The Bank Credit Analysis Handbook E-Book

Jonathan Golin

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 1961

Veröffentlichungsjahr: 2013

Beschreibung

The Bank Credit Analysis Handbook Praise for The Bank Credit Analysis Handbook "In this second edition, Philippe Delhaise and Jonathan Golin build on their professional experience with Thomson Bank Watch Asia to produce a clear introduction to bank credit risk analysis. As very few books on this topic exist, it is a most welcome publication. The short and transparent chapters are rich on institutional information, building on intuition. It is quite an achievement to analyze bank solvency with no reference to heavy mathematics and statistics. The book covers topics of recent interest such as liquidity risk, sovereign and banking crises, and bank restructuring." --Jean Dermine Professor of Banking and Finance, Chair, INSEAD "Messrs. Delhaise and Golin have written what must be considered the seminal book on bank credit analysis. Its breadth and scope is reflective of the decades of experience they have in deciphering the core elements of bank credit risk. I found the chapter on country and sovereign risk particularly useful. This book should be considered essential reading for anyone in the field of credit risk analysis." -- Daniel Wagner CEO of Country Risk Solutions and author of Managing Country Risk "This book is an excellent reference for anyone involved in bank risk management. It combines practical tools with case studies. Based on their substantial experience, Golin and Delhaise nicely bridge the gap between theory and practice." --André Farber Professor of Finance, Université Libre de Bruxelles "Jonathan Golin has done it again. Both he and Philippe Delhaise have taken a very complicated and timely topic and have distilled the subject matter into an easy read that is useful to those directly or indirectly involved with bank credit analysis." --Craig Lindsay Chairman, Hong Kong Securities and Investment Institute "Messrs. Delhaise and Golin have updated their first edition of this handbook with such a high degree of relevance and insight, on the heels of the 2007-2008 banking crisis, that this reference guide will surely be essential reading for every market participant involved with bank risk analysis. There are few people as qualified to write on this subject as these gentlemen; their experience speaks volumes. Once again, they are to be commended for distilling a complex subject into a practical and useful handbook." --Andrew Miller Management Consultant, Financial Services, Hong Kong

Leseprobe

Contents

Preface to the New Edition

Chapter 1: The Credit Decision

Definition of Credit

Willingness to Pay

Evaluating the Capacity to Repay: Science or Art?

Categories of Credit Analysis

A Quantitative Measurement of Credit Risk

Chapter 2: The Credit Analyst

The Universe of Credit Analysts

Role of the Bank Credit Analyst: Scope and Responsibilities

Credit Analysis: Tools and Methods

Requisite Data for the Bank Credit Analysis

Spreading the Financials

Additional Resources

Camel in a Nutshell

Chapter 3: The Business of Banking

Banks as Lenders

Banks as Financial Service Providers

Chapter 4: Deconstructing the Bank Income Statement

Anatomy of a Bank Income Statement: An Overview

A Further Dissection

Income Statements Under IAS

Chapter 5: Deconstructing a Bank’s Balance Sheet

Key Differences Between the Balance Sheets of Banks and Nonfinancial Companies

The Essential Line Items of the Bank Balance Sheet: Asset Side

The Essential Line Items of the Bank Balance Sheet: Liability Side

Off-Balance-Sheet Items and Derivatives

Chapter 6: Earnings and Profitability

The Importance of Earnings

Evaluating Earnings and Profitability: An Overview

Earnings Analysis

Profitability Ratio Analysis

Profitability: An Illustration of a Peer Analysis

Macro-Level Influences on Bank Profitability

Micro-Level Influences on Bank Profitability

Quality of Earnings

Chapter 7: Asset Quality

Asset Quality and NPLS: An Introduction

Resolution of NPLS

Accounting for NPLS

What Causes Excessive NPLS

Macroeconomic Influences on Asset Quality—Economic, Business, and Credit Cycles

Data and Ratio Analysis

Loan Book Composition, Credit Culture, and other Soft Factors

Chapter 8: Management and Corporate Governance

An Overview of Management Appraisal

Corporate Governance

Chapter 9: Capital

The Function and Importance of Capital

What is Capital?

Measuring Capital Strength: Traditional Ratios

Regulatory Capital and the First Basel Accord

The Basel II and Basel III Accords and the Concept of Economic Capital

Chapter 10: Liquidity

What is Liquidity and Why is it Important?

Elements of Bank Liquidity Analysis

Chapter 11: Country and Sovereign Risk

Overview

Fiscal, Monetary, and Trade Policies

Chapter 12: Risk Management, Basel Accords, and Ratings

Risk and the Importance of Risk Management

Categories of Bank Risk

Risk Management Methods

Basel II and Basel III

Ratings

Chapter 13: The Banking Regulatory Regime

Overview

The Rationale for Regulation

The Regulatory Regime

The Structure and Strength of the Regulatory Apparatus

The Quality of the Legal System and Creditors’ Rights

Gauging Banking System Fragility

State Ownership and State Support of Banks

Chapter 14: Crises: Banking, Financial, Twin, Economic, Debt, Sovereign, and Policy Crises

An Introduction to Banking and Financial Crises

Early-Warning Systems of Financial Crises

Chapter 15: The Resolution of Banking Crises

Recognizing the Crisis

First Response

Supply Liquidity and Stop the Bleeding

Recapitalization and Restructuring

Asset Disposal and Regulatory Reform

Bank Restructuring in Malaysia During the 1990s Asian Financial Crisis: A Practical Example

About the Authors

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more.

For a list of available titles, visit our Web site at www.WileyFinance.com.

Cover Design: Leiva-Sposato

Cover Image: Gradient © Pavel Khorenyan/iStockphoto;

Bank note © Luis Pedrosa/iStockphoto

Copyright © 2013 by John Wiley & Sons Singapore Pte. Ltd.

Published by John Wiley & Sons Singapore Pte. Ltd.

1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore 138628

All rights reserved.

First edition published in 2001.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center. Requests for permission should be addressed to the Publisher, John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07-01, Solaris South Tower, Singapore 138628, tel: [phone], fax: [phone], e-mail: [email protected].

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor the author shall be liable for any damages arising herefrom.

Other Wiley Editorial Offices

John Wiley & Sons, 111 River Street, Hoboken, NJ 07030, USA

John Wiley & Sons, The Atrium, Southern Gate, Chichester, West Sussex, P019 8SQ, United Kingdom

John Wiley & Sons (Canada) Ltd., 5353 Dundas Street West, Suite 400, Toronto, Ontario, M9B 6HB, Canada

John Wiley & Sons Australia Ltd., 42 McDougall Street, Milton, Queensland 4064, Australia

Wiley-VCH, Boschstrasse 12, D-69469 Weinheim, Germany

Library of Congress Cataloging-in-Publication Data

ISBN 978-0-470-82157-2 (Hardcover)

ISBN 978-0-470-82943-1 (ePDF)

ISBN 978-0-470-82942-4 (Mobi)

ISBN 978-0-470-82944-8 (ePub)

Preface to the New Edition

In early 1997, Jonathan Golin applied for a position of bank credit analyst with Thomson BankWatch. He had limited experience in financial analysis, let alone bank financial analysis, but Philippe Delhaise, then president of BankWatch’s Asia division, had long held the view that outstanding brains, good analytical skills, a passion for details, and a degree of latent skepticism were the best assets of a brilliant bank financial analyst. He immediately hired Jonathan.

Jonathan joined a team of very talented senior analysts, among them Andrew Seiz, Damien Wood, Tony Watson, Paul Grela, and Mark Jones. Philippe and the Thomson BankWatch Asia team produced, as early as 1994 and 1995, forewarning reports on the weaknesses of Asia’s banking systems that led to the Asian crisis of 1997.

After the crisis erupted, Philippe made countless presentations on all continents, and he conducted, with some of his senior analysts, a number of seminars on the Asian crisis. This led to a contract with John Wiley & Sons for Philippe to produce a book on the 1997 crisis that was very well received, and which we hope the reader will forgive us for quoting occasionally.

When in 1999 John Wiley & Sons started looking for a writer who could put together a comprehensive bank credit analysis handbook, Philippe had neither the time nor the courage to embark on such a voyage, but he encouraged Jonathan to take the plunge with the support of unlimited access to Philippe’s notes and experience, something Jonathan gave him credit for in the first edition of the Bank Credit Analysis Handbook, published in 2001.

Meanwhile, Thomson BankWatch—at one point renamed Thomson Financial BankWatch—merged with Fitch in 2000, but Philippe and Jonathan quit prior to the merger. Philippe carried on teaching finance and conducting seminars on bank risk management in a number of countries. Recently, in Hong Kong, Philippe cofounded CTRisks Rating, a new rating agency using advanced techniques in the analysis of risk. Jonathan moved to London, where he founded two companies devoted to bank and company risk analysis.

During the 2000s, the risk profile of most banks changed dramatically. Many changes took place in the manner banks had to manage and report their own risks, and in the way such risks shaped a bank’s own credit risk, as seen from the outside. Jonathan’s book needed an overhaul rather than a cosmetic update. This is how eventually Jonathan and Philippe joined forces to present this new, expanded edition to our readers.

In the preface of the first edition, Jonathan thanked Darren Stubing for his substantial contribution to several chapters, and most likely some of Darren’s original input still pervades this new version of the book. The same applies to texts contributed by Andrew Seiz in the first edition, and there is no doubt that research done by the Thomson BankWatch Asia team, together with some of their New York–based colleagues, permeates the analytical line adopted both in Jonathan’s first edition and in the present new edition of The Bank Credit Analysis Handbook. The only direct outside contribution to this edition is coming from Richard Lumley in the chapter on risk management. We are thankful to all direct and indirect contributors.

DRAMATIC CHANGES

The crisis that started in 2007 is still on at the time of writing. Banks and financial systems should share the blame with profligate politicians, outdated socioeconomic models, and a shift of the world’s center of gravity toward newcomers.

However deep the resentment against banking and finance—often fanned by otherwise entertaining political slogans1—banks are here to stay.

Banks remain a major conduit for the transformation of savings into productive investments. It is particularly so in emerging countries where capital markets are still not sufficiently developed and where savers have limited access to direct credit risk opportunities. Even in advanced economies, access to market risk often involves dealing with banks whose contribution as intermediaries is sometimes—and often justifiably—questionable.

More than most other financial intermediaries, banks do carry substantial credit and market risks. They act as shock absorbers by removing from their depositor’s shoulders—and charging, alas, hefty fees for the service—some of that burden.

As we shall point out in this book, weak banks actually rarely fail—they often merge or get nationalized—or at least their problems rarely translate into losses for depositors2 or creditors. Major disasters do occur, though, and we should not dismiss the view that the mere possibility of such an occurrence is enough for state ownership or state control of banks to gain respect in spite of the huge inefficiencies such models introduce. At the very least, banks should be submitted, within reason, to better regulatory control.

Banks, however, cannot survive unless they take risks. The trick for them is to manage those risks without destroying shareholder value—the fatter the better, from a creditworthiness point of view—and without endangering depositors and creditors.

STRUCTURE OF THE BOOK

This book explores the tools available to external analysts who wish to find out for themselves whether and to what extent a bank or a group of banks is creditworthy.

It is a jungle out there. A wide range of theoretical research is available. Extreme opinions exist on most topics, making it difficult to reach a consensus on a middle ground where depositors, creditors, and regulators should confine the banking systems’ risk analysis.

Our book is a modest attempt at balancing the wealth of research and opinions within a useful handbook for analysts, regulators, risk assessment offices, and finance students.

Dividing bank credit analysis in separate chapters was a headache. Asset quality has an impact on earnings and on capital adequacy, liquidity on asset quality and earnings, management skills on asset quality, earnings on capital, accounting rules on earnings and capital—all on convoluted Möbius strips.

The first three chapters explore the notions associated with the credit decision, with the tools used in creditworthiness analysis and generally with the business of banking, more specifically with those activities that expose banks to risk.

Chapters 4 and 5 explore the earnings—or income, or profit and loss—statement and the balance sheet of a bank, together with the increasingly important off-balance sheet. Those documents are the first documents an analyst will be confronted with. Except for the reader already familiar with bank financial statements, those chapters are essential to understand how the various activities of the bank find their way into the final published documents that disclose—and sometimes conceal or disguise—the facts, figures, and ratios that should shape the analyst’s opinion on the bank’s creditworthiness.

The two accounting chapters pave the way for the introduction, in separate chapters, of the five basic elements of CAMEL, the mainstream model for assessing a bank’s performance and financial condition. Each of those five chapters relates back, in some way, to the two accounting chapters.

Chapter 6 discusses earnings and profitability, with their many indicators. Chapter 7 is the most important as it attempts to describe how the analyst can assess the asset quality of a bank, and how the bank monitors its assets and deals with nonperforming loans and with its exposure to other impaired assets or transactions.

Management and corporate governance are covered in Chapter 8, where the analyst will, among other things, learn how to appraise a bank’s overall management skills, which, in spite of tighter external regulations, remain a critical factor.

Chapter 9 is about capital and its various definitions and indicators. This is where a first round of comments touches on the Basel Accords, because the earlier versions of those accords focused almost exclusively on capital adequacy.

Liquidity, which is in Chapter 10, has become a major issue in the wake of the 2007–2012 crisis. It is also a very difficult parameter to analyze. No single indicator is able to describe a bank’s liquidity position, to the point where even the proposed liquidity requirements under Basel III do not bring much light to the debate.

Chapter 11 is about country and sovereign risks, which used to be relevant only to emerging markets but came to the fore during the 2011–2012 debt crisis in Europe. Globalization and the free circulation of funds around most of the world have now pushed the analysis of country and sovereign risk way beyond the traditional ratios describing such basic factors as inflation or balance of payments. Bank creditworthiness is more than ever influenced by macroeconomic factors.

Risk management is analyzed in Chapter 12, together with the second part of our exploration of the Basel Accords, to which we added a section on ratings. Risk management is no doubt the topic that saw the most changes over the past few years.

The banking regulatory regime is explored in Chapter 13, with its structural and prudential regulations as well as its impact on systemic issues.

The regional and worldwide crises of the past 20 years have generated considerable research on the causes of, and remedies to bank crises, financial crises, debt crises, sovereign crises, and their various combinations. Those crises are described and explained in Chapter 14, while Chapter 15—our last chapter—is devoted to the resolution of banking crises specifically.

We decided against offering a glossary of financial terms, as the book is already heavy and, in this day and age, the reader will no doubt find excellent glossaries on the Internet.

In our attempt to render the reader’s task easier by dividing the book into 15 chapters, we created the need for many cross-references to other chapters. We believed that the reader would have neither the courage nor the need to swallow many chapters in one sitting, and we wanted, as much as possible, our chapter on, say, asset quality to cover most or all of what the reader would want to know when reading that chapter in isolation. Inevitably, as a result, there is a—small—degree of duplication here or there.

We would like to beg our readers’ forgiveness for offering many examples from Asia. Both authors are thoroughly familiar with banking systems in that region—which admittedly is no justification in itself—while, more importantly, Asia is by far the largest financial market outside of the EU and the United States. In addition, whatever the definition of an emerging market, Asia without Japan arguably harbors the biggest emerging market banking system in the world, a fertile ground for dubious banking practices.

Considerable research is available on banking systems, banking crises, and other topics relevant to the bank credit analyst. As a matter of fact, so much information and so many opinions are offered that the analyst would need to invest a year of her life just to get acquainted with the existing literature on bank creditworthiness. Our modest ambition was to distill academic research into something palatable, to pepper our findings with information gathered over our many years of experience in bank credit analysis, and to offer our reader a useful reference handbook.

London and Port Arthur

September 2012

NOTES

1. Malaysia’s Prime Minister Mahathir produced an interesting opinion in a speech on September 20, 1997 reported by the Manila Standard newspaper on September 22, 1997: “Currency trading is unnecessary, unproductive and immoral. . . . It should be illegal.” As reported in French by Le Parisien newspaper on January 12, 2012, socialist François Hollande said on that day in a meeting during his campaign for the French presidency “Dans cette bataille qui s’engage, mon véritable adversaire n’a pas de nom, pas de visage, pas de parti, mais il gouverne; cet adversaire c’est le monde de la finance,” which freely translates as: “In the battle that is starting, my true opponent has no name, no face, no party, but it reigns; this opponent is the world of finance.”

2. Especially so where deposit insurance schemes exist.

Chapter 1

The Credit Decision

CREDIT. Trust given or received; expectation of future payment for property transferred, or of fulfillment or promises given; mercantile reputation entitling one to be trusted;—applied to individuals, corporations, communities, or nations; as, to buy goods on credit.

—Webster’s Unabridged Dictionary, 1913 Edition

A bank lives on credit. Till it is trusted it is nothing; and when it ceases to be trusted, it returns to nothing.

—Walter Bagehot1

People should be more concerned with the return of their principal than the return on their principal.

—Jim Rogers2

The word credit derives from the ancient Latin credere, which means “to entrust” or “to believe.”3 Through the intervening centuries, the meaning of the term remains close to the original; lenders, or creditors, extend funds—or “credit”—based upon the belief that the borrower can be entrusted to repay the sum advanced, together with interest, according to the terms agreed. This conviction necessarily rests upon two fundamental principles; namely, the creditor’s confidence that:

1. The borrower is, and will be, willing to repay the funds advanced

2. The borrower has, and will have, the capacity to repay those funds

The first premise generally relies upon the creditor’s knowledge of the borrower (or the borrower’s reputation), while the second is typically based upon the creditor’s understanding of the borrower’s financial condition, or a similar analysis performed by a trusted party.4

DEFINITION OF CREDIT

Consequently, a broad, if not all-encompassing, definition of credit is the realistic belief or expectation, upon which a lender is willing to act, that funds advanced will be repaid in full in accordance with the agreement made between the party lending the funds and the party borrowing the funds.5 Correspondingly, credit risk is the possibility that events, as they unfold, will contravene this belief.

SOME OTHER DEFINITIONS OF CREDIT

Credit [is] nothing but the expectation of money, within some limited time.

—John Locke

Credit is at the heart of not just banking but business itself. Every kind of transaction except, maybe, cash on delivery—from billion-dollar issues of securities to getting paid next week for work done today—involves a credit judgment. . . . Credit . . . is like love or power; it cannot ultimately be measured because it is a matter of risk, trust, and an assessment of how flawed human beings and their institutions will perform.

—R. Taggart Murphy6

Creditworthy or Not

Put another way, a sensible individual with money to spare (i.e., savings or capital) will not provide credit on a commercial basis7—that is, will not make a loan—unless she believes that the borrower has both the requisite willingness and capacity to repay the funds advanced. As suggested, for a creditor to form such a belief rationally, she must be satisfied that the following two questions can be answered in the affirmative:

1. Will the prospective borrower be willing, so long as the obligation exists, to repay it?

2. Will the prospective borrower be able to repay the obligation when required under its terms?

Traditional credit analysis recognizes that these questions will rarely be amenable to definitive yes/no answers. Instead, they call for a judgment of probability. Therefore, in practice, the credit analyst has traditionally sought to answer the question:

What is the likelihood that a borrower will perform its financial obligations in accordance with their terms?

All other things being equal, the closer the probability is to 100 percent, the less likely it is that the creditor will sustain a loss and, accordingly, the lower the credit risk. In the same manner, to the extent that the probability is below 100 percent, the greater the risk of loss, and the higher the credit risk.

CASE STUDY: PREMODERN CREDIT ANALYSIS

The date: The last years of the nineteenth century

The place: A small provincial bank in rural England—let us call the institution Wessex Bank—located in the market town of Westport

Simon Brown, a manager of Wessex Bank, is contemplating a loan to John Smith, a newly arrived merchant who has recently established a bicycle shop in the town’s main square. Smith’s business has only been established a year or so, but trade has been brisk, judging by the increasing number of two-wheelers that can be seen on Westport’s streets and in the surrounding countryside.

Yesterday, Smith called on Brown at his office, and made an application for a loan. The merchant’s accounts, Brown noted, showed a burgeoning business, but one in need of capital to fund inventory expansion, especially in preparation for spring and summer, when prospective customers flock to the shop. While some of Smith’s suppliers provide trade credit, sharply increasing demand for cycles and limited supply have caused them to tighten their own credit terms. Smith projected, not entirely unreasonably, thought Brown, that he could increase his turnover by 30 percent if he could acquire more stock and promise customers quick delivery.

When asked by Brown, Smith said he would be willing to pledge his assets, including the shop’s inventory, as collateral to secure the loan. But Brown, as befits his reputation as a prudent banker, remained skeptical. Those newfangled machines were, in his view, dangerous vehicles and very likely a passing fad.

During the interview, Smith mentioned in passing that he was related on his father’s side to Squire Roberts, a prosperous local landowner well known to Brown and a longstanding customer of Wessex Bank. Just that morning, Brown had seen the old gentleman at the post office, and, to his surprise, Roberts struck up a conversation about the weather and the state of the timber trade, and mentioned that he had heard his nephew had called on Brown recently. Before Brown had time to register the news that Roberts was Smith’s uncle, Roberts volunteered that he was willing to vouch for Smith’s character—“a fine lad”—and, moreover, added that he was willing to guarantee the loan.