Assessment of Financial Statements

Topics: Asset, Balance sheet, Insurance Pages: 5 (1488 words) Published: July 14, 2013

Assessment of Financial Statements

Judith A Vicks

FIN7014-8: Managing Financial Institutions

Dr. Ekanayake: Northcentral University

June 23, 2013

It is important to understand the differences in how earnings and liabilities are generated or reported for different financial institutions. This paper will describe key points regarding the balance sheets of different financial institutions. Commercial Banks must mitigate interest rate and default risk, however, when a major financial crisis erupts they must have enough reserves on hand to cover their liabilities. Insurance companies use the float from the premiums paid in to invest their proceeds to cover their risk. Insurance companies will often increase premiums due to a variety of issues but must also be competitive. Investment companies often use fair market value when assessing the value of assets which serves them in two ways. First they can take advantage of a higher asset value during prosperous times, and secondly they can make firms seem more profitable especially when valuing mergers and acquisitions which is their largest money making business.

Assessment of Financial Statements
To assess the balance sheets of commercial banks it is important to understand what items appear on the assets and liabilities sides of the sheet. On the assets side of the balance sheet banks have the cash that they have accumulated, the discounted bills and securities, the banks investments and most importantly the loans and advances given among other assets. On the liabilities side of the balance sheet the banks have the shareholders capital, the reserve funds, the deposits, as well as borrowings and other liabilities. In conclusion, the goal of the bank is to make a profit and have a positive asset balance in comparison to their liabilities.

When a bank fails, it is likely the cause of a recession or sluggish economy. In the most recent failure of several large commercial banks in 2007-2009 a recession could be to blame. Abraham (2012) financial crises, and in particular banking crises, are symptoms of economic crises, where economic booms are reversed by economic downturns. This scenario contrasts the current literature (e.g., Diamond & Dybvig, 1983; Green & Lin, 2000) where it is claimed that short term deposits make long term loans and consequently mistrust amongst depositors is to blame for bank runs and financial instability. Likewise, Bech (2009) the continued fallout from the ongoing financial turmoil and the economic downturn weighed heavily on the performance of the US commercial banking industry in 2008. As house prices continued to decline, the performance of mortgage-related assets deteriorated further, and, with the onset of recession, credit problems spread to other asset classes and to a wider range of financial institutions. Delinquent loans on banks’ books continued to mount in all major loan categories,

particularly among residential mortgages and construction and land development loans related to residential projects. In conclusion, commercial banks are regulated to keep cash reserves on hand in case of default; however, a major financial crisis may not be totally mitigated by these reserves as in the case of the most recent financial crisis where the government had to step in to lend them more money.

Managing risk for commercial banks is a difficult task that enables them to handle normal economic conditions that may affect them. Commercial banks try to hedge their loans against any changes in the general interest rate level in the economy. Banks will carefully screen their customers to see if they are at risk of default. Commercial banks are always at risk that regulators may increase the level of their reserves. When banks are in fear that customers will default on their loans due to...

References: Abraham, A. (2012). Financial instability and banks ' balance sheets: A Note. Journal of Business Management 43 (3), 95-98.
Bech, M. R. (2009). Profits and balance sheet developments at US commercial banks in 2008. Washington D.C.: Federal Reserve.
Hemenway, C. (2012, October 1). Income Statements, Not Balance Sheets, Driving E&S Rate Increases. P & C 116(31), 28.
Karthik, R. (2013). Why fair value is the rule. Harvard Business Review 91(3), 99-101.
Orens, R. L. (2010). Determinants of sell-side financial analysts ' use of non-financial information. Accounting and Business Research 40 (1), 39-53.
Ruquet, M. E. (2012). Lloyd 's Reports Strong First Half; Says Underwriting Discipline 'Top Priority". P & C, 28.
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