Analyze The Performance Of Three Top Banks

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02 Nov 2017

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Abstract

This paperwork will analyze the performance of three top banks from India, Poland and Brazil especially during and after the time of crisis. This research paper will investigate the performance of the banks for the period 2007 – 2012 through deep analysis with the help of key financial ratios for banking sector. Theory was focused on identifying the risk factor involved during the crisis and especially from the other banks due to their interconnectivity as a result of globalization and financial integration. The key question is whether these three banks representing different continents will outperform their western counterparts to take a leading position in the global banking sector. Some of the macroeconomic factors were also into consideration to see the effects on specific banking indicators. Moreover, the mix of private entrepreneurial firm with Multinational Corporation would see the changes in the techniques and methods of adaption by the banks of respective countries. At last, this research paper intends to see how the banking sector has strengthen its financial roots and structure through strict regulations, establishing norms and capitalizing investment needs to mark a high level of growth and stability.

Introduction

In today’s world, banks are not means of money circulation and transaction, but also perform various banking functions necessary for the development of society and bank. Today, there is no country in the world which does not conduct banking activities at national and international level. Further, banks have diversified its activities by introducing new products and services which includes consumer finance, credit cards, fixed deposits, wealth management, life and general insurance, brokerage services and so on. Such diversified activities need systematic approach and thorough analysis of the banking market to be competitive at global level.

The history of banks started from the ancient world from or around 2000 B.C. This led to spread the developed banking from Italy to other parts of Europe with the help of innovations and inventions that took place during the Republic of Dutch in 16th century as well as in British Empire in 17th century ( London). Later, in the 20th century new and improved techniques like use of computers and telecommunications lead to major changes in the banking operations. Further, this result led spread its innovation geographically all around with its increase size and nature of conduct. The services like mortgage market which was already developed in the U.S and other developed economies had a great set back after the 2008-2009 financial crisis which had a tremendous share in the world GDP. In the next coming years, the growth of banking sector will be tremendous as more and more people will continue the services offered by various banks. This will lead to increase in capital, asset and portfolio investment along with processing of goods and services. New products will be discovered, markets will be tapped, sources of financing will increase, and technology, innovation, consumer tastes and other modes of modernization will affect the total supply and demand in the market.

Banking sector in emerging economies were considered high risk, while banks in developed world are generally believe to be well regulated with strict financial policy and structure. My analysis will include countries from emerging economies like Poland, India and Brazil. Despite the on-going current crisis, the emerging market banks have despite the on-going current crisis, the emerging market banks have raced ahead of their western counterparts. The last decade has seen tremendous change in the structure of financial system especially in developing countries after the lessons learned from the collapse of Lehmann Brothers. Since, most of the today’s analysts and economists are interested in the emerging banks which are going to take a leading position in the coming years. The transformation of Indian banks from traditional methods or techniques to more openness by setting up branches and offices overseas as a result of globalization. From the mid to late 1990s, the banking sector (private) was opened in Poland after the fall of communism. On the other hand, Brazilian banking sector enjoys strong and high level of capitalization will allow the economy to grow even during global slowdown. Lastly, the goal of dissertation is to see the financial condition of the banks before crisis – 2007, during crisis – 2008/2009 and after the crisis 2010 & 2011/12.

The goal of this paper work is to prove that the chosen three banks were performing better before and after the crisis period. To prove the above statement, it is necessary to compare financial performance of the banks through key ratios which are meant for the banking sector. Further, there performance will be judge on industry average of the respective ratios for banking sector.

CHAPTER 1

MACRO ECONOMIC PROSPECTIVE OF BANKING SECTOR

1.1 BANKING SECTOR IN INDIA

With the decline in macroeconomic situation in Euro zone area, the global economy is still showing deeper signs of stress during the past few months. This leads to loss of momentum in the Emerging economies along with the growth activities in the USA. In short, the macroeconomic situation still continues to raise the concern over the growth and stability. In India, the growth has slowed down significantly, inflation still remains beyond the comfort level of reserve bank of India. After conducting series of stress test, the results for the Indian banks were quite satisfactory and well above average. Indian banks still remain resilient which is a good sign, taking into account the crisis situation in Euro zone. The test was based on credit risk, liquidity and interest rate risk conducted by the reserve bank of India. However, there could be some problems in the liquidity of banks in case of extreme shocks and vulnerability.

The global financial meltdown which began from the subprime mortgage crisis originating from the USA that led banks to be more conservative. However, RBI (Reserve bank of India) has played a vital role in assisting the banking sector to manage its liquidity and growth oriented events. Capital adequacy was given the highest priority to make the banks enough liquidated or capital base to survive crisis situation. The minimum CRAR – Capital to risk weighted assets ratio was required to maintain at 9 %( Banking System Survey – Page 19 – credit quality) in India, which is 1% above the Basel II requirement. Over the last decade, there has been a remarkable progress in banking activities due to its size of operation, demand, nature and necessity. The business profits of the banks has transformed dramatically which includes non-traditional ways of banking like merchant banking, mutual funds, new & improved financial services and human resource development.

Source: Annual Survey (February 2010) – Federation of Indian Chambers of Commerce & Industries

From the above graph, we can see that the Forex management (71.43%) & Bancassurance (85.71 %) still remains the profitable part of banking sector in India. Derivatives was least profitable since it is under developed but with a lot of future potential. Furthermore, fee based sources of income has a tremendous scope for development due to nature of services which can be a dominant sector in near future. The core banking solutions is also well developed in India especially, in commercial banking. The advantage of core banking solutions is that it enables the banks to reinforce their technology across different geographical & functions area by leveraging cost with flexibility and scalability/capability to cope under increase workload.

Source: Indian Banking System: The current state and road ahead (Annual Survey, February 2010)

1.2 Banking sector in Brazil

Brazilian economy along with financial sector is exposed to the effects of volatility & imbalances in the international commodity & capital markets. The banking system has been strictly regulated on the basis of recommendation of FSAP (Brazil banking report 2012, Page 2, and IMF Country Report No.12/206). System risk have been declined especially, after the crisis, but the resilience to wide range of shock still remains in the economy. According to the stress test results, the rapid credit growth among households is creating a fear of vulnerability that should be monitored carefully. To enhance the central bank’s emergency liquidity assistance, it is important to emphasis on financial safety and soundness by strengthening the regulatory measures for giving credit. Even though Brazil has strong macro-economic framework – fiscal legislation, flexible exchange rate & controlled inflation helped Brazil to reduce its debt to GDP ratio. The entry of foreign banks is still limited due to dominance of public sector banks. Financial conglomerates include commercial bank along with investment banking, asset management, insurance, securities brokerage & control around 75% of the system’s asset.

Source: IMF country report no.12/206, July 2012 – Brazil Banking Report

From the above graph, we can say that due to openness of the economy, it is more vulnerable to external shock. The significant proportion of foreign investor’s sentiment can also affect the equity and derivatives market. Similarly, the household debt service to income ratio on average is high which is due to high interest rates and short term maturities. Furthermore, the corporate sector resilience to external shock also improved in recent years. With the rise in equity against debt, the leverage ratio has decline among the corporates along with rise in current liquidity & interest coverage ratio. At last, Brazilian banking system still remains profitable with a strong capital base and high level of capitalization. With its 10 %( Brazil Banking Report – 2012) of banks assets and liabilities denominated in foreign currency, it still remains one of the favorable destinations for investment.

1.3 Polish Banking Sector

Poland was one of the countries that survived the recession of 2009 & also performed well throughout the crisis period. The banking sector still remains under supervisory measures to improve the resilience of Polish banking system. Further, measures have been taken to improve the prospects of long term bank funding, establishing supervisory board, macroeconomic framework and continuing reforms to improve the stability in the banking system. The banking sector in Poland is highly interconnected with the European financial system. Foreign banks amount to 59 %( BIS Consolidated data report) of the GDP at the end of 2011, showing the openness of polish financial system. Due to this, there is also sense of potential spillovers & vulnerability that is escalating from sovereign and financial stress in the euro area. From the last year, the banking sector has seen rise in profitability with well capitalized and liquidity positions. The capital adequacy ratio on average was 13% (high) which constituted 90% of tier 1 capital. Almost 2/3 of the mortgagees are denominated in foreign currency which is mainly Swiss francs.

Source: IMF country report no.12/162 – Republic of Poland 2012 ARTICLE IV Consultation and National Bank of Poland calculations.

From the above graph, it can be seen that lending rate has grown by 12% in the first quarter of 2012 with a strong lending standards & corporate credit growth. Further, the credit also expanded at a steady pace under tight supervision. Overall, we can say that all relevant factors in the banking system and polish economy remain fairly good & satisfactory with strong liquidity position and high growth potential.

1.4 Post Crisis situation of banks in the Global Economy

After the global financial crisis the market and financial service sector is on the path of gaining momentum and confidence among the people, investors and institutions. One of the worst financial crisis in last 80 years, the banks in developing (emerging) countries have shown a sign of transformation by tightening the regulatory policies and restructuring of financial system. The countries in the west are suffering from heavy debts, credit crunch and uncertainty among the private sector especially, after the fall of Lehmann Brothers (The Global Banking Sector: Current Issues – CIMA Sector Report). In developing countries, banks are strictly regulated under supervision of central banks and also strong enough to face the competition from other multinational banks from developed countries. The main characteristics of banks in developed countries are deregulation of financial system which is mainly due to the capitalistic approach towards the economic development. The fall of the financial system was due to the immense flow of money in the economy as the banks were deregulated and they had freedom to conduct their activities which resulted in bursting of bubble arising from the real estate boom in U.S. The bank offered loans on credit at substantial low level interest rates without investigating/cross checking the credibility of the customer. As a result, people in U.S who were expecting a good return on their housing property failed to pay the loans as the returns were decreased due to low market value of the property. Finally, this led to fall of big banks in U.S which affected the other parts of the world including UK, Europe, Asia and Africa. Since banks are interconnected today due to globalization and financial integration, one slight mistake can cause a huge blow all over the world.

The banks in the developing economies have an immense scope for development since there financial markets are immature and the countries are still on the path of progress. In short, there is no saturation point likewise in developed countries. The banks in emerging countries like Poland, India and Brazil are more focused on "State Capitalism" which means stronger role of government within corporate laws, governance and banking regulation. The so called "Hard Currency" which was dominated by U.S dollar ($) may give away its position to the countries from emerging world which may capitalized market and play a big role in shaping the global banking sector. One important thing that banks learned from the crisis is to cooperate more at state level (government) and also support each other at international level to maintain confidence and steady flow of growth. The business model of the banks should be in such a way that it must understand the risks, performance indicators and execution of effective policy making to restore confidence among the investors and other market players in the economy.

Furthermore, China’s top four banks are state owned while three quarters of the banking sector in India is under government control. On the other hand, Brazil has three out of top 50(The Banker Database) banks in the global top list of world banks. All the above three countries have developed immensely from last 4 years especially after crisis which make their banks – one of the top most in the world.

CHAPTER 2

FINANCIAL ANALYSIS AND KEY BANKING RATIOS

2.1 Brief description of Financial Regulations and Forms of practices for Banks

In this chapter, we will evaluate the banks performance by using their balance sheet, income statement and cash flow statement. This will help to determine the stability, liquidity, profitability and sustainability of the banking sector. Financial statements are the most important source of first hand data which is easily accessible for investors, clients and other market sources. It is important to check the banks past performance in order to evaluate and estimate the future performance of the banks. To compare different banks from same sector, financial ratios are the most common form of analyzing the data comparison based on past performance of the bank. The use of financial ratios divides the company’s into different groups based on their performance in different sector and specialization in different field or departments. All analysts generally use these ratios for the forecasting calculations and behavior pattern in current and future market trend.

For financial analysis of banking sector, the Bank for international Settlements is responsible to set norms and regulations & monitoring the performance of banks in different countries. Bank for International Settlements (BIS) is a statutory international organization that cooperates between central banks and international monetary fund (policy makers). It is the oldest international financial organization which was formed in 1930(www.bis.org) to monitor and administer the money transactions as per the rules of Treaty of Versailles. It is key center for economic research and development which provides & shares key financial information. In short it is a central bank for other central banks representing different countries. Its functions limit to specific area of supervision and not all the central banks of the world. Its member includes the Federal Reserve Bank, European Central Bank (ECB) and Bank of Canada.

Later, the BCBS- Basel committee on banking supervision was formed in 1974 with the help of central bank governors of 10 countries. The main aim of the committee is to improve the quality of supervision and key issues for effective banking supervision. It does not issue or order any binding regulation. It in fact only functions as a forum which is informal in nature and develops policy solution and framework. This committee is further divided into four groups:

1) The standard implementation group (develops guidance, remuneration practices, effectiveness and consistency).

2) Policy development group (PDG) – Risk and liquidity management, capital instruments, monitoring and cross-border bank resolution.

3) Accounting task force – to keep accounting records and do timely auditing to maintain competitiveness, soundness and safety in the banking system.

4) Basel consultative group – It communicates between the banking supervisors which includes participants from non-member countries of Basel committee.

There are three types of Basel accord by the Basel committee. They are as follows:

Basel I – The minimum requirement of capital is set for financial institutions which provide a cushion in case of emergency situations. Banks that function and operate at international level have to maintain a minimum capital amount of 8 % based on the risk weighted assets (in %). The first Basel I (The Basel Handbook: A Guide for Financial Practitioners – Page 24) was more focused on credit risk and was issued in 1988 to create a bank asset classification system. The bank must maintain a minimum capital of 8 %which includes Tier 1capital and Tier 2 capital.

Basel II – It is the 2nd recommendation of Basel committee on supervision of banks. It was intended to create an international standard for regulators of bank(Banking on Basel: The Future of International Financial Regulation – Page 73) as how much capital banks should keep aside in case of financial and operational risk arising from any form of financial crisis or disturbances. They should allow minimize the lending risk and practices by maintaining sufficient balance. Theoretically it was believed that Basel II was form to protect the international financial system arising from major collapse of banks (Lehmann Brother – 2008). But politically and practically it was difficult to implement due to the regulatory environment in different countries and nature of working of banks.

Basel III – This was lasted recommendation by the Basel committee which was published in late 2009 in which banks were given time of 3 years to satisfy minimum requirements. This was form especially to tackle the crisis situation of 2008 – 2009 (Global Financial Crisis). The focus was more on marinating sufficient leverage ratio along with certain amount of capital requirements based on Basel II recommendation.

After the financial crisis, banks were screened under strict regulations and new reforms and regulations were introduced. The important focus of the 3rd Basel recommendation was to enhance greater resilience (Accenture Basel III Handbook) for all the banks with reduced risk of uncertainty and shocks (external as well as internal shocks).

2.2 Key Financial Ratios and Indicators for Banking Sector

Following are the key financial ratios necessary to evaluate the performance of banks. The banks health position and soundness will reflect their ability to retain customers and built confidence amongst the investors who are the playmakers of the market.

A) Capital Adequacy Ratio

Capital adequacy ratio is generally used to watch the bank’s health or is the bank performing well or not. It is the most important ratio that signals the performance of a bank in a given country. The central bank or regulatory authority keeps a track on bank’s capital adequacy ratio (CAR) to confirm or see whether it can absorb loss or shock in case of uncertainty or emergency situation. It is another form of maintaining confidence & surety in the working system of banks. It is also used to judge the capacity or ability to meet its liabilities and other forms of risk like market risk, credit & operational risk and so on. Sufficient amount of capital is needed in form of "cushion" to support or finance bank’s risk assets. In short, it is used to maintain stability and efficiency in the financial system of the banks all over the world. It is usually calculated by adding tier 1 and tier 2 capital divided b risk weighted assets. Tier 1 capital absorbs the losses without a bank being required to cease trading activities & Tier 2 protects the bank in the event of a winding up absorbing losses. Further tier 2 capital provides less degree of protection or stability than tier 1 capital to depositors.

Capital Adequacy Ratio (CAR) = Tier 1 + Tier 2

Risk Weighted Assets

B) Tier 1 Capital Ratio (Accenture Basel III Handbook, 2011)

Tier 1 capital is the important measurement of banks financial strength. It has a core capital which includes banks paid up capital, disclosed reserves, statutory reserves, common stock which may include non-redeemable & non-cumulative preferred shares. In short, it is the ratio of equity capital to its risk weighted assets (total).

Tier 1 capital ratio can be categorized or divided into two components: Common Capital Ratio and Total Capital Ratio.

Common ratio is always less than or equal to total capital ratio whereas total capital ratio includes preference shares and non-controlling interests (Accenture Basel III Handbook, 2011).

C) Tier 2 Capital Ratio (Accenture Basel III Handbook, 2011)

Tier 2 includes banks supplementary capital that includes undisclosed reserves, hybrid instruments, general reserves and subordinated term dates. Tier 2 capital is less reliable than tier 1 capital. Under general provisions, small amount of capital is kept in case of losses which are not noticed or identified. Important rules under general provision are:

Limitation to standard approach – 1.25% of RWA of banks (Risk Weighted Assets).

Limitation to IRB (Internal rating based) approach – 0.6% Credit for banks.

Undisclosed reserves are the profits earn by the banks but not shown in the retain earnings or general reserves of the bank accounts. Revaluation reserves represent an asset which is revalued & the increase in the price or value is shown on the bank’s balance sheet. For tier 2 capital the historic cost & actual valuation should be discounted by 55 % according to Basel II norms. Tier 2 capital may be divided into further two parts: Upper Tier 2 capital and lower tier 2 capital.

Upper tier 2 capital includes funds raised from the hybrid & long dated subordinate products. They have characteristics like perpetual, equity and senior to preferred share capital along with cumulative coupons. Upper tier 2 capital interest & principal can be written down. Lower tier 2 capital is very cheap to issue for banks in form of coupons and has a subordinated debt with a maturity period of at least 10 years (Accenture Basel III Handbook, 2011).

D) Risk Weighted Assets (RWA)

It is the necessary capital which is maintained by the banks to protect against risk of various assets and uncertain situations. This is an essential way to discount certain types of assets by the banks to use the capital more effectively and efficiently (Damodaran, 2001).

E) Accruals (% Revenue)

Accruals are the entity that records the expenses and revenues for which the bank expects to pay or receive cash in future reporting period. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue or profit is measurable.

F) Loan Loss Provision Margin (%)

It is one of the most important elements of the reserve account for the banks. It helps to cover unexpected defaults on loans by the borrowers. The borrowers are generally the people or institutions who failed to meet obligations. They are generally referred to as non-performing loans. The higher the percentage of non-performing loans & substantial charge of percentages, the higher the provision for loans losses which substantially reduces the net income & earning per share of the bank.

G) Net Loans (% Assets) = Net Loans/ Total Assets * 100

It is the measurement which shows the bank’s assets that are financed with loans. This financial obligation lasts for one year or more. The higher ratio indicates a low liquidity and high loaned up activities of the bank. In short, the higher the ratio, more risky is the bank.

H) Return on Equity (ROE)

It measures the profitability of the firm by the amount for profit the company has earned through the money invested by the shareholders. Under this measure, net income is taken for the full fiscal year without including preference shares in the shareholders equity. For banking sector, it is better to calculate the ROE in comparison to other banks. (Shapiro and Balbirer, 2000)

I) Return on Assets (ROA) = Net Income / Assets

This ratio indicates the profitability of a company in comparison to the total assets held by the company. It shows the efficiency of the management to generate revenue by using its assets. For publicly traded companies, the ROA might differ and also vary from industry to industry. Banking sector should compare its ROA with other banks or the same banks previous records or past performance. The higher ROA, the better is the company’s performance since it is converting its investment into profit. The following table shows the Return on Assets of PKO Bank Polski from the period 2007 to 2011(Nobes and Alexander, 2001).

J) Profit Margin Ratio = Net Income / Revenue

Profit margin measures the efficiency of company in generating income on every dollar invested. A sound profit margin does not mean that company is good performing. Increased revenue is good but does not mean that the company is improving and is sufficient with cash management.

K) Total Asset Turnover = Revenue / Assets

It measures the capacity of the company to generate sales for every dollar worth of assets. In other words, it demonstrates how well company is using its assets to generate revenue.

CHAPTER 3

FINANCIAL PERFORMANCE ANALYSIS OF ITAU UNIBANCO HOLDING

3.1 Profile of the Bank

Itau Uni Banco is a public bank situated in Brazil with its headquarters at Sao Paulo, Brazil. The bank is the 10th largest by market value in the world which was a result of its merging with Banco Itau and Unibanco to form Itau Uni Banco on 4th November, 2008. Currently, the bank is listed on Sao Paulo stock exchange and New York stock exchange (NYSE). It is the second largest bank in Brazil in term of assets. The bank also attracts deposits and provides services like commerce private & corporate banking as well as retail services. It also offers range of other financial services like insurance, pension plan, offshore business, commercial banking, etc. the company also provides various forms of loans like personal loans, mortgage loans, agriculture loans, mutual funds, pension assistance or plan, savings account, e-services, etc. Further, it specializes in insurance assistance or policies in form of house insurance, life insurance, vehicle protection plan, as well as brokerage services. Itau Unibanco has an important subsidiary in the Brazilian congolmerate company called Itausa. Itausa controls many companies which are active in the areas of real estate, metallurgy, chemicals, electronics and wood panels ( Annual Report – Itau Unibanco Holding,2011).

Ownership

Chairman – Pedro Moreira Salles

Co Vice Chairman – Alfredo Egydio Arruda Villela Filho

Executive Director – Marcos De Barros Lisboa

Executive Director – Ricardo Baldin

Executive Director – Sergio Ribeiro Da Costa Werlang

Executive Vice President – Candido Batelho Brocher

Executive Officer - Caio Ibrahim David

Co Vice Chairman/President/CEO - Roberto Egydio Setubal

Executive Director – Claudia Politanski

Key Facts and Figures of the Bank (Annual Report – Itau Unibanco Holding).

The bank has network of 4072 full active service branches.

To deal with customers, the bank hass setup 912 customer service branches along with 28,769 ATMs machines all over the world including Brazil.

The company changed its name from Itau Unibanco Multiplo S.A to its current name Itau Unibanco Holding S.A in April, 2009.

The company has its presence in Brazil and also 18 other countries which includes United States, Argentina, Switzerland, and China to name few.

Currently owned subsidiaries of Itau Unibanco Holdings include :

Banco Itau Uruguay SA

Banco Fiat SA

Banco Itau Argentina SA

6) The banks latest acquisition is 44.4 % stake in the share capital of Redcard SA, which accounts for 11 % of Brazilian market in retail banking services.

3.2 Financial ratio analysis of Itau Unibanco Holding

Performance analysis and financial analysis of Itau Unibanco Holding with the help of key financial ratios.

A) Total Asset Turnover = Revenue / Assets

It measures the capacity of the company to generate sales for every dollar worth of assets. In other words, it demonstrates how well company is using its assets to generate revenue. The following table shows the asset turnover ratio of Itau Unibanco Holding from the period 2007 to 2011.

Table 3.2.1 Total Asset Turnover of Itau Unibanco Holding

Values in BRL MLN

2007

2008

2009

2010

2011

Revenue

37924

36916

81127

74783

79621

Total Assets

269508

632728.4

608273.2

755112.3

851331.5

Total Asset Turnover

0.14

0.06

0.13

0.10

0.09

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

Revenue growth was increasing throughout the 5 years with an increase of 109.95%. The assets of the bank also continue to demonstrate positive growth trend.

The graph below shows the variations in the given five years for various reasons:

Graph 3.2.1 Total Asset Turnover of Itau Unibanco Holding

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

Asset turnover ratio depends on the time of industry or firm. Different sectors tend to produce different values based on the nature and type of business. From the above graph we can see that the year 2007 saw the maximum turnover of 0.14 times as compare to other years before and after the global financial crisis. The year 2008 saw a decline in revenue due to financial meltdown as a result of which banks operations was affected but the assets continue to growth with the turnover ratio of 0.06 for 2008. Overall, the average turnover ratio was 0.10 for the last 5 years which is well above average of 0.08 %( www.reuters.com) for banking sector.

B) Profit Margin Ratio = Net Income / Revenue

Profit margin measures the efficiency of company in generating income on every dollar invested. A sound profit margin does not mean that company is good performing. Increased revenue is good but does not mean that the company is improving and is sufficient with cash management. The following table shows the Profit margin of Itau Unibanco Holding from the period 2007 to 2011.

Table 3.2.2 Profit Margin of Itau Unibanco Holding

 Values in BRL MLN

2007

2008

2009

2010

2011

Net income

11921

10004

10067

13323.0

14621

Revenue

37924

36916

81127

74783

79621

Profit Margin(%)

19.74

13.14

17.36

14.8

17.318

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

For the year 2008 & 2009, there was a decline in the net income of the bank. However the bank recovers from the financial crisis as result of which there was increase in 22.65% in net income from 2007 – 2011.

The graph below demonstrates the variations over the last five years :

Graph 3.2.2 Profit Margin(%) of Itau Unibanco Holding

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

The average profit margin for the above five years was 16.4716 % which is quite good taking into consideration the global financial crisis. Profit margin for 2007 was equal to 19.74% which was the best result for the bank in last five years. The year 2008 saw a decline in profit to 13.14% which was due to decline in net income and revenue & also global financial crisis which took the world into crisis. The inter connectivity of banking sector throughout the world was also the main reason for crisis. Since Brazil is an emerging economy, it didn’t suffered the most like, American and European banks due to its strong financial system and strict regulations. Later, the bank show steady profit not consistent but enough liquidated to tackle crisis situation.

C) Return on Assets (ROA) = Net Income / Assets

This ratio indicates the profitability of a company in comparison to the total assets held by the company. It shows the efficiency of the management to generate revenue by using its assets. For publicly traded companies, the ROA might differ and also vary from industry to industry. Banking sector should compare its ROA with other banks or the same banks previous records or past performance. The higher ROA, the better is the company’s performance since it is converting its investment into profit. The following table shows the Return on Assets of Itau Unibanco Holding from the period 2007 to 2011.

Table 3.2.3 Return on Assets of Itau Unibanco Holding

 Values in BRL MLN

2007

2008

2009

2010

2011

Net Income

7485

7803.5

10066.6

13323

14620.6

Assets

269508

632728.4

608273.2

755112.3

851331.5

Return on Assets (ROA), %

2.8

1.21

2.4

1.5

1.7

Source: own evaluation based on data from Itau Unibanco Holding Annual reports 2007-2011

The following graph demonstrates how Return on Assets ratio of Itau Unibanco Holding was fluctuating over the said period.

Graph 3.2.3 Return on Assets(%) of Itau Unibanco Holding

Source: own evaluation based on data from Itau Unibanco Holding Annual reports 2007-2011

Return on Asset ratio was equal to 2.8 % in 2007. The next year it reduced to 1.21% which was due to the global meltdown and collapse of banking sector in an around the world. Brazilian banking sector was affected but it continue to grow at a steady speed. The ROA for 2008 is 1.21 % which shows the losses from its assets due to inter connectivity of banks as one bank falls leads to the performance of other dependent or connected to it. Generally, the ROA is low as compare other sectors like service, oil, mining, steel, etc. But for banks, 1.5% is treated as good and significant due to nature of banking industry. Looking at the above graph, Itau Unibanco Holding has performed siginfically well for the past five years with an average of 1.922 which is above the average of 1.5% for banking sector.

D) Return on Equity (ROE)

It measures the profitability of the firm by the amount for profit the company has earned through the money invested by the shareholders. Under this measure, net income is taken for the full fiscal year and without including preference shares in the shareholders equity. For banking sector, it is better to calculate the ROE in comparison to other banks. The following table shows the Return on Equity of Itau Unibanco Holding from the period 2007 to 2011.

Table 3.2.4 Return on Equity of Itau Unibanco Holding

 Values in BRL MLN

2007

2008

2009

2010

2011

Equity

35350

34387

69277

76625

73941

Net income

7485

4849

14085

11067

13837

Return on Equity (ROE), %

21.17

14.10

20.3

14.44

18.7

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

Net income of the bank was all time low in 2008/2009 during the crisis, but later the bank managed to increase its income and capitalization through acquiring assets and expanding its operations to different countries.

The graph below shows the fluctuations for the year 2007 – 2011.

Graph 3.2.4 Return on Equity(%) of Itau Unibanco Holding

Source: own evaluation based on data from Itau Unibanco Holding annual reports 2007-2011

The Return on Equity in 2007 was 21.17 %. In 2008, the income of the company reduces as a result of financial instability. Furthermore, 2011 saw an increase in income from various sources like expansion of banking business beyond the national borders, opening of branches in Latin America and other countries abroad, etc. which ultimately lead to increase return on equity ( 18.7%) to shareholders maximizing their wealth. Overall, the return on equity has declined over last five years as compare to other counter parts in the banking sector which indicate decline in operating performance of the Itau Unibanco Holding.

E) Net Loans (% Assets) = Net Loans/ Total Assets * 100

It is the measurement which shows the bank’s assets that are financed with loans. This financial obligation lasts for one year or more. The higher ratio indicates a low liquidity and high loaned up activities of the bank. In short, the higher the ratio, more risky is the bank.

Table 3.2.5 Net Loans as % of Assets for Itau Unibanco Holding

 Values in US $ (MLN)

2007

2008

2009

2010

2011

Net Loans

68721.6

106238.6

137616.4

174569.3

186678.6

Total Assets

165660.9

271324.1

348940.8

454887.2

456416.7

Net Loan to Asset Ratio

41.48%

39.16%

39.44%

38.38%

40.9%

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2007 – 2011.

The following graph shows different trends over the past five years.

Graph 3.2.5 Loan to Asset Ratio(%) of Itau Unibanco Holding

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2007 – 2011.

From the above graph, we can see that the loan asset ratio decreased from 41.48 % (2007) to 39.16% (2008) which shows the level of risk decreasing along with the financed loans of the bank. Later, the bank managed to keep its ratio with limits in order to have enough liquid funds to finance its business activities. On average, the banks’ loan to asset ratio remained at 39.87% for the last five years which is good enough to cover risk.

F) Loan Loss Provision Margin (%)

It is one of the most important elements of the reserve account for the banks. It helps to cover unexpected defaults on loans by the borrowers. The borrowers are generally the people or institutions who failed to meet obligations. They are generally referred to as non-performing loans. The higher the percentage of non-performing loans & substantial charge of percentages, the higher the provision for loans losses which substantially reduces the net income & earning per share of the bank.

Table 3.2.6 Loan loss provision margin % for Itau Unibanco Holding

 

2007

2008

2009

2010

2011

Loan loss provision margin (%)

26.86

59.14

31.1

23.15

31.59

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2007 – 2011

There is significant increase in provision of funds or safety funds especially, after the global financial meltdown for the year 2008 (59.14%). The banks have to keep sufficient amount of funds in form reserves as a backup in case of uncertainty or financial losses.

The graph below shows the fluctuation during the crisis period and after the crisis period of 2007-2008.

Graph 3.2.6 Loan loss provision margin % for Itau Unibanco Holding

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2007 – 2011

From the above graph, it can be clearly seen that loan provision margin has increased substantially after the crisis years (2008 – 2009). The year 2008 saw the maximum provision of 59.14 % because of fall down of major banks in US and Europe. Further, due to insolvency of many banks and customers, the bank loss sufficient amount of capital to cover their risk in 2009 (31.1%).The bank needed to secure or cover the risk involved in its assets by extra provision of finance and does reducing the net income and earning capacity of the bank. The year 2011 still saw a major provision margin of 31.59% which was due to uncertainty among the European banks that arise from ongoing euro crisis of 2010. Overall, the net loan loss provision remains to be 34.368% which is still high as more capital is blocked in form of cushion and risk coverage.

G) Capital Adequacy Ratio

Capital adequacy ratio is generally used to watch the bank’s health or is the bank performing well or not. It is the most important ratio that signals the performance of a bank in a given country. It is also used to judge the capacity or ability to meet its liabilities and other forms of risk like market risk, credit & operational risk and so on. Sufficient amount of capital is needed in form of "cushion" to support or finance bank’s risk assets. It is usually calculated by adding tier 1 and tier 2 capital divided b risk weighted assets.

Capital Adequacy Ratio (CAR) = Tier 1 + Tier 2

Risk Weighted Assets

Table 3.2.7 Capital adequacy ratio of Itau Unibanco Holding

 

2008

2009

2010

2011

Capital Adequacy Ratio (%)

16.15

17

16.61

17.77

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2008 – 2011

The graph below shows increase and decrease in CAR (capital adequacy) ratio for the period from 2008-2011.

Graph 3.2.7 Capital adequacy ratio of Itau Unibanco Holding

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self- analysis and evaluation for the period 2008 – 2011

From the above graph, we can say that capital adequacy ratio increase to 17% in 2009 as a necessity to satisfy Basel norms and regulations central bank of Brazil. Further, the bank increase its ratio to 17.77% to have enough core capital to cover the risk arising from internal and external shocks in the economy as well as banking sector. Overall, the bank maintains an average of 16.9% capital adequacy ratio for last 4 years which is well above 9% as specified by Basel Committee for banking regulations.

H) Accruals (% Revenue)

Accruals are the entity that records the expenses and revenues for which the bank expects to pay or receive cash in future reporting period. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue or profit is measurable. Over accrued shows the company’s under reported income whereas under accrued signals inflated net income & release of balance sheet to show reported earnings.

Table 3.2.8 Accruals (% Revenue) of Itau Unibanco Holding

 

2007

2008

2009

2010

2011

Accruals (% Revenue)

63.66

52.51

49

49.71

46.8

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self-analysis and evaluation for the period 2007 – 2011.

The graph below shows decrease in Accruals (% Revenue) ratio for the period from 2007-2011

Graph 3.2.8 Accruals (% Revenue) of Itau Unibanco Holding

Source: Data base from capitalcube.com & annual reports of Itau Unibanco holding .Self-analysis and evaluation for the period 2007 – 2011.

From the above graph, we can say that Itau Unibanco Holding accruals to revenue ratios is decrease over the last five years as compare to a high of 63.66% in 2007. Higher accruals ratio also signifies that more money is tied up with the customers in form of credit which is yet to be updated on the banks account statement. Overall, the ratio maintain by the bank was 52.34% for the last five year which is quite risky as bank has more money tied up with customers and is less liquid to manage its business operations.

I) Tier 1 Capital

Tier 1 capital is the important measurement of banks financial strength. It has a core capital which includes banks paid up capital, disclosed reserves, statutory reserves, common stock which may include non-redeemable & non-cumulative preferred shares. In short, it is the ratio of equity capital to its risk weighted assets (total).

Tier 1 capital ratio can be categorized or divided into two components: Common Capital Ratio and Total Capital Ratio.

Common ratio is always less than or equal to total capital ratio whereas total capital ratio includes preference shares and non-controlling interests.

Table 3.2.9 Tier 1 capital of Itau Unibanco Holding

 Value in USD MLN

2007

2008

2009

2010

2011

Tier 1 Capital

16,986.9

22,058.3

31,909

37,493.9

38,387.1

Source: Data base from capitalcube.com

The graph below shows increase and decrease in Tier 1 capital ratio for the period from 2007-2011.

Graph 3.2.9 Tier 1 capital of Itau Unibanco Holding

Source: Data base from capitalcube.com

From the above graph, we can see that the bank has increased its tier 1 capital after the crisis of 2007-2008. The main reason to keep sufficient tier 1 capital is to avoid bankruptcy among major national and domestic banks. After the crisis, the Basel committee has implemented strict rules and regulation to regulate the banking system in more efficient way. In short, the bank has fulfill the mandatory conditions of Basel committee. Over the period of last 5 years i.e. 2007 – 2011, the bank saw a 125.98% increase in its tier 1 capital which is outstanding and best result as it forms the core capital for functioning of banks.

J) Tier 2 Capital

Tier 2 capital is less reliable than tier 1 capital. Under general provisions, small amount of capital is kept in case of losses which are not noticed or identified. Tier 2 includes banks supplementary capital that includes undisclosed reserves, hybrid instruments, general reserves and subordinated term dates. Undisclosed reserves are the profits earn by the banks but not shown in the retain earnings or general reserves of the bank accounts. Revaluation reserves represent an asset which is revalued & the increase in the price or value is shown on the bank’s balance sheet.

Table 3.2.10 Tier 2 capital of Itau Unibanco Holding

 Value in USD MLN

2007

2008

2009

2010

2011

Tier 2 Capital

3897.5

6604.6

7364

11131.7

11531.9

Source: Data base from capitalcube.com

The graph below shows increase and decrease in Tier2 capital ratio for the period from 2007-2011.

Graph 3.2.10 Tier 2 capital of Itau Unibanco Holding

Source: Data base from capitalcube.com

From the above graph, the tier 2 capital increased from 2007 to 2011. This capital forms the less reliable part of capital than tier 1 capital. It is mainly use for compensation that includes hybrid instruments and undisclosed reserves. After the crisis, the banks focused more on tier 1 ratio along with tier 2 capital which forms the major source of finance for banks (core capital). Overall, there was increase in capital of 195.9% for the last five years. The main reason was the focus of the bank on building cash and reserves for tier 1 & 2 capital which makes the bank more resilient to external shocks arising due to different factors around the globe.

K) Risk Weighted Assets (RWA)

It is the necessary capital which is maintained by the banks to protect against risk of various assets and uncertain situations. This is an essential way to discount certain types of assets by the banks to use the capital more effectively and efficiently.

Table 3.2.11 Risk weighted Assets of Itau Unibanco Holding

 Value in USD MLN

2008

2009

2010

2011

2012

Risk weighted Assets (RWA)

177449.6

231019.8

292670.3

280872.3

284328.6

Source: Data base from capitalcube.com

The graph below shows increase and decrease in Risk weighted assets for the period from 2008-2012.

Graph 3.2.11 Risk weighted Assets of Itau Unibanco Holding

Source: Data base from capitalcube.com

From the graph, it can be seen that 2010 got the highest allocation which is due to the fact that many banks were default and creditors or customers who fail to meet obligations of money payback were need to be cover in the form of risk capital. This capital is fully concentrated on risky assets which are classified by the bank and need to be taken care to avoid any form of uncertainty and crisis situation. . Overall, there was 60.23% increase in capital allocation for the period 2008 till 2012.



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