain banks). The two primary statements are the Balance Sheet and the Profit & Loss Account, supplemented by Schedules and Notes to Accounts.

Part 1: Balance Sheet of a Commercial Bank

The bank’s balance sheet is divided into Capital and Liabilities (sources of funds) and Assets (uses of funds). The format is prescribed under Form A of the Third Schedule.

A. Capital and Liabilities

1. Capital: This includes equity share capital (paid-up ordinary shares) and preference shares. It represents the owners’ stake and acts as a buffer against losses. It also includes reserves and surplus (statutory reserves, capital reserves, share premium, investment fluctuation reserve, and retained earnings). Statutory reserve is mandatory under Section 17 of the Banking Regulation Act—banks must transfer at least 25% of net profits to this reserve until it equals the paid-up capital.

2. Reserves and Surplus: Apart from statutory reserve, banks maintain capital reserve (from sale of assets), securities premium account, and general reserve. These strengthen the capital base.

3. Deposits: This is the largest liability (typically 70-85% of total liabilities). It is sub-divided into:

   • Demand deposits (current accounts, no interest or low interest)

   • Savings bank deposits (interest-bearing, restrictions on withdrawals)

   • Term deposits (fixed deposits, recurring deposits, maturity-based)

4. Borrowings: Funds borrowed from RBI (lender of last resort), other banks (interbank borrowings), and institutions like NABARD, SIDBI, or via bonds/debentures.

5. Other Liabilities and Provisions: Includes bills payable, inter-office adjustments, unclaimed dividends, provision for taxation, proposed dividends, contingencies, and employee benefits.

B. Assets

1. Cash and Balances with RBI: This is the most liquid asset. It includes cash in hand (currency notes and coins), balances with RBI (maintained as Cash Reserve Ratio or CRR), and balances with other banks (current accounts). This asset earns no or very low interest but is mandatory for liquidity and statutory compliance (CRR).

2. Investments: Banks invest in government securities (Statutory Liquidity Ratio or SLR requirement), treasury bills, bonds, debentures, and equity shares (up to limits). Under RBI norms, investments are classified into:

   • Held to Maturity (HTM) – valued at cost

   • Available for Sale (AFS) – valued at market price

   • Held for Trading (HFT) – valued at market price, marked to market daily

3. Loans and Advances (Banks’ largest asset, 55-70% of total assets): This includes cash credit, overdraft, term loans, bill discounted/purchased, and priority sector lending. They are classified into performing and non-performing assets (NPAs). RBI mandates classification into:

   • Standard assets (regular, slight risk)

   • Sub-standard assets (NPA for ≤12 months)

   • Doubtful assets (NPA >12 months, also called bad loans)

   • Loss assets (uncollectible)

4. Fixed Assets: Premises, furniture, computers, ATMs, vehicles – similar to other companies but a small portion of total assets (usually <2%).

5. Other Assets: Inter-office adjustments, accrued interest receivable, tax paid in advance, deferred tax assets, and non-banking assets acquired in settlement of loans.

Part 2: Profit and Loss Account of a Commercial Bank

The Profit and Loss Account (Form B of Third Schedule) has four distinct heads: Income, Expenditure, Operating Profit, and Appropriations.

A. Income (Revenue)

1. Interest Earned (largest component, 70-85% of total income): This includes interest on loans/advances, interest on investments (government bonds, corporate bonds), discount on treasury bills, and interest on inter-bank lending. This is the bank’s core operating revenue.

2. Other Income (Fee-Based or Non-Interest Income): This includes commission/exchange/brokerage (from issuing DDs, LCs, collecting cheques), profit on sale of investments, foreign exchange income (forex trading), rental income from lockers, processing fees, service charges, and recovery from written-off accounts. This income is crucial during economic downturns when interest spreads compress.

B. Expenditure

1. Interest Expended (largest expense, 40-60% of total expenditure): Interest paid on deposits (savings, term, demand), interest on borrowings from RBI and other banks, and discount on bills rediscounted. The Net Interest Income (NII) = Interest Earned minus Interest Expended.

2. Operating Expenses: These include employee costs (salaries, bonuses, provident fund, pension), rent, rates and taxes (excluding income tax), legal fees, postage, printing, advertising, IT maintenance, security, insurance, amortization of software, and depreciation on fixed assets.

3. Provisions and Contingencies: This is unique to banks. Banks must make provisions for: (a) Non-performing assets (NPAs) as per RBI norms (e.g., 15% for sub-standard, 25-100% for doubtful), (b) Standard assets (0.25% to 1% depending on sector), (c) Income tax, (d) Wealth tax, (e) Investment depreciation, (f) Fraud cases.

C. Operating Profit & Net Profit:

Operating profit = (Interest Earned + Other Income) – (Interest Expended + Operating Expenses). Net Profit = Operating Profit – Provisions & Contingencies. Part of net profit is transferred to Statutory Reserve (25% minimum), Capital Reserve, Investment Fluctuation Reserve, and then dividend is proposed.

Part 3: Analysis of Bank Financial Statements

Analysis of banks differs significantly from non-financial firms. The CAMELS framework (Capital, Asset Quality, Management, Earnings, Liquidity, Sensitivity) is widely used by regulators. Key ratios and analytical tools include:

A. Capital Adequacy Ratios

• Capital to Risk-Weighted Assets Ratio (CRAR / Capital Adequacy Ratio – CAR): (Tier I + Tier II Capital) ÷ Risk-Weighted Assets. RBI mandates minimum 11.5% for PSBs and 10% for private banks (Basel III: 8% internationally). Tier I includes equity and reserves; Tier II includes subordinated debt and revaluation reserves.

• Common Equity Tier I (CET I) Ratio: Minimum 8% for Indian banks. Indicates core equity strength.

B. Asset Quality Ratios

• Gross NPA Ratio: (Gross NPAs ÷ Gross Advances) × 100. Higher ratio indicates poor asset quality. Indian banking target <6%.

• Net NPA Ratio: (Net NPAs ÷ Net Advances) × 100. Net NPAs = Gross NPAs minus provisions. Ideal <2%.

• Provision Coverage Ratio (PCR): (Total Provisions ÷ Gross NPAs) × 100. RBI encourages >70%. Higher PCR means bank has set aside more buffer.

C. Profitability Ratios

• Net Interest Margin (NIM): (Net Interest Income ÷ Total Earning Assets) × 100. Measures how efficiently bank manages interest spread. Healthy range: 3–4%.

• Return on Assets (RoA): (Net Profit ÷ Total Assets) × 100. Banks have lower RoA (0.8–1.5%) than manufacturing firms due to high leverage. Below 0.5% is concerning.

• Return on Equity (RoE): (Net Profit ÷ Average Shareholders’ Equity) × 100. Typically 12–15% for well-run banks.

• Cost-to-Income Ratio: (Operating Expenses ÷ (Net Interest Income + Other Income)) × 100. Lower is better. Indian banks range 45–60%. Above 55% indicates inefficiency.

D. Liquidity Ratios

• Liquidity Coverage Ratio (LCR) (Basel III): High-quality liquid assets ÷ total net cash outflows over 30 days. Minimum 100%.

• Statutory Liquidity Ratio (SLR): Minimum 18% of Net Demand and Time Liabilities (NDTL) to be held in government securities/cash/gold.

• Cash Reserve Ratio (CRR): Minimum 4.5% (currently 4.5% as of 2025) of NDTL to be kept with RBI.

• Credit-Deposit Ratio (CD Ratio): (Total Advances ÷ Total Deposits) × 100. Ideal 70–75% for liquidity safety; high ratio (80–85%) risks liquidity crunch.

E. Other Bank-Specific Metrics

• Yield on Advances: Interest earned on loans ÷ average advances.

• Cost of Deposits: Interest paid on deposits ÷ average deposits.

• Borrowings to Deposits Ratio: Indicates reliance on unstable wholesale funding. High ratio signals vulnerability.

• CASA Ratio: (Current Account + Savings Account deposits) ÷ Total deposits. Higher CASA (40%+) gives low-cost, sticky funds, improving NIM.

Part 4: Limitations of Bank Financial Analysis

Despite standardized reporting, analysts face challenges: (a) Window dressing – Banks may defer NPA recognition before reporting dates, temporarily show better asset quality. (b) Provision discretion – Within regulatory limits, banks may over-provide in good years and under-provide in bad years, smoothing profits. (c) Off-balance sheet items – Letters of credit, guarantees, derivatives (interest rate swaps) may hide contingent liabilities. (d) Revaluation reserves – Inflation of asset values (e.g., premises) can artificially boost capital. (e) Non-comparability – Banks following different accounting standards (Ind AS vs. old GAAP) or different NPA recognition policies cannot be directly compared.

Therefore, analysts must read Notes to Accounts, observe trend analysis over 5-10 years, and include non-financial parameters like management quality, board governance, technology adoption, and RBI inspection reports (where available).