Sesi 6

Chapter 16
ANALYSIS OF FINANCIAL INSTITUTIONS –

PART 1
Presenter’s name
Presenter’s title
dd Month yyyy
CONTENTS
1. Introduction
2. What Makes Financial Institutions Different?
3. Analyzing a Bank
2
WHAT MAKES FINANCIAL
INSTITUTIONS DIFFERENT?
3
DISTINCTIVE FEATURES
• A distinctive feature of financial institutions—in particular, banks—

is their systemic importance.
- Their smooth functioning is essential to the overall health of an
economy
• The fundamental role of banks is to serve as intermediaries,
accepting deposits from capital providers and providing capital via
loans to borrowers (creates financial inter-linkages across all types
of entities).
- The failure of one bank will negatively affect other financial and non-
financial entities.
Copyright © 2020 CFA Institute 4

• Systemic risk is a risk of disruption to financial services that is:

- (i) caused by an impairment of all or parts of the financial system and
- (ii) has the potential to have serious negative consequences for the
economy as a whole.
• Because of their systemic importance, financial institutions’ activities
are heavily regulated.
- Regulations attempt to constrain excessive risk taking that could
cause an entity to fail.

• Another distinctive feature of financial institutions is that their assets

are predominantly financial assets, such as loans and securities.
- Financial assets create direct exposure to a different variety of risks,
including credit risks, liquidity risks, market risks, and interest rate
risks.
- Unlike many tangible assets, financial assets are often measured at
fair market value for financial reporting.

GLOBAL ORGANIZATION
• The Basel Committee on Banking Supervision (BCBS) is the
primary global standard setter for the prudential regulation of banks
and provides a forum for regular cooperation on banking supervisory
matters.
• BCBS which was established in 1974 and is a standing committee
hosted and supported by the Bank for International Settlements (BIS).
• BCBS has 45 members comprise central banks and bank supervisors
from 28 jurisdictions.
• BCBS developed the international regulatory framework for banks
known as Basel III, which is the enhanced framework succeeding
Basel I and Basel II.
Additional source: https://www.bis.org/bcbs/basel3.htm

• BASEL I
Latar belakang: Kekhawatiran atas krisis utang Amerika Latin (Brazil, Argentina,
Meksiko) pada awal 1980an yang dapat meningkatkan risiko perbankan
internasional.
• BASEL II
Latar belakang : Perubahan yang terjadi pada industri perbankan dan pasar
keuangan termasuk krisis keuangan yang terjadi di Asia Tenggara dan Asia selatan
tahun 1997-1998.
• BASEL III
Latar belakang: Krisis Keuangan Global yang terjadi pada tahun 2007-2009.
• Dimulai pada tahun 2010, Basel III merupakan reformasi pengaturan di sektor
perbankan sebagai respon krisis keuangan dunia tahun 2008 yang diakibatkan oleh
kurangnya kecukupan modal, tingginya variasi ATMR antar Bank-bank, leverage
yang sangat tinggi dan liquidity crunch.
• https://ojk.go.id/id/kanal/perbankan/implementasi-basel/Pages/Road-Map.aspx
• SALINAN SURAT EDARAN OTORITAS JASA KEUANGAN REPUBLIK INDONESIA NOMOR 24 /SEOJK.03/2021 TENTANG
PERHITUNGAN ASET TERTIMBANG MENURUT RISIKO UNTUK RISIKO KREDIT DENGAN MENGGUNAKAN PENDEKATAN
STANDAR BAGI BANK UMUM
• https://www.ojk.go.id/id/regulasi/Documents/Pages/Perhitungan-Aset-Tertimbang-Menurut-Risiko-Untuk-Risiko-Kredit-Dengan-
Menggunakan-Pendekatan-Standar-Bagi-Bank-Umum/SEOJK%2024%20-%2003%20-%202021.pdf
8
ANALYZING A BANK
9
BASEL III
• An internationally agreed set of measures developed by BCBS in
response to the financial crisis of 2007-09.
- The measures aim to strengthen the regulation, supervision and risk
management of banks.
• Basel III standards are minimum requirements which apply to
internationally active banks.
- Members are committed to implementing and applying standards in
their jurisdictions within the time frame established by the Committee.
Additional source: https://www.bis.org/bcbs/basel3.htm

THREE IMPORTANT HIGHLIGHTS OF BASEL III
Minimum capital requirement

• Specifies the minimum percentage of its risk-weighted assets
that a bank must fund with equity capital.
Minimum liquidity
• Specifies that a bank must hold enough high-quality liquid
assets to cover its liquidity needs in a 30-day liquidity stress
scenario.
Stable funding
• Requires a bank to have a minimum amount of stable funding
relative to the bank’s liquidity needs over a one-year horizon.

CAMELS
An acronym for the six components of a widely used bank
rating approach originally developed in the United States
Liquidity Sensitivity
Capital Asset Management Earnings
position, to market
adequacy, quality, capabilities, sufficiency,
and risk

CAMELS
• A bank examiner using the CAMELS approach to evaluate a bank
conducts an analysis and assigns a numerical rating of 1 through 5 to
each component.
- A rating of 1 is the best rating : the best practices in risk management
and performance and generating the least concern for regulators.
- A rating of 5 is the worst rating : the poorest performance and risk
management practices and generating the highest degree of
regulatory concern.
• After the components are rated, a composite rating for the entire bank
is constructed from the component ratings.
- Each component is weighted by the examiner performing the study.
- The examiner’s judgment will affect the weighting accorded to each
component’s rating.

CAPITAL ADEQUACY
• It is important for a bank (as with any company) to have adequate
capital so that potential losses can be absorbed without causing the
bank to become financially weak or even insolvent.
• Tingkat kesehatan bank dari aspek modal dinilai atau diukur

menggunakan Capital Adequacy Ratio (CAR).
• Rasio ini merepresentasikan kemampuan bank dalam menggunakan
modalnya sendiri untuk menutup penurunan aktiva.

CAPITAL ADEQUACY
• The proportion of the bank’s assets funded with capital.
- A bank’s assets are adjusted based on their risk, with riskier assets
requiring a higher weighting.
- The risk weightings are specified by individual countries’ regulators,
and these regulators typically take Basel III into consideration.
- For example:
- cash has a risk weighting of zero, so cash is not included in the risk-weighted
assets. As a result, no capital is required to fund cash.
- Corporate loans have a risk weighting of 100%, and certain risky assets, such
as loans on high-volatility commercial real estate and loans that are more than
90 days past due, have a weighting greater than 100%

CAPITAL ADEQUACY
For purposes of determining a bank’s capital and its capital adequacy, a bank’s capital is
classified into hierarchical tiers.
Bank capital funding those assets is also stratified into tiers:
a. Common Equity Tier 1 Capital (predominant form of bank capital, the
most loss-absorbing form of capital, as it is permanent and places shareholders’ funds
at risk of loss in the event of insolvency )
b. Other Tier 1 Capital

c. Tier 2 Capital.
a. Common Equity Tier 1 Capital includes :

 common stock,
 issuance surplus related to common stock,
 retained earnings,
 accumulated other comprehensive income, and
 certain adjustments, including the deduction of intangible assets and deferred tax assets

CAPITAL ADEQUACY
b. Other Tier 1 Capital
includes : other types of instruments issued by the bank that meet certain criteria.
The criteria require, for example,
that the instruments be subordinate to such obligations as deposits and other debt obligations,
not have a fixed maturity, and
not have any type of payment of dividends or interest that is not totally at the discretion of
the bank.
c. Tier 2 Capital
includes instruments that are subordinate to depositors and to general creditors of the bank,
have an original minimum maturity of five years, and
meet certain other requirements.

CAPITAL ADEQUACY
• Example:
A hypothetical bank with three assets:
$10 in cash,
$1,000 in performing loans, and
$10 in non-performing loans.
The bank’s risk-weighted assets (RWAs)* would equal

($10 × 0%) + ($1,000 × 100%) + ($10 × 150%) = $1,015
*ATMR (asset tertimbang menurut resiko)

2. ASSET QUALITY
• Kualitas aktiva yang produktif mencerminkan kinerja keuangan perusahaan

perbankan.
• Penilaian kualitas aktiva dilakukan dengan membandingkan antara aktiva produktif
yang diklasifikasikan dengan total aktiva produktif.
• The amount of existing and potential credit risk associated with a bank’s assets,
focusing primarily on financial assets.
- Loans typically constitute the largest portion of a bank’s assets.
• The concept of asset quality extends beyond the composition of a bank’s assets
and encompasses the strength of the overall risk management processes by which
the assets are generated and managed.

3. MANAGEMENT CAPABILITIES
• Penilaian manajemen menentukan apakah suatu institusi dapat bereaksi baik terhadap
tekanan keuangan.
• Peringkat komponen ini dicerminkan oleh kemampuan manajemen untuk
mengendalikan risiko kegiatan harian dalam perusahaan.
• Many of the attributes of effective management of financial institutions are the same as
those for other types of entities.
- Successfully identifying and exploiting appropriate profit opportunities while simultaneously managing
risk.
- Compliance with laws and regulations.
- Strong governance structure with an independent board.

3. MANAGEMENT CAPABILITIES
• For financial institutions, a particularly important aspect
of management capability is the ability to identify and
control risk, including credit risk, market risk, operating
risk, legal risk, and other risks.
- Directors of banks set overall guidance on risk exposure levels
and appropriate implementation policies and provide oversight
of bank management.
- Banks’ senior managers must develop and implement effective
procedures for measuring and monitoring risks consistent with
that guidance.

4. EARNINGS SUFFICIENCY
• Bank yang sehat tentu akan dilihat dari kemampuannya memperoleh
pendapatan berupa laba. Semakin besar laba yang diperoleh menunjukkan
bahwa kinerja bank semakin baik dan kondisi keuangannya semakin sehat.
• In general, high-quality earnings mean that accounting estimates are unbiased
and the earnings are derived from sustainable rather than non-recurring items.
• For banks, one important area involving significant estimates is loan
impairment allowances.
• Banks also must use estimates in valuing some financial assets and
liabilities that must be measured at fair value.
- When fair value of an investment is based on observable market prices,
valuation requires little judgment.
- However, when fair values cannot be based on observable market prices,
judgment is required.
• Other areas involving significant estimates are common to non-financial and
financial companies.

4. EARNINGS SUFFICIENCY
• Regarding sustainability of a bank’s earnings, it is important to
examine the composition of earnings typically comprise:
- net interest income (the difference between interest earned on
loans minus interest paid on the deposits supporting those loans),
- service income, and
- trading income.
• Of these three general sources, trading income is typically the
most volatile.
- A greater proportion of net interest income and service income is
typically more sustainable than trading income.
• Lower volatility within net interest income is desirable.
- Highly volatile net interest income could indicate excessive
interest rate risk exposure.

5. LIQUIDITY POSITION
• Aspek likuiditas berkaitan dengan kemampuan bank dalam membayar
utangnya. Semakin mampu suatu bank membayar utang, maka
semakin likuid bank tersebut
• Banks’ systemic importance increases the importance of adequate

liquidity because deposits constitute the primary component of a
bank’s current liabilities, the impact of a bank’s failure to honor a
current liability could affect an entire economy.
- Deposits in most banks are insured up to some specified amount by
government insurers.

• Basel III thus introduced two minimum liquidity standards,

both to be phased in over subsequent years:
(1) The Liquidity Coverage Ratio (LCR) : the minimum
percentage of a bank’s expected cash outflows that
must be held in highly liquid assets.
o The expected cash outflows (the denominator) are
the bank’s anticipated one-month liquidity needs in a
stress scenario, and the highly liquid assets (the
numerator) include only those that are easily
convertible into cash.
o The standards set a target minimum of 100%.

• Basel III thus introduced two minimum liquidity standards, both to be
phased in over subsequent years:
(2) The Net Stable Funding Ratio (NSFR) : the minimum percentage of a
bank’s required stable funding that must be sourced from available
stable funding.
o Required stable funding (the denominator) is a function of the
composition and maturity of a bank’s asset base, whereas
available stable funding (the numerator) is a function of the
composition and maturity of a bank’s funding sources (i.e.,
capital and deposits and other liabilities).
o Under Basel III, the available stable funding is determined by
assigning a bank’s capital and liabilities to one of five categories
(see text book p. 768 Exhibit 8). The amount assigned to each
category is then multiplied by an available stable funding (ASF)
factor, and the total available stable funding is the sum of the
weighted amounts.
o The standards set a target minimum of greater than 100%.
6. SENSITIVITY TO MARKET RISK
• Bank harus bisa menyesuaikan operasionalnya sesuai dengan
keadaan pasar keuangan agar usaha yang dijalankan sesuai
dengan keadaan pasar.
• The nature of banks’ operations generally makes sensitivity of
earnings to market risks a particularly important consideration
for analysts.
- It is important to evaluate the strength of a bank’s ability to
manage market risks.
• Exposure to risk arises not only from loans and deposits on a
bank’s balance sheet but also from off-balance-sheet
exposures, including, for example, guarantees or derivatives
positions linked to interest rates, exchange rates, equities, or
commodities.

BANKING-SPECIFIC ANALYTICAL CONSIDERATIONS
NOT ADDRESSED BY CAMELS
• Government support.
- A government’s interest to have a healthy banking system because a nation’s
economy is affected by banks’ lending activity, and a nation’s central bank
needs a healthy banking system for the effective transmission of monetary
policy.
- A healthy banking system also facilitates commerce by providing adequate payment
processing and instilling depositor confidence in the safekeeping of their deposits.
- An investor can qualitatively assess whether a bank will enjoy the support of
the government in times of economic distress by the following factors:
a) Size of the bank. Is the bank large enough to bring damage to a significant part of the
economy in the event of its failure? Is it “too big to fail”?
b) Status of the country’s banking system. Is the nation’s banking system healthy enough to
handle a particular bank’s failure? Rather than force the banking system to cope with the
failure of a particular bank, would it be a better solution for the government to intervene
with taxpayer funds to support it?
o The global financial crisis of 2008–2009 led the US Federal Reserve to develop the
concept of SIFIs: systemically important financial institutions, ones that would pose a
significant risk to the economy in the event of a failure. Such institutions have been the
target of an increased degree of regulation in the post-crisis era.
• Government ownership.
- Government ownership may exist for several reasons.
a) A “development” view of government ownership incorporates a belief
that government ownership aids financial development of the banks,
leading to broad economic growth.
b) A more pessimistic view is that a nation’s banking system is not
strong enough to stand on its own and attract large amounts of capital,
because of low ethical standards within the industry or a lack of
confidence in the banking system among the nation’s public at large—an
important source of funds for any bank
• Mission of banking entity.
- The mission of the bank and the economics of its constituents will affect the
way the bank manages its assets and liabilities.
- The global bank is more diversified against a single risk than any community
bank.

• Corporate culture.
- A bank’s culture may be very risk averse and cautious and make only loans
perceived to be low risk, or it may be risk seeking and willing to take risk in pursuit
of high returns on investment, or a bank’s culture may be somewhere in the middle
of those two extremes.
- A bank’s cultural environment can be assessed qualitatively by considering factors
such as these:
a) Has the bank generated recent losses resulting from a narrowly focused
investment strategy, such as a large, outsized exposure to a particularly risky
country or area of the economy?
b) Has the bank restated its financial statements owing to financial reporting
internal control failures?
c) Does the bank award above-average equity-based compensation to its top
managers, possibly incentivizing risk-taking behavior and short-termism?
d) What does the bank’s experience with loss reserves say about its culture? Has it
frequently been slow to provide for losses, only to record large asset write-
downs later?
ANALYTICAL CONSIDERATIONS NOT ADDRESSED BY
CAMELS THAT ARE ALSO RELEVANT FOR ANY
COMPANY (INCLUDE BANK)
• Competitive environment.
- A bank’s competitive position, relative to its peers, may affect how it allocates
capital and assesses risks.
- A regional bank may have a near-monopolistic hold on a particular region
and not take very many risks beyond maintaining its grip.
- A global bank may be affected by the actions of other global banks.

• Off-balance-sheet items.
- Off-balance-sheet assets and liabilities pose a risk to entities and their
investors if they should unexpectedly drain resources.
- Some off-balance-sheet items:
- the existence of as variable interest entities (VIEs)
- variable interest entity may also result in off-balance-sheet assets and
liabilities for a bank if the bank has an interest in the VIE but is not required
to consolidate it.
- benefit plans
- although these are not completely off-balance-sheet items because the net
benefit plan assets or obligations appear on the balance sheet, the
economics that drive them are different from the bank’s business.
- assets under management (AUM)
- assets belong to the clients and are not consolidated with a bank’s balance
sheet accounts, yet they drive the returns of the bank.

• Segment information.
- Banks may be organized in different lines of business.
- It can help the investor decide whether capital is being allocated well within
the bank’s internally competing operations.
• Currency exposure.
- Banks may finance and lend in a variety of currencies, resulting in foreign
currency transaction exposure.
- Banks may actively trade in foreign currencies and actively hedge using
foreign exchange derivatives, leading to unforeseen gains or losses when
world events affect currencies unexpectedly; not all banks may be successful
currency traders.
- Global banks face the same balance sheet translation issues that affect other
multinational corporations.

• Risk factors.
- Investors should review the risk factors presented in a company’s annual
filing.
• Basel III disclosures.
- The Basel III requirements include extensive disclosures that complement
the minimum risk-based capital requirements and other quantitative
requirements with the goal of promoting market discipline by providing useful
regulatory information to investors and other interested parties on a
consistent, comparable basis

THANK YOU
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Chapter 16

ANALYSIS OF FINANCIAL INSTITUTIONS –

• A distinctive feature of financial institutions—in particular, banks—

Copyright © 2020 CFA Institute 4

• Systemic risk is a risk of disruption to financial services that is:

Copyright © 2020 CFA Institute 5

• Another distinctive feature of financial institutions is that their assets

Copyright © 2020 CFA Institute 6

Additional source: https://www.bis.org/bcbs/basel3.htm

Copyright © 2020 CFA Institute 7

Additional source: https://www.bis.org/bcbs/basel3.htm

Copyright © 2020 CFA Institute 10

Minimum capital requirement

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• Tingkat kesehatan bank dari aspek modal dinilai atau diukur

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b. Other Tier 1 Capital

a. Common Equity Tier 1 Capital includes :

Copyright © 2020 CFA Institute 16

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The bank’s risk-weighted assets (RWAs)* would equal

*ATMR (asset tertimbang menurut resiko)

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• Kualitas aktiva yang produktif mencerminkan kinerja keuangan perusahaan

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• Banks’ systemic importance increases the importance of adequate

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• Basel III thus introduced two minimum liquidity standards,

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