Know your bank!

by Business Times
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This is the season of results, when Uganda’s commercial banks and other financial institutions are obligated by statute, to publish their financial statements.

Marketing managers of our daily newspapers are always happy. It means several pages of paid advertisement.

Admittedly, making sense of all those columns of figures does not make for thrilling reading. But it is useful to have a basic understanding of what they mean, if you want to know how well your bank is doing in the market place.

Some of us will merely look for the profit-after-tax figure then move on, but there is much more to a bank than how much money it makes. It is also instructive to have a good idea of how they made it. Think of it as an exercise in financial literacy.

According to the International Accounting Standards (IAS), the over-riding intention for publishing the balance sheet is to provide the public with the appropriate information that assists them in evaluating the financial position and performance of a relevant bank.

In the banking industry they have a term—‘Know Your Customer’. Well in this case, here is a chance for you, the customer, to ‘Know Your Bank’.

Public sentiments about banks are often misconstrued. Just because you have been denied a loan and feel hard done by, remember banks are not charities. They are businesses that exist, like other commercial enterprises, to make profits for their shareholders.

But banks also operate in a highly regulated environment that demands that management weighs all the risks at a much higher set of standards than other businesses. That’s because they are dealing with other people’s money.

Stripped of all the technical jargon, a bank takes the shareholders’ and depositors’ money then lends it to creditworthy borrowers at a price or interest that varies according to market conditions. Putting this money to work in the most profitable ways to generate returns, is what drives the banking industry. It is also why we are frequently given inducements to take out loans. At the same time though, the bank must be able to give the depositor access to their money on demand.

Banks earn income from the difference between the interest they earn on lending and the cost of storing customer deposits. From this income they must cover all their overheads, taxes and other expenditure before deriving any profit. Banks also make money from their various additional products and services that include wealth management advice, account fees, overdraft fees, ATM fees and fees on credit cards. Another notable source is lending to the government by investing in government securities, such as treasury bills.

It’s a tricky juggling act and the main reason why being trusted is a bank’s oxygen. Without it, there is no reason to be in business. In deciding not to cough up more money for Credit Suisse, as a major shareholder, the Saudi National Bank blatantly showed its lack of trust which then triggered a stampede of depositors pulling out their money.

Almost everything you want know about your bank is on the balance sheet. However, there are three indicative factors to look out for namely liquidity, solvency and profitability.

Liquidity tells us there is enough cash available at any point for the bank to meet its obligations. Solvency looks at the bank’s creditworthiness or being in a position of sufficiency by having quality assets. Profitability conveys the bank’s profit-making capability using the available resources.

When you are going through the figures in the newspaper, it might help your understanding to know that for banks, loans are assets, but depositors’ money is a liability. However, loans also come with risk, specifically when borrowers do not pay back which directly affects the bank’s income.  But again, here is the funny part, the greater the percentage of deposits as liabilities, the more profitable a bank is likely to be. That’s because it has more money to lend out.

Take note of the item ‘shareholder equity’ which is the difference between assets and liabilities. The greater the ratio of assets to equity, the greater the risk to the bank if it’s loans become non-performing.

A bank’s income statement contains two general categories: interest income and non-interest income. The former is the money earned from lending out customer deposits and the interest earned. Non-interest income covers all the other business activities that a bank is involved in.

A bank’s income statement will also include interest expense. This is the cost of looking after customer deposits, which would be deducted from interest-related revenue. A bank’s income statement also includes an item called ‘provisions’ line which covers loans that have defaulted and will not be repaid.

Here are a couple more items for you to watch out for. The capital adequacy ratio (CAR) comes from dividing the bank’s available capital by the total loans. The higher the CAR, the better capitalised the bank is.

Non-performing assets (NPAs) indicate how much of a bank’s loan book is in danger of not being repaid. NPAs are further categorised as gross and net NPAs. Gross NPA includes both the principal and interest aspects of the loan, whereas net NPA is calculated mainly by subtracting the provisions made by the bank from the gross NPA.

Under the item, ‘provision coverage ratio (PCR)’, banks cater for bad loans by setting aside funds to a prescribed percentage of their bad assets. A high PCR means that most of these bad loans have been written off.

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To judge the day-to-day efficiency of a bank’s operations, look for the item, ‘cost of income’. This is calculated by dividing operating expenses by the bank’s operating income (interest income plus other income).  However, there is an inverse relation between cost to income and the bank’s profitability in that the lower the cost-to-income ratio, the better the profitability is.

Of most importance is the ‘return on assets (ROA)’. From this figure you can tell how profitable the bank is relative to its total assets. It is calculated by dividing net profit by total assets.

A high ROA relative to other banks can be due  to various factors, including substantial additional income, aggressive lending practices, operational efficiency and other factors. The ROA is a source of bragging rights, because it shows shareholders, investors and other stakeholders of the bank that, we are doing well.

As of June 30, 2022, there were 25 licensed banks in the country. While Bank of Uganda is their regulator, the Uganda Bankers Association acts as their champion, ready to lobby their interests whenever and where ever it is necessary.

You may ask: who then lobbies for the customer? Apparently, BoU has Financial Consumer Protection Guidelines which all our financial institutions are party to. But let’s face it—when your money disappears from your account, the first inclination is to make a lot of noise, bang tables and demand to see the manager and for good measure, also seek media coverage. Who bother about guidelines!

By virtue of having vast amounts of money under their watch, some banks are more important than others. These are technically referred to by BoU as Domestic Systemically Important Banks. Their fate is closely linked with Uganda’s financial stability and the economy at large. 

Recently, Equity Bank Uganda Limited was elevated into this heavyweight category to join Stanbic Bank Uganda Limited; Standard Chartered Bank Uganda Limited; Centenary Bank Limited; dfcu Bank Limited and Absa Uganda Limited.

These are banks with deep pockets who can easily keep up with BoU’s rising capital requirements. They also have in place recovery plans, acceptable to BoU, in case of emergencies. When any of these banks wobble, it is cause for all of us to be concerned.

The emergence of digital technology is rapidly transforming the banking industry, resulting in ever greater convenience for customers. For those of us whose account balance is a constant struggle to rise from zero, it is comforting to deal with a faceless software application than go through the physical ordeal having the teller jot down your financial misery.

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