Safe Bank

The article is devoted to the narrow issue of the financial analysis of banks: a comparative study. An adequate selection of reference for the evaluation and comparison of the calculated indices determines the possibility of making a proper assessment on the financial condition of a bank or a selected aspect of its performance. The paper presents the principles of comparative analysis in four dimensions: structure analysis, comparisons across time (dynamics) and space (other banks), and references to the benchmarks. In discussing the internal analysis (changes in time) one of the specific issues of concern is presented: the comparability of interim indicators (requiring to annualize the rated measures). The guidelines for external comparisons (with other entities) are recommended and the principles of construction of the synthetic measure (allowing for a multi-criteria comparative
analysis) are presented. The article concludes with a list of methodological notes associated with carrying out comparative analyses.

Counterparties of financial institutions, in order to calculate the price of the product or the required level of collateral, need to assess their standing. The purpose of this article is to present possible causes of incorrect assessment of the financial institution’s standing based on the data publicly disclosed by the institution.

Such causes may result from adopted financial reporting standards (IFRS, US GAAP or other), which differ in matters that are crucial for reporting of the financial institution’s position such as offsetting financial assets and financial liabilities (otherwise known as netting) or derecognition of financial assets, which determines the accounting for repo transactions. This lack of convergence reduces the comparability of financial statements and requires thorough accounting knowledge to understand and eliminate the impact of these differences on the assessment of the financial standing.

The financial institution may also take deliberate actions to present its financial results in a particular way. Transactions may be designed and structured in order to ensure the expected presentation in the financial statements, positive impact on the financial ratios etc., in line with the financial reporting standards, but against the economic substance of a transaction.

Such mechanism has been implemented by Lehman Brothers, who focused on reducing their publicly disclosed leverage ratios. Lehman Brothers employed transactions called “Repo 105” and “Repo 108”, and accounted for these transactions as “sales” under US GAAP, as opposed to financing transactions, based upon the overcollateralization or higher than normal haircut. By recharacterizing the transaction as “sales,” Lehman temporarily removed securities from its balance sheet, to improve their leverage ratio and created a misleading picture of the firm’s financial conditions. Moreover Lehman Brothers did not publicly disclose its use of Repo 105/108 transactions, its accounting treatment for them, volumes and their impact on the firm’s ratios. SEC, FED and rating agencies were also unaware of Lehman’s Repo 105/108 transactions, while by applying them, Lehman temporarily reduced
its net balance sheet at quarter-end by approximately $38.6 billion in the fourth quarter of 2007, $49.1 billion in the first quarter of 2008, and $50.38 billion in the second quarter of 2008.

After “Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner Report” had been released in March 2010, SEC made inquiries of about two dozenfinancial firms to determine whether their repo activities over the past few years had been similar to those of Lehman. Moreover the Financial Accounting Standards Board, which sets U.S. accounting rules, decided to change repo accounting under US GAAP effective from 15 December 2011, making a significant step in the IFRS and US GAAP convergence project and improving the comparability of financial statements.

Data Envelope Analysis (DEA) is one of the methods used to measure the effectiveness of entities. There are two possible options in building the DEA models: CCR model – input oriented and BCC – output oriented. Authors of the paper decided to use the former one which means that the chosen ratios (as inputs) will be minimised. The purpose of this research is to check the effectiveness of a few banks operating in Poland. The time range for this analysis was 2004–2009, so it covered the last financial crisis which had a visible influence on the banking sector. Banks were the entities that suffered a lot during the crisis. Results obtained from the DEA model were compared with the classical methods of the financial analysis (i.e. profitability and efficiency ratios). On the basis of the results it was possible to assess which from the chosen banks were effective and how the effectiveness changed in the analysed time range.

This paper reviews literature on earnings management in banks, focusing on income smoothing through loan loss provisions. The paper presents motivations underlying income smoothing, the effect of this process on bank capital and its influence on procyclicality of bank activities. A crucial role of bank management is underlined, as the income smoothing process is driven by bank managers with prudential and non-prudential motivations. The paper summarises recent results of empirical studies in the income smoothing area. The introduction of anticyclical reserves recommended by the Financial Stability Board stays in close proximity
with conclusions from international research. However, potential regulations also have to account for the behaviour of bank managers, who optimise not only bank value, but also their private benefits derived from more stable income streams of the managed institutions.

The changes that have occurred on U.S. financial market over the last several years have led to a dynamic growth of this market. In the past, deposit and credit activities were carried out mainly by banks. Currently, these transactions are conducted by both the banking sector, as well as by several institutions operating in the financial market which, however, do not belong to the traditional banking sector. Due to the fact that non-banking financial institutions were not subject to applicable regulations and a safety net, they have been named shadow banking system.

The article describes the system of shadow banking and presents the significance of this system during the financial crisis of 2007–2008. Events that occurred in the financial market have confirmed that shadow banking not only contributed to the occurrence of the crisis but also gave it the character of a systemic crisis. Based on the findings on the causes of the crisis new financial market regulations were introduced in the United States. Although these regulations increase the safety of this market, they still fail to provide its stability