Assignment And Quiz

Eco. 521 Assignment —30/01/2018

Discuss
the following concepts in Monetary Economics
1.   
Risk analysis
2.   
Bank capital
adequacy
3.   
Bank earnings
4.   
Balance sheet
management
5.   
Liquidity
concepts and policies
6.   
Lending policies
7.   
Investment
instruments and policies
8.   
Comparative
Financial Systems
(Not more than 12 -15pages on or before 20/2/2018)
Tags

Tony Orji

Dr. Tony Orji is the founder and owner of Success Tonics Blog. He is a Senior Lecturer at the Department of Economics, University of Nigeria, Nsukka.

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  1. 1 RISK ANALYSIS
    Most financial investments entail taking risk. Risk analysis, therefore, is the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. Risk analysis is the study of the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, variance of portfolio/stock returns, the probability of a project's success or failure, and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects. It is a very important concept in monetary economics.
    A risk analyst starts by identifying what could go wrong. The negative events that could occur are then weighed against a probability metric to measure the likelihood of the event occurring. Finally, risk analysis attempts to estimate the extent of the impact that will be made if the event happens. We can divide risk analysis into the following;
    Quantitative Risk Analysis
    Risk analysis can be quantitative or qualitative. Under quantitative risk analysis, a risk model is built using simulation or deterministic statistics to assign numerical values to risk. Inputs which are mostly assumptions and random variables are fed into a risk model. For any given range of input, the model generates a range of output or outcome. The model is analyzed using graphs, scenario analysis, and/or sensitivity analysis by risk managers to make decisions to mitigate and deal with the risks.
    A Monte Carlo simulation can be used to generate a range of possible outcomes of a decision made or action taken. The simulation is a quantitative technique that calculates results for the random input variables repeatedly, using a different set of input values each time. The resulting outcome from each input is recorded, and the final result of the model is a probability distribution of all possible outcomes. The outcomes can be summarized on a distribution graph showing some measures of central tendency such as the mean and median, and assessing variability of the data through standard deviation and variance.
    The outcomes can also be assessed using risk management tools such as scenario analysis and sensitivity tables. A scenario analysis shows the best, middle, and worst outcome of any event. Separating the different outcomes from best to worst provides a reasonable spread of insight for a risk manager. For example, an American Company that operates on a global scale might want to know how its bottom line would fare if the exchange rate of select countries strengthens. A sensitivity table shows how outcomes vary when one or more random variables or assumptions are changed. A portfolio manager might use a sensitivity table to assess how changes to the different values of each security in a portfolio will impact the variance of the portfolio. Other types of risk management tools include decision trees and break-even analysis.
    Qualitative Risk Analysis
    Qualitative risk analysis is an analytical method that does not identify and evaluate risks with numerical and quantitative ratings. Qualitative analysis involves a written definition of the uncertainties, an evaluation of the extent of impact if the risk ensues, and countermeasure plans in the case of a negative event occurring. Examples of qualitative risk tools include SWOT Analysis, Cause and Effect diagrams, Decision Matrix, Game Theory, etc. A firm that wants to measure the impact of a security breach on its servers may use a qualitative risk technique to help prepare it for any lost income that may occur from a data breach.
    Almost all sorts of large businesses require a minimum sort of risk analysis. For example, commercial banks need to properly hedge foreign exchange exposure of oversees loans while large department stores must factor in the possibility of reduced revenues due to a global recession. It is important to know that risk analysis allows professionals to identify and mitigate risks, but not avoid them completely.

  2. 2 BANK CAPITAL ADEQUACY/CAPITAL ADEQUACY RATIO
    The bank capital adequacy, also known as the capital adequacy ratio (CAR) is a measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted credit exposures.
    Also known as capital-to-risk weighted assets ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of financial systems around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors. Capital Adequacy Ratio (CAR) is also called "Capital to Risk Weighted Assets Ratio (CRAR)."
    The reason why minimum capital adequacy ratios are critical is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. Capital adequacy ratios ensure the efficiency and stability of a nation’s financial system by lowering the risk of banks becoming insolvent. If a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system.

    During the process of winding-up, funds belonging to depositors are given a higher priority than the bank’s capital, so depositors can only lose their savings if a bank registers a loss exceeding the amount of capital it possesses. Thus the higher the bank’s capital adequacy ratio, the higher the degree of protection of depositor's monies.
    Tier One and Tier Two Capital
    Tier one capital is the capital that is permanently and easily available to cushion losses suffered by a bank without it being required to stop operating. A good example of a bank’s tier one capital is its ordinary share capital.
    Tier two capital is the one that cushions losses in case the bank is winding up, so it provides a lesser degree of protection to depositors and creditors. It is used to absorb losses if a bank loses all its tier one capital.
    When measuring credit exposures, adjustments are made to the value of assets listed on a lender’s balance sheet. All the loans the bank has issued are weighted based on their degree of risk. For example, loans issued to the government are weighted at 0 percent, while those given to individuals are assigned a weighted score of 100 percent.
    Credit Exposures
    Off-balance sheet agreements, such as foreign exchange contracts and guarantees, have credit risks. Such exposures are converted to their credit equivalent figures and then weighted in a similar fashion to that of on-balance sheet credit exposures. The off-balance and on-balance sheet credit exposures are then lumped together to obtain the total risk weighted credit exposures.
    In the United States, the minimum capital adequacy ratio is applied based on the tier assigned to the bank. The tier one capital of a bank to its total risk weighted exposure shouldn’t go under 4 percent. The total capital, which comprises tier one capital plus tier two minus specific deductions, so the total risk-weighted credit exposure should stay above 8 percent. Nigeria’s capital adequacy ratio, on the other hand, revolves around 10%.

  3. 3 BANK EARNINGS
    A bank is financial institution and hence, a business organization. We will therefore explain bank earnings in line with earnings as is obtained in other business organizations. Earnings typically refer to after-tax net income. Earnings are the main determinant of share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statements, because they show a company's profitability compared to analyst estimates and company guidance.

    Earnings are the amount of profit that a company produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Every quarter, analysts wait for the earnings of the companies they follow to be released. Earnings are studied because they represent a direct link to company performance. A company that beats estimates is outperforming its peers; thus, the CEO will be praised and the Board will pat itself on the back. A company that misses earnings is under-performing its peers; so the CEO will be blamed and the Board may elect a new CEO.

    Measures and Uses of Earnings

    There are many different measures and uses of earnings. Some analysts like to calculate earnings before taxes. This is referred to as pre-tax income, earnings before taxes, or EBT. Some analysts like to see earnings before interest and taxes. This is referred to as earnings before interest and taxes, or EBIT. Still other analysts, mainly in industries with a high level of fixed assets, prefer to see earnings before interest, taxes, depreciation and amortization, also known as EBITDA. All three measures provide varying degrees of profitability.

    Earnings Per Share

    Earnings per share is a commonly cited ratio used to show the company's profitability on a per-share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. The price-to-earnings ratio, calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of companies in the same industry. A company with a high price compared to the earnings it makes is considered overvalued. Likewise, a company with a low price compared to the earnings it makes is undervalued.

    Earnings Manipulation

    While earnings may appear to be the holy grail of performance measures, they can still be manipulated. Some companies intentionally manipulate earnings higher. These companies are said to have a poor or weak quality of earnings. Earnings per share can also be manipulated higher, even when earnings are down, with share buybacks. Companies do this by repurchasing shares with retained earnings or debt.

  4. 4 BALANCE SHEET MANAGEMENT

    Before we discuss the balance sheet management, it is only customary that we do a run-down on the meaning of balance sheet first, as it will give us a clearer understanding.
    A balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by shareholders.

    The balance sheet adheres to the following formula:

    Assets = Liabilities + Shareholders' Equity
    The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders' equity on the other – must balance out. This is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).

    For example, if a company takes out a five-year, $4,000 loan from a bank, its assets – specifically the cash account – will increase by $4,000; its liabilities – specifically the long-term debt account – will also increase by $4,000, balancing the two sides of the equation. If the company takes $8,000 from investors, its assets will increase by that amount, as will its shareholders' equity. All revenues the company generates in excess of its liabilities will go into the shareholders' equity account, representing the net assets held by the owners. These revenues will be balanced on the assets side, appearing as cash, investments, inventory, or some other asset.

    Assets, liabilities and shareholders' equity are each comprised of several smaller accounts that break down the specifics of a company's finances. These accounts vary widely by industry, and the same terms can have different implications depending on the nature of the business. Broadly, however, there are a few common components investors are likely to come across.
    Assets

    Within the assets segment, accounts are listed from top to bottom in order of their liquidity, that is, the ease with which they can be converted into cash. They are divided into current assets, those which can be converted to cash in one year or less; and non-current or long-term assets, which cannot.

    Here is the general order of accounts within current assets:

    Cash and cash equivalents: the most liquid assets, these can include Treasury bills and short-term certificates of deposit, as well as hard currency
    Marketable securities: equity and debt securities for which there is a liquid market
    Accounts receivable: money which customers owe the company, perhaps including an allowance for doubtful accounts (an example of a contra account), since a certain proportion of customers can be expected not to pay
    Inventory: goods available for sale, valued at the lower of the cost or market price
    Prepaid expenses: representing value that has already been paid for, such as insurance, advertising contracts or rent

    Long-term assets include the following:

    Long-term investments: securities that will not or cannot be liquidated in the next year
    Fixed assets: these include land, machinery, equipment, buildings and other durable, generally capital-intensive assets
    Intangible assets: these include non-physical, but still valuable, assets such as intellectual property and goodwill; in general, intangible assets are only listed on the balance sheet if they are acquired, rather than developed in-house; their value may therefore be wildly understated—by not including a globally recognized logo, for example—or just as wildly overstated

  5. Liabilities

    Liabilities are the money that a company owes to outside parties, from bills it has to pay to suppliers to interest on bonds it has issued to creditors to rent, utilities and salaries. Current liabilities are those that are due within one year and are listed in order of their due date. Long-term liabilities are due at any point after one year.

    Current liabilities accounts might include:

    Current portion of long-term debt
    Bank indebtedness
    Interest payable
    Rent, tax, utilities
    Wages payable
    Customer prepayments
    Dividends payable and others

    Long-term liabilities can include:

    Long-term debt: interest and principle on bonds issued
    Pension fund liability: the money a company is required to pay into its employees' retirement accounts
    Deferred tax liability: taxes that have been accrued but will not be paid for another year; besides timing, this figure reconciles differences between requirements for financial reporting and the way tax is assessed, such as depreciation calculations
    Some liabilities are off-balance sheet, meaning that they will not appear on the balance sheet. Operating leases are an example of this kind of liability.

    Shareholders' equity

    Shareholders' equity is the money attributable to a business' owners, meaning its shareholders. It is also known as "net assets," since it is equivalent to the total assets of a company minus its liabilities, that is, the debt it owes to non-shareholders.

    Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt; the rest is distributed to shareholders in the form of dividends.

    Treasury stock is the stock a company has either repurchased or never issued in the first place. It can be sold at a later date to raise cash or reserved to repel a hostile takeover.

    Some companies issue preferred stock, which will be listed separately from common stock under shareholders' equity. Preferred stock is assigned an arbitrary par value—as is common stock, in some cases—that has no bearing on the market value of the shares (often, par value is just $0.01). The "common stock" and "preferred stock" accounts are calculated by multiplying the par value by the number of shares issued.

    Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the "common stock" or "preferred stock" accounts, which are based on par value rather than market price. Shareholders' equity is not directly related to a company's market capitalization: the latter is based on the current price of a stock, while paid-in capital is the sum of the equity that has been purchased at any price.

  6. Real World Example

    Below is a reproduction of Amazon.com Inc.'s (AMZN) Balance Sheet for the quarter ended June 2017. All amounts are in million of U.S. dollars.
    Assets:
    Cash & Short Term Investments 21,451
    Short Term Receivables 8,046
    Inventories 11,510
    Other Current Assets –
    Total Current Assets 41,007
    Net Property, Plant & Equipment 37,083
    Total Investments and Advances 1,377
    Long Term Note Receivable –
    Intangible Assets 4,254
    Other Assets 4,060
    Total Assets 87,781

    Liabilities:
    Short Term Debt 6,136
    Accounts Payable 21,439
    Income Tax Payable –
    Other Current Liabilities 12,945
    Total Current Liabilities 40,520
    Long Term Debt 17,483
    Provision for Risks Charges –
    Deferred Tax Liabilities –
    Other Liabilities 6,564
    Total Liabilities 64,567

    Equity:
    Non-Equity Reserves –
    Preferred Stock Carrying Value –
    Total Common Equity 23,214
    Total Shareholders’ Equity 23,214
    Accumulated Minority Interest –
    Total Equity 23,214

    The balance sheet is a snapshot, representing the state of a company's finances at a moment in time. By itself, it cannot give a sense of the trends that are playing out over a longer period. For this reason, the balance sheet should be compared with those of previous periods. It should also be compared with those of other businesses in the same industry, since different industries have unique approaches to financing.

    A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company's finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet. Let us now explain balance sheet management.

    Balance Sheet Management

    Balance Sheet Management is aimed at the determination of the optimal composition of different funding elements such as debt, assets and equity for a company. This entails ensuring the right balance in a business organization’s financial statement.

    It is a challenge to find the right balance in the contradicting objectives of short-term liquidity risk and lowering the long-term funding costs of the company.

    On the one hand, corporates are seeking sufficient financial buffers in order to mitigate liquidity risk, while on the other hand a more leveraged funding structure lowers the after tax funding costs and hence increases shareholder value. Next to these contradicting objectives, other prerequisites need to be taken into account, such as differing shareholder and stakeholder objectives, bank relationship management in order to determine the optimal composition of the balance sheet in a dynamic way.

  7. 5 LIQUIDITY CONCEPTS AND POLICIES

    For a deeper understanding of liquidity concepts and policies, we will go ahead and explain liquidity as well as try to identify and expanciate the different forms it can come.
    The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. In this definition, two issues should be noted. First, liquidity can be understood in terms of flows (as opposed to stocks), in other words, it is a flow concept. In our framework, liquidity will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and market. Second, liquidity refers to the “ability” of realizing these flows. Inability of doing so would render the financial entity illiquid.

    Central Bank Liquidity
    Central bank liquidity is the ability of the central bank to supply the liquidity needed to the financial system. It is typically measured as the liquidity supplied to the economy by the central bank, i.e. the flow of monetary base from the central bank to the financial system. It relates to “central bank operations liquidity”, which refers to the amount of liquidity provided through the central bank auctions to the money market according to the “monetary policy stance”. The latter reflects the prevailing value of the operational target, i.e. the control variable of the central bank. In practice, the central bank strategy determines the monetary policy stance, that is, decides on the level of the operational target (usually the key policy rate). In order to implement this target, the central bank uses its monetary policy instruments (conducts open market operations) to affect the liquidity in the money markets so that the interbank rate is closely aligned to the operational target rate set by the prevailing monetary policy stance.
    Funding Liquidity
    The Basel Committee of Banking supervision defines funding liquidity as the ability of banks to meet their liabilities, unwind or settle their positions as they come due (BIS, 2008). Similarly, the IMF provides a definition of funding liquidity as the ability of solvent institutions to make agreed upon payments in a timely fashion. However, references to funding liquidity have also been made from the point of view of traders (Brunnemeier and Pedersen, 2007) or investors (Strahan, 2008), where funding liquidity relates to their ability to raise funding (capital or cash) in short notice. All definitions are compatible (see a relevant discussion in Drehmann and Nikolaou, 2008). This can be clearly seen in practice, where funding liquidity, being a flow concept, can be understood in terms of a budget constraint. Namely, an entity is liquid as long as inflows are bigger or at least equal to outflows. This can hold for firms, banks, investors and traders. This paper mainly focuses on the funding liquidity of banks, given their importance in distributing liquidity in the financial system. It is therefore useful to consider the liquidity sources for banks. A first one is, as already seen, the depositors, who entrust their money to the bank. A second is the market. A bank can always go to the asset market and sell its assets or generate liquidity through securitization, loan syndication and the secondary market for loans, in its role as “originator and distributor”. Moreover, the bank can get liquidity from the interbank market, arguably the most important source of liquidity. Finally, a bank can also choose to get funding liquidity directly from the central bank. In the euro system, this is possible by bidding in the open market operations of the ECB (see Drehmann and Nikolaou, 2008 for an extended analysis of the sources and their importance). Knowledge of these sources is important in order to better understand the liquidity linkages.

  8. Market Liquidity
    The notion of market liquidity has been around at least since Keynes (1930). It took a long time, however, until a consensus definition became available. A number of recent studies define market liquidity as the ability to trade an asset at short notice, at low cost and with little impact on its price. It therefore becomes obvious that market liquidity should be judged on several grounds. The most obvious would be the ability to trade. Moreover, Fernandez (1999) points out that “(market) liquidity, as Keynes noted […] incorporates key elements of volume, time and transaction costs. Liquidity then may be defined by three dimensions which incorporate these elements: depth, breadth (or tightness) and resiliency”. These dimensions ensure that any amount of assets can be sold anytime within market hours, rapidly, with minimum loss of value and at competitive prices.

    Having seen these forms of liquidity therefore, we can say that liquidity concepts are the very essential terms used in financial market discussions to refer to how liquid or illiquid an asset could be as well as the type of liquidity available in the commodity. On the other hand, liquidity policies are the legislations or regulations made by the regulators of the financial market (such as the Central Bank), which specifies what liquidity of an asset entails.

  9. RISK ANALYSIS: Risk analysis entails the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. Risk analysis is the study of the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, variance of portfolio/stock returns, the probability of a project's success or failure, and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects.
    Risk analysis is also a financial derivatives adopted by financial institutions to control or reduce the level of risk and volatility being faced in the financial market. Some of these financial derivatives include forward contracts, financial futures, options, and swaps. Financial derivatives can be used to reduce risk by invoking the following basic principle of hedging: Hedging risk involves engaging in a financial transaction that offsets a long position by taking an additional short position, or offsets a short position by taking an additional long position. In other words, if a financial institution has bought a security and has therefore taken a long position, it conducts a hedge by contracting to sell that security (take a short position) at some future date. Alternatively, if it has taken a short position by selling a security that it needs to deliver at a future date, then it conducts a hedge by contracting to buy that security (take a long position) at a future date. We first look at how this principle can be applied using forward contracts.

  10. CREDIT DERIVATIVES:
    Just like other derivatives, credit derivatives offer payoffs on previously issued securities, but ones that bear credit risk. In the past ten years, the markets in credit derivatives have grown at an outstanding pace and the notional amounts of these derivatives now number in the trillions of dollars. These credit derivatives take several forms.
    Credit options work just like the options discussed earlier: For a fee, the purchaser gains the right to receive profits that are tied either to the price of an underlying security or to an interest rate. Suppose you buy $1 million of General Motors bonds but worry that a potential slowdown in the sale of SUVs might lead a credit-rating agency to downgrade (lower the credit rating on) GM bonds. such a downgrade would cause the price of GM bonds to fall. To protect yourself, you could buy an option for, say, $15 000 to sell the $1 million of bonds at a strike price that is the same as the current price. With this strategy, you would not suffer any losses if the value of the GM bonds declined because you could exercise the option and sell them at the price you paid for them. In addition, you would be able to reap any gains that occurred if GM bonds rose in value. The second type of credit option ties profits to changes in an interest rate such as a credit spread (the interest rate on the average bond with a particular credit rating minus the interest rate on default-free bonds such as those issued by the Canadian government).

  11. BANK CAPITAL ADEQUACY: Banks have to make decisions about the amount of capital they need to hold for three reasons. First, bank capital helps prevent bank failure, a situation in which the bank cannot satisfy its obligations to pay its depositors and other creditors and so goes out of business. Second, the amount of capital affects returns for the owners (equity holders) of the bank. Third, a minimum amount of bank capital (bank capital requirements) is required by regulatory authorities. Regulators try to ensure that banks and other financial institutions have sufficient capital to keep them out of difficulty. This not only protects depositors, but also the wider economy, because the failure of a big bank has extensive knock-on effects.
    Bank capital adequacy also deals on percentage ratio of a financial institution's primary capital to its assets (loans and investments), used as a measure of its financial strength and stability. According to the Capital Adequacy Standard set by Bank for International Settlements (BIS), banks must have a primary capital base equal at least to eight percent of their assets: a bank that lends 12 dollars for every dollar of its capital is within the prescribed limits.
    When a bank becomes insolvent, government regulators close the bank, its assets are sold off, and its managers are fired. We therefore see an important rationale for a bank to maintain a sufficient level of capital: a bank maintains bank capital to lessen the chance that it will become insolvent. However because owners of a bank must know whether their bank is being managed well, they need good measures of bank profitability. A basic measure of bank profitability is the return on assets (ROA), the net profit after taxes per dollar of assets:
    ROA = net profit after taxes
    assets
    The return on assets provides information on how efficiently a bank is being run, because it indicates how much profit is generated on average by each dollar of assets. However, what the bank s owners (equity holders) care about most is how much the bank is earning on their equity investment. This information is provided by the other basic measure of bank profitability, the return on equity (ROE), the net profit after taxes per dollar of equity capital:

  12. ROA = net profit after taxes
    equity capital
    There is a direct relationship between the return on assets (which measures how efficiently the bank is run) and the return on equity (which measures how well the owners are doing on their investment). This relationship is determined by the equity multiplier (EM), the amount of assets per dollar of equity capital:
    EM = assets
    equity capital

    net profit after tax net profit after taxes assets
    ——————— = ———————— * ——-
    equity capital assets equity capital

    which, using our definitions, yields:
    ROE = ROA * EM
    The above formula tells us what happens to the return on equity when a bank holds a smaller amount of capital (equity) for a given amount of assets. As we have seen, the High Capital Bank initially has $100 million of assets and $10 million of equity, which gives it an equity multiplier of 10 ( $100 million/$10 million). The Low Capital Bank, by contrast, has only $4 million of equity, so its equity multiplier is higher, equalling 25 ($100 million/$4 million). Suppose that these banks have been equally well run so that they both have the same return on assets, 1%. The return on equity for the High Capital Bank equals 1% * 10 = 10%, while the return on equity for the Low Capital Bank equals 1% * 25 = 25%. The equity holders in the Low Capital Bank are clearly a lot happier than the equity holders in the High Capital Bank because they are earning more than twice as high a return. We now see why owners of a bank may not want it to hold a lot of capital. Given the return on assets, the lower the bank capital, the higher the return for the owners of the bank.

  13. THE BANK BALANCE SHEET:
    To understand how banking works, we start by looking at the bank balance sheet, a list of the bank s assets and liabilities. As the name implies, this list balances; that is, it has the characteristic that:
    Total assets =total liabilities + capital
    A banks balance sheet is also a list of its sources of bank funds (liabilities) and uses to which the funds are put (assets). Banks obtain funds by borrowing and by issuing other liabilities such as deposits. They then use these funds to acquire assets such as securities and loans. Banks make profits by earning an interest rate on their holdings of securities and loans that is higher than the expenses on their liabilities. Another category on the liabilities side of the balance sheet is bank capital, the bank s net worth, which equals the difference between total assets and liabilities.

  14. BANK EARNINGS: A bank acquires funds by issuing (selling) liabilities such as deposits, which are the sources of funds the bank uses. The funds obtained from issuing liabilities are used to purchase income-earning assets. Banks have three main sources of funds: deposits, borrowings, and equity. Also under banks earning is the use of Fixed-term deposit; Fixed-term deposits are the primary source of bank funds. Owners (retail customers, small and medium-sized businesses, large corporations, governments, and other financial institutions) cannot write cheques on fixed-term deposits, but the interest rates are usually higher than those on chequable deposits. There are two main types of fixed-term deposits: savings accounts and time deposits (also called certificates of deposit, or CDs).

  15. BORROWINGS: Banks obtain funds by borrowing from the Central Bank of Nigeria, other banks, and corporations. Borrowings from the Central Bank of Nigeria are called overdraft loans (also known as advances). Banks also borrow reserves overnight in the overnight market from other banks and financial institutions. Banks borrow funds overnight to have enough settlement balances at the Bank of Canada to facilitate the clearing of cheques and other transfers.
    LOANS: Banks make their profits primarily by issuing loans.some 50% of bank assets are in the form of loans, and in recent years they have generally produced more than half of bank revenues.
    DEPOSITS AT OTHER BANKS: Many small banks hold deposits in larger banks in exchange for a variety of services, including cheque collection, foreign exchange transactions, and help with securities purchases. These deposits are known as interbank deposits.

  16. BANK'S LENDING POLICIES:
    The bank's lending policies shall address the business of lending comprehensively and shall be used as guidance for lending transactions. Each bank's lending policy shall cover the following, in consistency with the scope, nature and complexity of its lending transactions:
    Levels of authority: The lending policy shall clearly identify the levels of lending authorities of each department and unit involved in lending transactions. The existing banking laws, expertise and qualifications of employees shall be taken into account when assigning decision-making and loan application assessment authorities to the bank's business units and individual employees. In order to prevent any conflicts of interest, the credit risk evaluation as well as loan classification function of the bank should be separate and independent from the function responsible for overseeing the quality of the loan portfolio, as well as compliance, prudential reporting, internal requirements and limits.
    Lending limits and loan concentrations: The bank's policy shall identify limits, regular monitoring and reporting requirements with respect to all known loan concentrations (loan types, related parties, economic sectors, geographic regions, etc.). Determination of limits should incorporate the required level of return on each type of loan and the outcomes of sensitivity evaluation of the loan portfolio as well as borrowed funds used to finance loans. The bank policy shall set, at a minimum, the following limits with respect to the loan portfolio or the total capital, in compliance with the Central Bank's related prudential requirements:Types and areas of lending. Each bank shall develop and put in place individual lending, monitoring and control policies for each type of loan, in consistency with the lending strategy and nature of different types of loans.
    Loan maturities and terms: The maturity/term of a loan (principal and interest) shall be predicated on the purpose, type, source of repayment of the loan, seasonal/periodic nature of the borrower's business as well as realistic cash flow projections.
    DISCOUNTS: Banks shall define relevant criteria for discounted loans. Clear and precise procedures should be determined for discounted lending, i.e., for granting loans to borrowers at more favorable conditions as compared to other borrowers who take loans of the same type, and such procedures should not be in conflict with the bank's overall lending strategy as well as the existing banking laws.

  17. INVESTMENT INSTRUMENTS AND POLICIES:
    Some of the investments Instrument includes the following:
    CERTIFICATES OF DEPOSIT: A certificate of deposit (CD) is a debt instrument sold by a bank to depositors that pays annual interest of a given amount and at maturity pays back the original purchase price. CDs are often negotiable, meaning that they can be traded, and in bearer form (called bearer deposit notes).
    COMMERCIAL PAPER: Commercial paper is an unsecured short-term debt instrument issued in either naira or other currencies by large banks and well known corporations, such as NBL. Because commercial paper is unsecured, only the largest and most creditworthy corporations issue commercial paper.
    REPURCHASE AGREEMENTS: Repurchase agreements, or repos, are effectively short-term loans (usually with a maturity of less than two weeks) for which treasury bills serve as collateral, an asset that the lender receives if the borrower does not pay back the loan.
    Capital market instruments are debt and equity instruments with maturities of greater than one year. They have far wider price fluctuations than money market instruments and are considered to be fairly risky investments.
    STOCKS: Stocks are equity claims on the net income and assets of a corporation. Their value was $324.1 billion at the end of 2008. The amount of new stock issues in any given year is typically quite small less than 1% of the total value of shares outstanding. Individuals hold around half of the value of stocks; pension funds, mutual funds, and insurance companies hold the rest.
    MORTGAGES: Mortgages are loans to households or firms to purchase housing, land, or other real structures, where the structure or land serves as collateral for the loans.
    CORPORATE BONDS: These are long-term bonds issued by corporations with very strong credit ratings. The typical corporate bond sends the holder an interest payment twice a year and pays off the face value when the bond matures.
    CENTRAL BANK OF NIGERIA BONDS: Intermediate-term bonds (those with initial maturities from one to ten years) and long-term bonds (those with initial maturities greater than ten years) are issued by the federal government to finance its deficit, because they are the most widely traded bonds in Nigeria, they are the most liquid security traded in the capital market. They are held by the Central Bank of Nigeria, banks, households, and foreign investors.
    Fiscal and monetary policies
    Fiscal policies include government expenditure, taxes and subsidies. Taxes, on the other hand, may be targeted to help regulate resource use, such as resource rent taxes or taxes on polluters. Some specific examples of targeted expenditures and taxes are discussed under later sub-headings.
    Trade and exchange rate polices
    This group of policies includes taxes on imports and exports and controls on trade. Such policies tend to reduce the domestic producer prices for export products and to push up the domestic prices on imported items. These impacts will affect commodities and sectors differentially. In a global setting, a more open foreign trade framework, with fewer taxes and restrictions on imports and exports, is usually held to be good for sustainable development.

  18. COMPARATIVE FINANCIAL SYSTEMS
    Comparative financial systems focused on two sets of issues. Normative: How effective are different types of financial systems at various functions? Positive: What drives the evolution of the financial system?
    The financial system is among the key institutional features structuring business systems, financial systems vary on a number of dimensions but the critical feature deals with the processes by which capital is made available and priced.
    Allen & Gale (2000) expressed that an efficient capital market is an important component of a capitalist system. In such a system, the ideal is a market where prices are accurate signals for capital allocation. That is, when firms’ issues securities to finance their activities they can expect to get fair prices and when investors choose among the securities that represent ownership of firms activities they can do so under the assumption they are paying fair prices. In short, if the capital market is to function smoothly in allocating resources, prices of securities must be good indicators of value.
    Comparative financial system however talks about the role of information asymmetric in financial system and how some stringent financial or political regulations can lead to or correct some financial crises.

  19. RISK ANALYSIS:
    Every investment has an element of risk involve, also in every financial instrument one is dealing on also has its own risk associate to it. Risk is a situation that exists when perfect information is unavailable to a decision maker; however, the probabilities associated with all outcomes are unknown. It could be also put as a potential of gaining or losing a valuable item. In the process to attain a value it can be gained or lost when taking an action. From business dictionary, it been express as the probability that an actual return on an investment will be lower than the expected return. It also implies as a future uncertainty about deviation from expected outcome. It measures the uncertainty that a business man is willing to take in other to gain from a given investment. All risk is being diversified so that transitory shocks will not have full impact on the investment.
    Risk could be of different types which could be originate from different situation such as; liquidity risk, insurance risk, business risk, etc. due to uncertainty that arise out of various factors that influence an investment. An investor could be said to be risk averse, risk preferring, risk neutral.
    Risk Averse: An investor is said to be risk averse if the expected return he receives from the outcome associated with a risky choose of investment is less than the return received from a certain investment outcome, which is equal to the expected outcome associated with the risky investment choice.
    Risk preferring: In these situation, an investor is said to be risk preferring if the expected return he receives from an investment outcome associated with a risky decision is greater than the return he received from an investment outcome with certainty.
    Risk neutral: This occur if the expected return he receives from an investment outcome associated with a risky choice is equal to the return he receives from an investment outcome with certainty.
    An investor can manage the level of risk in his business. Risk management implies as the process of identifying, assessing and controlling threats to a business capital and earnings. These risks could come from variety of sources which include; financial uncertainty, legal liabilities, natural disasters and management errors. The ability of an investor to control the level of risk in his business will help to know whether the business is making progress or not. Buying and selling of financial instruments comes with a significant risk of losses and damages and each investor must understand that the investment value can both rise and decrease

  20. BANK CAPITAL ADEQUACY:
    Commercial banks have some level of capital in other to enable them to be in business. Let start from letting us know the meaning of some terms that will help us understand the topic of interest.
    First the Bank capital; which can be seen as the difference between the value of the bank’s assets minus its liabilities. Its assets include cash, loans and securities, while its liabilities are customer deposits, money owed to other banks and bondholders. Secondly, the capital adequacy or requirement; this is the amount of capital a bank or other financial institution has to hold as required by it financial regulator (central Bank), which is use as an instrument to protect depositors and promote the stability and efficiency of financial systems around the banking world. The bank requirement is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk weighted assets.
    The Capital Adequacy Ratio (CAR) is also known as capital to Risk(weighted) Assets Ratio (CRAR), is the ratio of a bank’s capital to its risk. An international standard which recommends minimum capital adequacy ratios has developed to ensue banks can absorb a reasonable level of losses before becoming insolvent.
    The minimum capital adequacy ratio serves to protect depositors and promote the stability and efficiency of the financial system. When a bank become insolvent this may lead to a loss of confidence in the financial system, causing financial problems to other banks thereby becoming a threat to the smooth function of financial markets. In the case of a winding up, depositor’s funds become the priority before the capital, so depositors would only lose money if the bank made a loss which exceeded the amount of capital it had. The higher the capital adequacy ratio, the higher the level of protection available to depositors.
    In Nigeria, the Central Bank of Nigeria (CBN) has the mandate to regulate the actives of financial institution in Nigeria. According to publication made by CBN which show the Guidance that will be follower for Regulatory Capital “Banks are required to maintain a minimum regulatory capital adequacy ratio (CAR) of 10% to 15% on an on-going basis’’. In its effort to maintain a strong financial institution the CBN in her address on 6th July, 2004, by the Central Bank Governor said “the Nigerian banking system today is fragile and marginal. Our vision is a banking system that is part of the global change, and which is strong, competitive and reliable. It is a banking system which depositors can trust, and investors can rely upon. Evolving such a banking system is a collective responsibility of all agents in the Nigerian economy.” He gave reasons such as persistent illiquidity, weak corporate governance, poor assets quality, insider abuses, weak capital base, unprofitable operations, and over-dependency on public sector funds, among others, that necessitated the banking sector reform. In the same paper, the CBN Governor said “One of the recent developments in the banking system, which is of great concern to the monetary authorities is the significant dependence of many Nigerian banks on government deposits, with the three tiers of government and parastatals accounting for over 20 percent of total deposit liabilities of deposit money banks. The CBN gave a dateline for bank recapitalization which enable commercial bank to increase their capital to N25 billion, following this process a lot of banks were not able to meet up to that amount which result to some bank merge together to form a strong bank. On 1st January, 2005, after the close of the un-extended deadline, 25 banks emerged as having met the N25bn recapitalization requirement.

  21. BANK EARNINGS:
    Banks basically make money by leading money at higher than the cost of the money they lend. More specifically, they collect interest on loan and interest payments from the debt securities they own and pay interest on deposit. The interest rates a bank charges its borrowers depends on both the number of people who want to borrower and the amount of money the bank has available to lend. Banks also earn money from the fees the charge for services like checking, ATM access and overdraft protection. Also another source of income for banks is investment and securities.
    One of the most important bank accruals, loan loss provision(LLP), is been calculated based on an incurred loss approach and reflects the expected losses arising from their lending business. Is our interest to note that unexpected losses, been defined as negative deviations from the expected losses, should be adsorbed by bank capital and are calculated through risk weighted assets. The banks might use the LLPs to stabilize earnings levels, to reduce the volatility in earnings and to implement the payout policy.
    Moyer (1990) predicts that banks opportunistically realize securities gains and losses to increase regulatory capital. Based on a sample of 845 bank-year observations relating to 142 banks from 1981 to 1986, Moyer (1990) finds evidence consistent with banks using realized securities gains and losses to increase regulatory capital, but only for banks with regulatory capital below the minimum. Based on a sample basically the same as that in Moyer (1990), Scholes, Wilson, and Wolfson (1990 SWW) finds a significant negative relation between regulatory capital and realized securities gains and losses, which indicates that banks manage regulatory capital through the realization of these gains and losses.

  22. BALANCE SHEET MANAGEMENT:
    Balance sheet literally means a financial repost that show the value of a company’s assets, liabilities and owner’s equity on a specific date, usually at the end of an accounting period, such as a quarter or a year. The balance sheet management covers regulatory policy for investment securities, Bank owned life insurance, liquidity risk and interest rate for national bank, as well as assessment of interest rate and liquidity risk for national banking system as a whole. This deal with the management of risk that arise from the balance sheet of a retail bank.
    The four main areas of balance sheet management which include interest rate risk management, liquidity risk management, capital management and management of discretionary investment portfolios will help us understand more about the concept of balance sheet management.
    The liquidity risk has been one of the most important area of focus within the Assets and Liability Management (ALM) framework. The experience from the financial crisis have indicate the dimension and severity of consequence from liquidity problems. Many banks have undertaken a reviews and upgrades of their liquidity risk framework. The primary measure of liquidity risk is the static maturity gap using a combination of contractual and expected term data, however the use of cash flow forecasts using stressed or expected cash flows is gaining greater prominence as the primary measure of liquidity risk.

    The interest rate risk is the area that has probably had the most attention within banks. Research has shown that banks have been performing some of interest rate risk management activities and have well established processes. One of the key performance metrics for managing interest rate risk is the use of a benchmark for the investment term or duration of equity. The challenge for the measurement and management of interest rate risk has been to strike the appropriate balance between the short term impact on earnings and the longer term impact on economic value.

    Capital management is One of the biggest challenges for banks is to establish an
    effective, integrated operating model to bring all of the components together and thus enable consistency and clarity within the application of the whole and related sub-components.
    The Discretionary investment portfolios consist of investments that are outside the normal business activities of banks which involve; trading portfolios, temporary warehousing of securitization pipelines and debt investment resulting from problem loan work-outs.

  23. LIQUIDITY CONCEPTS AND POLICIES:
    Liquidity is very critical phenomenon for smooth operation of banking businesses. In fact, growth, development and survival of banks depend on liquidity. Liquidity can be described as a bank or firm’s ability to meet the cash demand of its policy and contract that it holds with minimal or no loss. The liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. From this expression, two things are being noted. First, it’s been understanding that liquidity can be in terms of flows ie as opposed to stocks. Liquidity refers to the unhindered flows among the agents of the financial system. Secondly, liquidity refers to the ability of realizing these flows. Inability of doing so would render the financial entity illiquid.
    Three main liquidity notions namely; central bank liquidity, market liquidity and funding liquidity are explained and discussed below. Their complex and dynamic linkages can give us a good understanding of the liquidity workings in the financial system and reveal positive or negative effects for financial stability, depending on the levels of liquidity risk prevailing. The causes of liquidity risk lie on departures from the complete markets and asymmetric information paradigm, which can lead to moral hazard and adverse selection. Liquidity risk is endemic in the financial system and can cause a vicious link between funding and market liquidity, prompting systemic liquidity risk.
    In the process to eliminate systemic liquidity risk, greater transparency of liquidity management practices is needed. Supervision and regulation are the fundamental weapons against systemic liquidity risk. These practices can help to tackle the root of liquidity risk by minimizing asymmetric information and moral hazard through effective monitoring mechanisms of the financial system.
    Central bank liquidity: This refer to the ability of the central bank to supply the liquidity needed to the financial system. It’s being measured as the liquidity supplied to the economy by the central bank, i.e. the flow of monetary base from the central bank to the financial system. The central bank liquidity can also be defined as the money the central bank auctions to the money market. This point to the central bank monetary policy stance which decide the level of operational target. In a way to attain these target, they use its monetary instruments such as open market operation to affect the liquidity in the money markets.
    The funding liquidity: This refers as the ability of banks to meet their liability, settle their positions as they come due. The IMF define funding liquidity as the ability of solvent institutions to make agreed upon payments in a timely fashion. from the view point of traders, it means the ability to raise fund in the short notice. A bank can always go to the asset market and sell its assets or generate liquidity through securitization, loan syndication and the secondary market for loans, in its role as originator and distributor. The can also get liquidity from the interbank market which saves as the most important source of liquidity. They can also get liquidity directly from the central bank. The viability and efficiency of a bank is greatly influenced by the availability of liquidity in sufficient amount at all times. Banks must meet their due obligations and execute payments on the exact day they are due, otherwise, the banks stand the risk of being declared illiquid.
    Market liquidity: This refers as the ability to trade an asset at short notice, at low cost and with little impact on its price. It provides an investor the ability to buy and sell a sizeable amount of assets without appreciably affecting the price of the asset in a liquid market. Therefore, market liquidity is made up of key elements of time, volume and transaction costs upon which it should be defined.

  24. LENDING POLICIES:
    The provision of credit has been identified as an important tool for raising the income of people, mainly by mobilizing resources to more productive uses. In the process to actualize self-employment in non-firm activities requires investment in working capital. At low level of income, the accumulation of such capital may be difficult. In this situation, the only means to raise such income is by obtaining loan from friends, family members or banks.
    The commercial banks and other financial institution mainly have their terms and condition to give out such loans to people that are need of such. The work by Stiglitz and Weiss (1981) marks the beginning of attempts at explanations
    of credit rationing in credit markets. In this explanation, interest rates charged by a credit institution are seen as having a dual role of sorting potential borrowers (leading to adverse selection), and affecting the actions of borrowers (leading to the incentive effect). Interest rates thus affect the nature of the transaction and do not necessarily clear the market. Both effects are seen as a result of the imperfect information inherent in credit markets.
    Adverse selection occurs because lenders would like to identify the borrowers most likely to repay their loans since the banks’ expected returns depend on the probability of repayment. The incentive effect occurs because as the interest rate and other terms of the contract change, the behavior of borrowers is likely to change since it affects the returns on their projects. Other terms of the contract, like the amount of the loan and the amount of collateral, will also affect the behavior of borrowers and their distribution, as well as the return to banks. In the process of raising the interest rate or the collateral is not always good for the borrowers and banks has to deny loans to certain borrowers.
    The credit markets in Africa have been face by the inability to satisfy the existing demand for credit in rural areas. For the informal sector of the economy the main reason for this inability is the small size of the resources it controls, for the formal sector it is not an inadequate lending base on the reasons of difficulties in loan administration like screening and monitoring, high transaction costs, and the risk of default.
    Credit markets are characterized by information asymmetry, agency problems and poor contract enforcement mechanisms and because of this, lending units are unable to meet the needs of borrowers interested in certain types of credit. The result is a credit gap that captures those borrowers who cannot get what they want from the informal market, yet they cannot gain access to the formal sources.

  25. INVESTMENT INSTRUMENTS AND POLICIES:
    The term investment is defined as the process of employment of fund with the aim of getting return on it. In general view, investment means the use of money in hope of making more money. Also in finance, investment means the purchase of a financial product or other item of value with an expectation of favorable future return.
    Financial Investment instrument: This is an allocation of monetary resources to assets that are expected to yield some gain or return over a given period of time. It means an exchange of financial claims such as shares and bonds, real estate, etc.
    Financial investment involves contrasts written on pieces of paper such as
    shares and debentures. People invest their funds in shares, debentures, fixed
    deposits, national saving certificates, life insurance policies, provident fund etc. in their view investment is a commitment of funds to derive future income in the
    form of interest, dividends, rent, premiums, pension benefits and the appreciation
    of the value of their principal capital. In primitive economies most investments are
    of the real variety whereas in a modern economy much investment is of the
    financial variety.
    Bonds: A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, states and governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer. They are commonly known as fixed income securities. Corporate and government bonds are traded publicly exchanges while others are traded only over-the-counter (OTC).
    When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing debts, they may issue bonds directly to investors instead of obtaining loans from a bank. The indebted entity (issuer) issues a bond that contractually states the interest rate that will be paid and the time at which the loaned funds (bond principal) must be returned (maturity date). The interest rate, called the coupon rate or payment, is the return that bondholders earn for loaning their funds to the issuer. There are three main categories of bone which include corporate bonds; they are issued by companies, municipal bonds are issued by governments and the treasury bonds that has a maturity of more than 10 years.
    Company shares: A share signifies a unit of ownership of a company that represents equity in the company’s capital structure. The owners of shares in a company is called a shareholder. It entitles its holder to an equal claim on the company’s profits and an equal obligation for the company’s debts and losses.
    Fixed deposit: This is a financial instrument provided by banks which provides investors a higher rate of returns than other account that people operate in a bank. Until it reaches its maturity date the owner is not allowed to withdrew it.
    In an investment decision, every good investor always makes some speculation on how to allocate its investment. One can see it as an activity in which a person assumes high risk, often without regard for the safety of their invested principal, to achieve large capital gains. Speculation includes the buying, holding, selling and short selling of stocks, bonds, commodities, currencies, real estate collectibles, derivatives or any valuable financial instrument.

  26. COMPARATIVE FINANCIAL SYSTEMS:
    The reason for the financial system is to channel funds from people with surpluses to another with deficit. The financial market and financial intermediaries have the basic function of getting people, by moving funds from those who have a surplus of funds to those who have a shortage of funds.
    The financial market has the mandate of channeling funds from households, firms and government that have surplus funds that are saved to those that run short of funds. In general view, those who have saved are now the Leander’s while those who must get fund to finance their budget are borrowers. The most important borrower-spending are business and the government, but the household and foreigners also borrow to finance their expenses. Financial markets are thus essential
    to promoting economic efficiency. Firms borrows for the purpose of increasing production in their business. They allow funds to move from people who lack productive investment opportunities to people who have such opportunities. Thus financial markets are critical for producing an efficient allocation of capital, which contributes to higher production and efficiency for the overall economy.
    The financial market is structure in various ways such as; debt and equity market, primary and secondary markets, exchanges and over- the-counter market, money and capital markets.
    The most common way an individual can obtain fund in a financial market is through the issue of debt instrument, such as a bond, which the holder of the instrument is been pay a fixed amount at regular interval ie interest and principal payment until the maturity date when a final payment is made. The debt instrument is short term if its maturity is less than a year and long term if its maturity is ten years above. Also, another way to rise fund is through the issuing of equity such as common stock. Equity holders are being paid dividend periodically and they are considered long term securities because they have no maturity date.
    The primary market is a market where new securities such as a bond or a stock, are sold to initial buyers by the government agency borrowing funds. while in the secondary market, second hand securities that have been previously issued can be sold.

  27. In the exchange and over-the-counter market; the exchange market is a secondary market where buyers and sellers of securities meet in one central point to conduct trade, for instance the Nigeria Stock Exchange (NSE). In other hands, the Over-the-counter (OTC) is also a secondary market where deals at different locations with the help of internet buy and sell securities. The OTC market is very competitive and nat different from other market.
    Another important market in financial structure that have contribute immensely to the development of the economy is the money and capital market. The money market has been defined as a financial market that deals with short term debt instrument. They are more liquid than the capital market. The commercial banks use the money market to earn interest on surplus funds that they expect to have only temporarily. In another hands, capital market is a financial market where long term debt and equity instruments are traded. The securities such as stocks and bonds are held by financial intermediaries such as insurance companies and pension funds.
    The growth of Nigeria financial market has been the result of large increase in the pool of savings and recently the recapitalization of banks in 2004. The financial system played an important role in the industry revolution which has contribute to the economy growth of the country.
    We cannot conclude here without mentioning the financial regulators. Through the activities of the government regulates by making information available to investors so as to ensure the soundness and robustness of the financial system.
    The Nigeria financial system consist of banks and non-banking financial institutions which are regulates by the Central Bank of Nigeria (CBN) and federal ministry of finance, Nigeria deposit insurance corporation (NDIC), Security and exchange commission (SEC), the national insurance commission (NIC) and the federal mortgage bank of Nigeria (FMBN).

  28. RISK ANALYSIS
    Risk is the possibility; likelihood or chance that something unpleasant or unwelcomed will happen that is capable of damaging an asset, or all of the original investment or the possibility of financial loss. More precisely, risk is the possibility of damage or any other negative occurrence that is caused by external or internal vulnerabilities, which may be avoided through preemptive action. Risk is commonly associated with uncertainty, as the event may or may not happen. It is an essential part of business, because enterprises cannot function without taking risks as business grows through risk taking. Hence, risk is related with opportunities and threat, which may harmfully affect an action or expected outcome.
    Risk Analysis helps identify and manage potential problems that could undermine key business initiatives or projects. To carry out a Risk Analysis, one must first identify the possible threats that you face, and then estimate the likelihood that these threats will materialize. Risk Analysis can be complex, but need to draw on detailed information such as project plans, financial data, security protocols, marketing forecasts, and other relevant information. However, it is an essential planning tool, and one that could save time, money, and reputations.
    Risk analysis can be qualitative or quantitative. Qualitative risk analysis uses broad terms (e.g., moderate, severe, catastrophic) to identify and evaluate risks or presents a written description of the risk, while quantitative risk analysis calculates numerical probabilities over the possible consequences.
    Quantitative risk analysis seeks to numerically assess probabilities for the potential consequences of risk, and is often called probabilistic risk analysis or probabilistic risk assessment (PRA). The analysis often seeks to describe the consequences in numerical units such as dollars, time, or lives lost. PRA often seeks to answer three questions:
    1. What can happen? (i.e., what can go wrong?)
    2. How likely is it that it will happen?
    3. If it does happen, what are the consequences?
    Once identified the threats facing, you need to calculate out both the likelihood of these threats being realized, and their possible impact. One way of doing this is to make your best estimate of the probability of the event occurring, and then to multiply this by the amount it will cost you to set things right if it happens. This gives you a value for the risk:
    Risk Value = Probability of Event x Cost of Event
    As a simple example, imagine that you have identified a risk that your rent may increase substantially. You think that there is an 80 percent chance of this happening within the next year, because your landlord has recently increased rents for other businesses. If this happens, it will cost your business an extra $500,000 over the next year.
    So the risk value of the rent increase is:
    0.80 (Probability of Event) x $500,000 (Cost of Event) = $400,000 (Risk Value)

  29. BANK CAPITAL ADEQUACY
    Capital Adequacy Ratio (CAR) is basically the proportion of the bank’s tier 1& tier 2 equity (Qualifying capital or Equity) as a proportion of its risk weighted assets (loans). It is the proportion of a bank’s own equity in relation to its risk exposure. If a bank for example, has N200billion risk weighted assets and has a qualifying capital of N60billion then its CAR is N60billion/N200billion which is equal to 30%.
    The capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking license, respectively.
    In the computation of CAR recommended by Basel Committee on Banking Supervision (BCBS), Tier 2 capital should not constitute more than 50% of the qualifying capital, that is, 100% of Tier 1. However, banks designated as SIBs would be required to maintain a minimum CAR of 15% out of which Tier 2 capital should not constitute more than 25% of the qualifying capital.
    In other words, Tier 1 capital should be at least 75% of the bank’s qualifying capital. In addition, Systematic Important Banks (SIBs) in Nigeria would be required to set aside Higher Loss Absorbency (HLA) or additional capital surcharge of 1% to their respective minimum required CAR.
    This should be met with Common Equity Tier 1 (CET1) capital. The aim of the additional loss absorbency requirement is to ensure that the SIBs have a higher share of their balance sheet funded by instruments that re-enforce the resilience of the institution as a going concern.
    In a situation where the foreign subsidiary of a Nigerian bank is considered systemically important by the host authority, the Central Bank of Nigeria and the host authorities would make arrangements to coordinate and cooperate on the appropriate HLA requirement, within the constraints imposed by the relevant laws in the host jurisdiction.
    CAR helps regulators protect depositors from banks who lend aggressively and in doing so do not get back most of the money lent. This is because when a bank makes large loan losses that wipe out its total equity, it may lead to an immediate bankruptcy thus making depositors lose their money.
    Different countries have methods of determining what constitutes Tier 1 & 2 capital as well as risk weighted assets. According to CBN Guidance Note, to determine a bank's CAR, the CBN (being the financial regulator), must first ascertain, from its balance sheet, the bank's total capital. This is derived by a summation of the bank's Tier 1 Capital (comprising of its paid-up share capital, stocks, retained profits, share premiums, etc.) and Tier 2 Capital (comprising of its revaluated debts (recently valued tangible assets), general loan-loss reserve (sum set aside to service outstanding debts), capital instruments, subordinated debts etc.,). Thereafter, the ascertained capital is divided by the bank's total credit exposures (its loans, performance bonds, losses carried forward from the previous financial year, etc.,). A percentage of the ascertained figure, which is currently pegged at 10%/15% depending on whether the Bank is a Systematically Important bank or not, is referred to as the Bank's CAR.
    The CBN also takes into account relevant risk factors and the internal capital adequacy assessments of each bank to ensure that the capital held by banks are sufficient to absorb its overall risk profile.

  30. BANK EARNINGS
    Earnings of banks must consistently cover expenses if an effective and stable system of banking facilities is to be maintained. An increasing number of banks failed to preserve the necessary balance between income and outgo, at least a balance adequate to absorb losses, and were consequently compelled to discontinue operations. During the drastic liquidation some banks generally suffered severe losses which had to be charged off against current earnings, reserves and capital. Even so, the allowances made for losses were admittedly insufficient. In the sweeping banking reorganization stringent measures of capital rehabilitation had to be taken in all too many cases. Furthermore, as earning and expense reports for the last two years attest, unab-sorbed losses in considerable volume were carried forward for adjustment under more favorable conditions.
    Despite a general improvement in banking conditions, reflecting the effects of various monetary policies, bank¬ing reforms, widespread business recovery and a phenom¬enal growth of deposits, the difficulty of balancing income and outgo for many banks has been only moderately alleviated. Earnings have been seriously affected by de¬clining interest yields on marketable assets which banks have come to hold in increasing volume. In addition, slack demands for business and personal accommodation have confronted banks everywhere, and progressive con-cessions on interest charges to borrowers have been forced. While operating expenses have been severely reduced, thanks to the elimination of interest on demand deposits by law and Federal regulation of interest paid on time deposits, considerable resistance to further reduc¬tion apparently exists. As suggested above, moreover, some past losses remain to be absorbed, and reserves for future contingencies provided. This current struggle of banking institutions to cover their expenses out of earn¬ings and to rehabilitate their capital and reserves impera¬tively challenges analysis, both by those interested in the practical side of banking and by banking theorists.
    The extent to which past earnings are used to ex- plain current and future earnings is an important measure of earnings predictability and this can lead to more accurate valuation, as it enables investors to more accurately anticipate expected future cash flows. The extents to which investors depend on disclosed or reported financial information to predict future cash flows is a function of the quality of information contained in those financial statements (Uwuigbe, U et al 2016). The quality of financial statements is also dependent on the accounting standards employed in their preparation (Yahaya and Adenola, 2011). The accounting standards issued by the authoritative body in different country influences the content of the financial statement to a large extent, thereby making it difficult to compare financial reports of companies prepared with different accounting standard in different countries. To enhance comparability, the need for a uniform set of international accounting standards is considered imperative. According to Okere, E. O. (2009), the issues affiliated with financial statement comparability will be reduced by the embracing of a single set of international accounting standards. This will in the long run help to improve the quality of accounting information disclosed

  31. BALANCE SHEET MANAGEMENT
    Balance sheet shows the capital position of a company. Before delving into the details of capital management, it is useful to understand the function of capital in the broader context of a balance sheet. This also means that one needs to become familiar with the different departments within a bank or insurance company that are responsible for managing parts of the balance sheet and can therefore implicitly impact capital management and vice versa. Balance sheet helps Capital management to be responsible for managing the capital position of a bank or insurance company in relation to the risks that are being run. This means that capital management has to focus both on the actual amount of capital that a bank or insurance company holds (i.e. available capital) as well as on the risks that are being taken, which are reflected on the balance sheet and ultimately determine the amount of capital that needs to be held (i.e. required capital). This means that, in order to manage capital, one need to manage the interaction between capital and the rest of the balance sheet. Hence, capital management and balance sheet management are interdependent and heavily intertwined. What makes capital management so difficult is that the available capital can be managed solely by the capital management department, but the capital management department has much less influence over the rest of the balance sheet. The rest of the balance sheet is shaped by activities that are employed by many other departments, but is a crucial variable in managing capital well, as this is the basis for required capital. This is the main challenge of any capital manager and his success depends on his own ability to direct and convince other departments, as well as on the support he gets from the chief executive officer (CEO). In this perspective, it is good to point out that capital management, similar to risk management, has an advisory role and functions as a co-pilot to the CEO, who ultimately makes all the decisions.

  32. LIQUIDITY CONCEPTS AND POLICIES
    Financial liquidity is an elusive notion, yet of paramount importance for the well- functioning of the financial system. Three main liquidity notions, namely central bank liquidity, market liquidity and funding liquidity are defined and discussed. Their complex and dynamic linkages can give us a good understanding of the liquidity workings in the financial system and reveal positive or negative effects for financial stability, depending on the levels of liquidity risk prevailing.
    The causes of liquidity risk lie on departures from the complete markets and symmetric information paradigm, which can lead to moral hazard and adverse se¬lection. To the extent that such conditions persist, liquidity risk is endemic in the financial system and can cause a vicious link between funding and market liquidity, prompting systemic liquidity risk. It is exactly this type of market risk that typi¬cally alerts policy makers, because of its potential to destabilize the financial system. In such cases emergency liquidity provisions can be a tool to restore balance.
    The central bank has the ability and the obligation to minimize the real costs of liquidations and the probability of a financial system meltdown. However, the role of central bank liquidity in such turbulent periods does not have guaranteed success, as it cannot tackle the roots of liquidity risk. In fact, the potential benefits are limited by the fact that the central bank cannot distinguish between illiquid and insolvent banks with certainty. Therefore, it should only focus on halting (temporarily) the vicious circle between funding and market liquidity. The trade between the benefits and costs of intervention should be taken into account when the central bank has to decide on its liquidity providing strategy. This task is not easy and there is no established rule of thumb. In order to eliminate systemic liquidity risk, greater transparency of liquidity management practices in needed. Supervision and regulation are the fundamen¬tal weapons against systemic liquidity risk. These practices can tackle the root of liquidity risk by minimizing asymmetric information and moral hazard through effective monitoring mechanisms of the financial system. In this way it is easier to distinguish between solvent and illiquid agents and therefore impose liquidity cushions to the ones most in need. This would also help markets become more complete. However, such mechanisms can be costly, due to the amount of informa¬tion that needs to be gathered. They should, therefore, be run by the most cost efficient and result- effective agent.

  33. LENDING POLICIES
    The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans. Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General Fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    i. Lending authority of each loan officer;
    ii. Lending authority of a loan or executive committee, if any;
    iii. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    iv. Guidelines under which unsecured loans will be granted;
    v. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    vi. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    vii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    viii. Maintenance and review of complete and current credit files on each borrower;
    ix. Appropriate and adequate collection procedures including, but not limited to, actions

  34. to be taken against borrowers who fail to make timely payments;
    x. Limitations on the maximum volume of loans in relation to total assets;
    xi. Limitations on the extension of credit through overdrafts;
    xii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiii. Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    xiv. Guidelines addressing the bank's loan review and grading system ("Watch list");
    xv. Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    xvi. Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation. Examiners should also encourage management to develop specific guidelines for each lending department or function. As with overall lending policies, it is not the FDIC's intent to suggest universal or standard loan policies for specific types of credit. The establishment of these policies is the responsibility of each bank's Board and management. Therefore, the following discussion of basic principles applicable to various types of credit will not include or allude to acceptable ratios, levels, comparisons or terms. These matters should, however, be addressed in each bank's lending policy, and it will be the examiner's responsibility to determine whether the policies are realistic and being followed.

  35. INVESTMENT INSTRUMENTS AND POLICIES
    By using opportunities in local and international market the Bank always develop effective investment solutions towards protection of invested capital, reaching current yield and further capital appreciation via following investing tools.
    Money market instruments
    Money market instruments can allocate their funds for a short term period, Money market instruments, allowing more flexible and efficient cash management.
    • Government securities (buying and selling, forward contracts)
    • Forex trading (buying and selling, currency swaps, forward contracts)
    • Repurchase agreements
    • Gold bullions
    Stocks
    Stock signifies an investor’s right of ownership in a corporation, granting them a number of privileges, prerogatives and authorities. We offer stocks to customers who anticipate high revenues while accepting an equivalent level of risk. Stockholders can anticipate solid returns from fluctuations of stock prices under favorable market conditions.
    Bonds
    Bonds provide a certain return on invested capital at a set date in the future. They are less volatile than stocks, offering greater capital security and assured income. Unlike stockholders, whose returns are uncertain, bondholders have the advantage of more predictable returns.
    Investment funds shares
    Investment funds generate income by issuing shares and investing them in other instruments of the market. The collective investments of the funds’ shareholders are managed by a professional fund manager, based on a continuous analysis of the securities market. As investment funds use a range of financial instruments, they provide investors with a level of diversification not available to an individual investor and – unlike stocks and bonds – offer a high return with a moderate risk level.
    Futures contracts
    A futures contract is an agreement to buy or sell an underlying asset – e.g. energy, foreign currency, metals and agricultural products – at a pre-determined price in the future. Futures contracts do not assume physical delivery of the underlying asset. The difference between the market price of the underlying asset in the physical (real) market on the futures contract's expiry date – or on a date when an offset deal is concluded – and the pre-determined price is paid to the

  36. succeeded party. Futures contracts reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flow more effectively.
    Currency options
    A currency option is a contract between two parties which gives the buyer of the option a right but not an obligation – to purchase the underlying currency from the seller at a pre-determined price and date in the future against a premium. Like futures contracts, currency options reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flow more effectively.
    Investment policy in the private finance initiative (PFI) relates to a country’s laws, regulations and practices that directly enables or discourages investment and that enhance the public benefit from investment. It covers, for instance, policies for transparent and non-discriminatory treatment of investors, expropriation and compensation laws and dispute settlement practices.
    The quality of a country’s investment policies directly influences the decisions of investors, be they small or large, domestic or foreign. Transparency, property protection and non-discrimination are core investment policy principles that underpin efforts to create a quality investment environment for all.
    Investors are also concerned with the way that investment policy is formulated and changed. They will avoid circumstances where policies are modified at short notice, where governments do not consult with industry on proposed changes and where laws, regulations and procedures are not clear, readily available and predictable.
    The PFI Investment Policy chapter identifies through eight questions the most important issues relevant for judging the effectiveness of a country’s investment policies and practices. The issues are often directly relevant to the specific needs of foreign investors, but they apply in most instances to domestic investors as well. This section of the Toolkit offers additional detail on why these investment policy questions are important, and specific guidance on the topics to scrutinize in order to form an opinion on how well a country’s investment policies perform vis-a-vis good practices.
    The eight PFI questions on Investment Policy relate to:
    i. Laws and regulations
    ii. Effective ownership registration
    iii. Intellectual property rights
    iv. Contract enforcement and dispute resolution
    v. Expropriation laws and review processes
    vi. Non-discriminatory treatment for national and international investors
    vii. International co-operation and periodic review
    viii. International arbitration instruments

  37. COMPARATIVE FINANCIAL SYSTEMS
    The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Fifty years ago, the financial system could be neatly bifurcated in this way. Rich households and large firms used the equity and bond markets, while less wealthy households and medium and small firms used banks, insurance companies and other financial institutions. Rather than intermediating directly between households and firms, financial institutions have increasingly come to intermediate between households and markets, on the one hand, and between firms and markets, on the other. This makes it necessary to consider the financial system as an irreducible whole. The notion that a financial system transfers resources between households and firms is, of course, a simplification. Governments usually play a significant role in the financial system. They are major borrowers, particularly during times of war, recession, or when large infrastructure projects are being undertaken. These overviews have focused on two sets of issues. Normative: How effective are different types of financial systems at various functions? Positive: What drives the evolution of the financial system? The first set of issues focus on investment and saving, growth, risk sharing, information provision and corporate governance, respectively. And the influence of law and politics on the financial system while Second section looks at the role financial crises has had in shaping the financial system.
    References
    Yahaya, and Adenola, K. (2011). Compliance with statements of accounting standards by Nigerian quoted banks. European Journal of Economics, Finance and Administrative Sciences, 34(34), 104-113

    Central Bank Publication (2004). “Risk Management for Central Bankers" UBS Warburg.

    Uwuigbe, U., Francis, K. E., Uwuigbe, O. R., & Oyenike, I. O. (2016). Mandatory International Financial Report-ing Standards Adoption and Cost of Equity Capital in Nigeria. Euro Economica, 35(1), 92-102.

    Velury, U., Jenkins, D. S. (2006). Institutional ownership and the quality of earnings. Journal of Business Research, 59, 1043-1051. 42.

    Okere, E. O. (2009). International Financial Reporting and Accounting Issues: Imperatives of Attainment of Economic Development in Nigeria, ICAN 39 Annual Accountants Conference.

  38. AN ASSIGNMENT SUBMITTED IN PARTIAL FULFILMENT OF ECON 521 (MONETARY ECONOMICS) BY OGBODO CHINEDU JOEL
    Topic: Discuss the following concepts in monetary economics:
    1. Risk Analysis
    2. Bank Capital Adequacy
    3. Bank Earnings
    4. Balance Sheet Management
    5. Liquidity Concepts and Policies
    6. Lending Policies
    7. Investment Instruments and Policies
    8. Comparative Financial Systems
    RISK ANALYSIS
    Risk analysis, has been defined as a tool for risk management, is a method of identifying vulnerabilities and threats, and assessing the possible damage to determine where to implement security safeguards. Risk analysis is used to ensure that security is cost effective, relevant, timely and responsive to threats. Security can be quite complex, even for well-versed security professionals, and it is easy to apply too much security, not enough security or the wrong security components, and spend too much money in the process without attaining the necessary Risk analysis helps companies prioritize their risks and shows management the amount of money that should be applied to protecting against those risks in a sensible manner.

    Generally a risk analysis has four main goals:
    1. Identify assets and their values
    2. Identify vulnerabilities and threats
    3. Quantify the probability and business impact of these potential threats
    4. Provide an economic balance between the impact of the threat and the cost of the countermeasure
    The process of conducting a risk analysis is very similar to identifying an acceptable risk level. Essentially, you do a risk analysis on the organization as a whole to determine the acceptable risk level. This is then your baseline to compare all other identified risks to determine whether the risk is too high or if it is under the established acceptable risk level.

  39. Step one: Identify assets and their values
    Risk analysis provides a cost/benefit comparison, which compares the annualized cost of safeguards to protect
    against threats with the potential cost of loss. A safeguard, in most cases, should not be implemented unless the annualized cost of loss exceeds the annualized cost of the safeguard itself. For example if a facility is worth N100, 000, it does not make sense to spend N150, 000 trying to protect it.
    The value of an asset should reflect all identifiable costs that would arise if there were an actual impairment of the asset. The following issues should be considered when assigning values to assets:
    • Cost to acquire or develop the asset
    • Cost to maintain and protect the asset
    • Value of the asset to owners and users
    • Value of the asset to adversaries
    • Value of intellectual property that went into developing the information
    • Price others are willing to pay for the asset
    • Cost to replace the asset if lost
    • Operational and production activities that are affected if the asset is unavailable
    • Liability issues if the asset is compromised
    • Usefulness and role of the asset in the organization
    Understanding the value of an asset is the first step to understanding what security mechanisms should be put in place and what funds should go toward protecting it.

    Step two: Identify vulnerabilities and threats
    Once the assets have been identified and assigned values, all of the vulnerabilities and associated threats need to be identified for each asset or group of assets. The Internal Risk Management team needs to identify the vulnerabilities that could affect each asset's integrity, availability or confidentiality requirements.

  40. Step three: Quantify the probability and business impact of these potential threats
    The team carrying out the risk assessment needs to figure out the business impact for the identified threats.
    To estimate potential losses posed by threats, the Risk Management Team should answer the following questions:
    • What physical damage could the threat cause, and how much would that cost?
    • How much productivity loss could the threat cause, and how much would that cost?
    • What is the value lost if confidential information is disclosed?
    • What is the cost of recovering from a virus attack?
    • What is the cost of recovering from a hacker attack?
    • What is the value lost if critical devices were to fail?
    • What is the single loss expectancy (SLE) for each asset and each threat?
    The team then needs to calculate the probability and frequency of the identified vulnerabilities being exploited. The team will need to gather information about the likelihood of each threat taking place from people in each department, past records and official security resources. If the team is using a quantitative approach, then they will calculate the annualized rate of occurrence (ARO), which is how many times the threat can take place in a 12-month period.

    Step four: Identify countermeasures and determine cost/benefit
    The team then needs to identify countermeasures and solutions to reduce the potential damages from the identified threats. A security countermeasure must make good business sense, meaning that it is cost-effective and that its benefit outweighs its cost. This requires another type of analysis: a cost/benefit analysis.
    The cost of a countermeasure is more than just the amount that is filled out on the purchase order. The following items need to be considered and evaluated when deriving the full cost of a countermeasure:
    • Product costs
    • Design/planning costs
    • Implementation costs
    • Environment modifications
    • Compatibility with other countermeasures
    • Maintenance requirements
    • Testing requirements
    • Repair, replacement or update costs
    • Operating and support costs
    • Effects on productivity

  41. Goals of a risk analysis
    The risk analysis team should have clearly defined goals that it is seeking. The following is a short list of what generally is expected from the results of a risk analysis:
    • Monetary values assigned to assets
    • Comprehensive list of all possible and significant threats
    • Probability of the occurrence rate of each threat
    • Loss potential the company can endure per threat in a 12-month time span
    • Recommended safeguards, countermeasures and actions
    Although this list looks short, there is usually an incredible amount of detail under each bullet item. This report is presented to senior management, which will be concerned with possible monetary losses and the necessary costs to mitigate these risks. Although the reports should be as detailed as possible, there should be executive abstracts so that senior management may quickly understand the overall findings of the analysis.

    Bank Capital Adequacy
    According to the Central Bank of Nigeria (CBN), bank capital adequacy is the proportion of a banks own equity in relation to its risk exposure. If a bank for example, has N200billion risk weighted assets and has a qualifying capital of N60billion then its CAR is 60billion/N200billion which is equal to 30%. The capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking licence, respectively.

    Bank Earnings
    Bank Earnings is the initial safeguard against the risks of engaging in the banking business, and represents the first line of defense against capital depletion resulting from shrinkage in asset value. From a bank regulator’s standpoint, the essential purpose of bank earnings, both current and accumulated, is to absorb losses and augment capital. Earnings performance should also allow the bank to remain competitive by providing the resources required to implement management’s strategic initiatives. The analysis of earnings includes all bank operations and activities. When evaluating earnings, examiners should develop an understanding of the bank’s core business activities. Core activities are those operations that are part of a bank’s normal or continuing business. Therefore, when earnings are being assessed, examiners should be aware of nonrecurring events or actions that have affected bank earnings performance, positively or negatively, and should adjust earnings on a tax equivalent (TE) basis for comparison purposes.

  42. Balance Sheet Management
    Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole. It is important to note that the objective of managing a bank’s balance sheet is to optimize reward versus risk. This requires:
    • An assessment and statement of the bank’s appetite for risk leading to the establishment of Key Risk Indicators (KRIs) within a Risk Appetite framework.
    • A determination by the Bank’s Board of a target range for measures of success – such as Return on Assets, Return on Equity, Return on Risk Adjusted Risk Assets etc., referred to as Key Performance Indicators (KPIs) that will be judged acceptable by the stakeholders.
    Managing the success of this optimization is achieved by the development of complementary long-term strategic and short-term operating plans; and monitoring the actual outcome of KRIs and KPIs against the forecast. However, this optimization process is complex for several reasons:
    • The strategy will optimize KPIs constrained by KRIs (risk appetite targets) and will be run under a ‘business as usual’ scenario, but
    • The management will have to take into consideration also the capability of the bank to manage KRIs (risk capacity and risk tolerance) under stressed scenarios, to meet regulatory constraints.

    Liquidity Concepts and Policies
    Liquidity can implies how quickly you can get your hands on your cash. In simpler terms, liquidity is to get your money whenever you need it. For example Liquidity might be your emergency savings account or the cash lying with you that you can access in case of any unforeseen happening or any financial setback. Liquidity also plays an important role as it allows you to seize opportunities. If you have cash and easy access to fund and a great deal comes along, then it's easier for you to cease that opportunity. Cash, savings account, checkable account are liquid assets because they can be easily converted into cash as and when required. It is also very important that we know that in finance, liquidity management takes one of two forms based on the definition of liquidity. One type of liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. The other definition of liquidity applies to large organizations, such as financial institutions. Banks are often evaluated on their liquidity, or their ability to meet cash and collateral obligations without incurring substantial losses. In either case, liquidity management describes the effort of investors or managers to reduce liquidity risk exposure.
    Liquidity Policy is usually composed of providing an overview of a business model from the viewpoint of liquidity management; specifying governance related to liquidity management, defining liquidity risk and; defining the Bank’s liquidity risk tolerance; describing the Bank’s stress testing approach for measuring liquidity risk and describing practices for managing liquidity risk; specifying the procedures for the activation of the contingency plan, and describing requirements for liquidity risk reporting.

  43. Lending Policies
    Lending policies is the lending institution's statement of its philosophy, standards, and guidelines that its employees must observe in granting or refusing a loan request. These policies determine which sector of the industry or business will be approved loans and which will be avoided, and must be based on the country's relevant laws and regulations. Also, lending policy is said to be a set of guidelines and criteria developed by a bank and used by its employees to determine whether an applicant for a loan should be granted or refused the loan.

    Investment instruments and policies
    The financial world is full of terminology which those persons who routinely operate outside of it may need to have clarified. We can find explanations for some of the instruments traded in the securities market.

    Investment Instruments
    Securities– an investment instrument that has financial value and can be traded. This instrument entitles the owner to specified types of financial benefits. The main classes of securities include:
    1. equity
    2. stocks
    3. debt instruments
    4. mutual funds
    Equity- an investment instrument through which a corporation raises capital/money by issuing shares which entitle holders to an ownership interest in a corporation. It also entitles the holder to a proportionate share in the corporation’s assets and profits.
    Stocks– are a share of the ownership of a company. Initially, they are sold by the original owners of a company to gain additional funds to help the company grow. The owners basically sell control of the company to the stockholders. After the initial sale, the shares can be sold and resold on the stock market.

    Bonds– a debt investment in which an investor loans money to an entity (corporate or governmental). In this case the individual is considered the lender and the government or company is the borrower. The funds are borrowed for a defined period of time at an agreed interest rate. Bonds are used by companies, and governments to finance a variety of projects and activities. A bondholder is entitled to regular interest payments as due, as well as the return of principal when the bond matures
    Mutual funds- an investment vehicle which pools money from investors and purchases various types of securities such as shares, bonds or money market securities based on stated investment objectives. Each investor owns shares, which represent a portion of the holdings of the fund. Also called a collective investment scheme (CIS) this fund provides almost absolute control of the investment to the company pooling and investing the money.

  44. An individual can make money from a mutual fund in three ways:
    • Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution.
    • If the fund sells securities that have increased in price, the fund has a capital gain. Most fund also pass on these gains to investors in a distribution.
    • If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit.
    Investment Policy
    Investment policy in relates to a country’s laws, regulations and practices that directly enable or discourage investment and that enhance the public benefit from investment. It covers, for instance, policies for transparent and non-discriminatory treatment of investors, expropriation and compensation laws and dispute settlement practices. The quality of a country’s investment policies directly influences the decisions of investors, be they small or large, domestic or foreign. Transparency, property protection and non-discrimination are core investment policy principles that underpin efforts to create a quality investment environment for all. Investors are also concerned with the way that investment policy is formulated and changed. They will avoid circumstances where policies are modified at short notice, where governments do not consult with industry on proposed changes and where laws, regulations and procedures are not clear, readily available and predictable.

    Comparative Financial Systems
    According to Whitley, the financial system is among the key institutional features structuring business systems. Financial systems vary on a number of dimensions. But the critical feature deals with the processes by which capital is made available and priced. Whitley use the traditional dichotomy to classify financial system:
    Capital-market-based financial systems versus Credit-based financial systems.
    Characteristics of capital-market-based financial systems:
    • Mobilize and distribute capital through large and liquid markets
    • Financial claims are traded and priced through the usual commodity-market process
    • Short-termism is enhanced
    • Only weak commitment to the growth of any single firm
    • A strong market for corporate control is encouraged
    Characteristics of credit-based financial systems
    • Exhibit weak and fairly illiquid and thin capital markets
    • capital markets play only a minor role in mobilizing and pricing investment funds
    • Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks co-ordinated by state agencies and ministries, as in France, Japan and some other countries
    • Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector)
    • Interlocking and ‘Haus banks’
    This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”.

  45. 1. RISK ANALYSIS
    What is risk analysis?
    After identifying and classifying the risks, we are going to proceed with their analysis, that is, the possibility and the consequences of each risk factor are examined in order to establish the level of risk of our project. The risk analysis will determine which risk factors would potentially have a greater impact on our project and, therefore, must be managed by the entrepreneur with particular care.
    Risk Analysis Methods; There are three kinds of methods used for determining the level of risk of our business. The methods can be: Qualitative Methods ,Quantitative Methods , Semi-quantitative Methods. Qualitative Methods: This is the kind of risk analysis method most often used for decision making in business projects; entrepreneurs base themselves on their judgment, experience and intuition for decision making. These methods can be used when the level of risk is low and does not warrant the time and resources necessary for making a full analysis. These methods are also used when the numerical data available are not adequate for a more quantitative analysis that would serve as the basis for a subsequent and more detailed analysis of the entrepreneur’s global risk. The qualitative methods include: Brainstorming Questionnaire and structured interviews Evaluation for multidisciplinary groups Judgment of specialists and experts (Delphi Technique)
    Semi-Quantitative Methods: Word classifications are used, such as high, medium or low, or more detailed descriptions of likelihood and consequences. These classifications are shown in relation to an appropriate scale for calculating the level of risk. We need to give careful attention to the scale used in order to avoid misunderstandings or misinterpretations of the results of the calculation. Quantitative Methods: Quantitative methods are considered to be those that enable us to assign values of occurrence to the various risks identified, that is, to calculate the level of risk of the project. Los quantitative methods include: Analysis of likelihood ,Analysis of consequences , Computer simulation The development of these measurements can be effected by means of different mechanisms, among which we note particularly the Monte Carlo Method, which is characterized by: – A broad vision in order to show a range of possible scenarios – Simplicity in putting it into practice – Suitable for performing computer simulations.
    The development of these measurements can be effected by means of different mechanisms, among which we note particularly the Monte Carlo Method, which is characterized by: – A broad vision in order to show a range of possible scenarios – Simplicity in putting it into practice – Suitable for performing computer simulations
    Monte Carlo Method This is a quantitative method for the development of a risk analysis. The method was given this name in reference to the Principality of Monaco, which is famous as “the capital of games of chance”. This method seeks to represent reality through a mathematical risk model, in such a way that by assigning values randomly to the variables of the model, different scenarios and results are obtained. The Monte Carlo Method is based on making a sufficiently high number of iterations (assignments of values in a random fashion), so that the sample of results obtained is sufficiently broad so as to be considered to be representative of a real situation. These iterations can be made by using a data processing engine. With the results obtained from the various iterations made, a statistical study is performed, from which relevant conclusions are extracted with respect to the risk of the project, such as mean, maximum and minimum values, standard deviations, variances and likelihood of occurrence of the different variables determined on which to measure the risk.

  46. 2. BANK CAPITAL ADEQUACY
    Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. An international standard which recommends minimum capital adequacy ratios has been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent. Applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt. Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet. The loans a bank has made are weighted, in a broad brush manner, according to their degree of riskiness, e.g. loans to Governments are given a 0 percent weighting whereas loans to individuals are weighted at 100 percent. Off-balance sheet contracts, such as guarantees and foreign exchange contracts, also carry credit risks. These exposures are converted to credit equivalent amounts which are also weighted in the same way as on-balance sheet credit exposures. On-balance sheet and offbalance sheet credit exposures are added to get total risk weighted credit exposures. The minimum capital adequacy ratios that

  47. apply are: tier one capital to total risk weighted credit exposures to be not less than 4 percent; total capital (tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 percent.
    An international standard has been developed which recommends minimum capital adequacy ratios for international banks. The purpose of having minimum capital adequacy ratios is to ensure that banks can absorb a reasonable level of losses before becoming insolvent, and before depositors funds are lost. Applying minimum capital adequacy ratios serves to promote the stability and efficiency of the financial system by reducing the likelihood of banks becoming insolvent. When a bank becomes insolvent this may lead to a loss of confidence in the financial system, causing financial problems for other banks and perhaps threatening the smooth functioning of financial markets. Accordingly applying minimum capital adequacy ratios in New Zealand assists in maintaining a sound and efficient financial system here. It also gives some protection to depositors. In the event of a winding-up, depositors' funds rank in priority before capital, so depositors would only lose money if the bank makes a loss which exceeds the amount of capital it has. The higher the capital adequacy ratio, the higher the level of protection available to depositors. This article provides an explanation of the capital adequacy ratios applied by the Reserve Bank and a guide to their calculation. For more detail, the Reserve Bank policy document Capital Adequacy Framework, issued in January 1996, available from the Reserve Bank Library, should be consulted. Development of Minimum Capital Adequacy Ratios The "Basle Committee" (centred in the Bank for International Settlements), which was originally established in 1974, is a committee that represents central banks and financial supervisory authorities of the major industrialised countries (the G10 countries). The committee concerns itself with ensuring the effective supervision of banks on a global basis by setting and promoting international standards. Its principal interest has been in the area of capital adequacy ratios. In 1988 the committee issued a statement of principles dealing with capital adequacy ratios. This statement is known as the "Basle Capital Accord". It contains a recommended approach for calculating capital adequacy ratios and recommended minimum capital adequacy ratios for international banks. The Accord was developed in order to improve capital adequacy ratios (which were considered to be too low in some banks) and to help standardise international regulatory practice. It has been adopted by the OECD countries and many developing countries. The Reserve Bank applies the principles of the Basle Capital Accord in New Zealand.

  48. 3. BANK EARNINGS
    Similarly to non-financial companies, banks can use accruals to manage their earnings (e.g., Beaver et al., 1989; Moyer, 1990; Scholes et. al. 1990; Wahlen, 1994; Beatty et. al, 1995; Beaver and Engel, 1996; Kim and Kross, 1998; Liu and Ryan, 2006). One of the most important bank accruals, loan loss provisions (LLPs), is calculated based on an incurred loss approach and reflects the expected losses arising from their lending business. Unexpected losses, defined as negative deviations from the expected losses, should be absorbed by bank capital and are calculated through risk weighted assets. From a prudential perspective, there is little research on how the management of earnings through LLPs is associated to the risk profile of a bank. The related capital management hypothesis states that banks adjust the provisioning behavior to manage the capital ratios (e.g., Kim and Kross, 1998; Beatty et. al, 1995; Collins et. al., 1995). The evidence from the literature is not conclusive and could be advanced by jointly considering the interaction between LLPs and changes of risk weighted assets. In this paper, we take a new perspective that combines the bank earnings and risk management considerations. We investigate how banks use LLPs to manage the level and volatility of their earnings and examine the implications for risk. Banks’ incentives to engage in earnings management with LLPs depend on their business objectives, governance, and performance. Especially the level and volatility of earnings and the need to build up capital reserves through retained earnings play an important role (e.g., Fan and Wong, 2002; Ahmed and Takeda, 1998; Liu, Ryan and Wahlen, 1997). On the one hand, banks might use the LLPs to stabilize earnings levels, to reduce the volatility in earnings, and to implement the desired payout policy. Hence, too high LLPs lower the reported profitability but increase the buffer against expected losses. On the other hand, low LLPs increase the reported profitability but also increase the chance that a bank must use its capital to cover large losses. (e.g., Laeven and Majnoni, 2003). A key feature of LLPs, unlike accruals of non-financial firms, is that they simultaneously influence bank profitability and bank risk, which results in a trade-off (Bushman and Williams, 2011; Beatty and Liao, 2009).

  49. 4. BALANCE SHEET MANAGEMENT
    A bank’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows a bank flexibility in terms of timing the raising of capital. It can thus, factor in market conditions and unforeseen events. The following points can be kept in mind while capital planning:
     The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
     Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.
    Asset- Liability Management
    Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximising the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximised given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimised.
    Tracking the continuous changes in the way the banking business is conducted and the ever-changing external environment is an important constituent of the ALM function. These factors affect risk at a strategic level, and hence need to be continuously monitored. While these days a lot of information is available that enables such tracking, the frequency and intensity of unforeseen events and their effects has also heightened. It needs to be ensured that such unforeseen events do not affect the bank too adversely.
    Ensuring efficient use of capital is the other important function of ALM. Growth of loans and advances need not necessarily lead to a proportionate growth in Risk-Weighted Assets (RWA). Some ways of limiting the growth in RWA without affecting loan growth are:
     Giving more performance guarantees rather than financial guarantees.
     Getting borrowers rated so that the risk weight and hence required capital comes down.
     Covering the export credit portfolio through ECGC (Export Credit Guarantee Corporation).
     Covering medium and small sector loans through CGT-MSE (Credit Guarantee fund Trust for Micro and Small Enterprises).
    Transfer pricing can be used as an instrument for transmitting organisational strategy and policy to various departments and branches of the bank. It can also be used to make these individual units aware of the costs associated with their activities, and thereby more aware of their profitability. This helps keep the unit goals in line with organisational goals.
    Management of the various risks faced by a bank requires availability, accuracy, adequacy and timeliness of information. It also requires top management involvement, and their commitment to ALM.

  50. 5. LIQUITY CONCEPTS AND POLICIES
    Financial liquidity is an elusive notion, yet of paramount importance for the wellfunctioning of the Önancial system. In fact, the events in Önancial markets since August 2007 bear all the hallmarks of increased funding liquidity risk, but also reveal how this type of risk can contaminate market liquidity and necessitate reactions from central banks. This project combines literature on liquidity from various Öelds of research in a schematic and holistic way in order to provide a uniÖed and consistent account of Önancial system liquidity and liquidity risk. The outcome of this e§ort reveals the following: Three main liquidity notions, namely central bank liquidity, market liquidity and funding liquidity are deÖned and discussed. Their complex and dynamic linkages can give us a good understanding of the liquidity workings in the Önancial system and reveal positive or negative e§ects for Önancial stability, depending on the levels of liquidity risk prevailing. The causes of liquidity risk lie on departures from the complete markets and symmetric information paradigm, which can lead to moral hazard and adverse selection. To the extent that such conditions persist, liquidity risk is endemic in the Önancial system and can cause a vicious link between funding and market liquidity, prompting systemic liquidity risk. It is exactly this type of market risk that typically alerts policy makers, because of its potential to destabilise the Önancial system. In such cases emergency liquidity provisions can be a tool to restore balance. The central bank has the ability and the obligation to minimise the real costs of liquidations and the probability of a Önancial system meltdown. However, the role of central bank liquidity in such turbulent periods does not have guaranteed success, as it cannot tackle the roots of liquidity risk. In fact, the potential beneÖts are limited by the fact that the central bank cannot distinguish between illiquid and insolvent banks with certainty. Therefore, it should only focus on halting (temporarily) the vicious circle between funding and market liquidity. The tradeo§ 5 ECB Working Paper Series No 1008 February 2009 between the beneÖts and costs of intervention should be taken into account when the central bank has to decide on its liquidity providing strategy.

  51. 6. LENDING POLICIES
    The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans. Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General Fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    i. Lending authority of each loan officer;
    ii. Lending authority of a loan or executive committee, if any;
    iii. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    iv. Guidelines under which unsecured loans will be granted;
    v. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;

  52. vi. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    vii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    viii. Maintenance and review of complete and current credit files on each borrower;
    ix. Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    x. Limitations on the maximum volume of loans in relation to total assets;
    xi. Limitations on the extension of credit through overdrafts;
    xii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiii. Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    xiv. Guidelines addressing the bank's loan review and grading system ("Watch list");
    xv. Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    xvi. Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation. Examiners should also encourage management to develop specific guidelines for each lending department or function. As with overall lending policies, it is not the FDIC's intent to suggest universal or standard loan policies for specific types of credit. The establishment of these policies is the responsibility of each bank's Board and management. Therefore, the following discussion of basic principles applicable to various types of credit will not include or allude to acceptable ratios, levels, comparisons or terms. These matters should, however, be addressed in each bank's lending policy, and it will be the examiner's responsibility to determine whether the policies are realistic and being followed.

  53. 7. INVESTMENT INSTRUMENTS AND POLICIES
    Given that the goal of sustainability policy is to transfer the equivalent of the current resource base to the next generation, investment policy is obviously crucial. In part, this is a matter of creating an environment that is 'friendly' towards private investors. Too many barriers for the entry of foreign investors will deter the international flow of capital, as will too strict rules on the repatriation of profits. Similarly, both economic instability and social unrest will deter all investors, foreign or local.
    On the other hand, investments can be devastating for SARD if investors do not have to pay for negative externalities they cause (e.g. dams taking water from downstream users, wells lowering the water table for all). Clearly, measures need to be in place either to prevent such negative externalities, or to make investors pay for them.
    The importance of avoiding interventions that cause financial repression and so deny would-be investors, especially those in rural areas, access to credit markets has already been discussed.
    Because public funds are always limited, direct government investment should be allocated to areas where market failure leads to underinvestment. Such areas include investments in human capital (i.e. in people). Building human capital for sustainability is likely to require substantial government investments in health services, education and training. Similarly, public investments may be needed in open access resources such as many fisheries and some forests, as well as in state-owned resources such as rural infrastructure. (See Bromley and Cernea 1989 for a discussion of the different types of resource property regimes.) For SARD, an appropriate proportion of such improvements needs to be directed to rural areas where these services are typically very inferior to those in the cities.
    Common property and open access resources important for SARD may include fisheries, forests, and water supplies. Some state property, such as public roads, also has open access characteristics. Because individual private investors are seldom able to capture for themselves all the benefits from investments in open access resources, there is often a need for intervention. Governments may need to step in either to undertake those investments that are socially profitable but privately unprofitable, or to create institutional arrangements whereby externalities are internalized to enable private investors to earn an appropriate return on their capital. Examples of the latter type of policy intervention include the privatization of water supply agencies and the letting of contracts for the construction and operation of toll roads.
    Government investment decisions need to be based, so far as possible, on a careful assessment of the social benefit of each investment. The methods for undertaking such project

  54. appraisals are well known, and have been extended in recent years to try to take proper account of environmental impacts (Edwards-Jones 1996; World Bank 1991). However, as discussed earlier, performance measures based on discounted cash flow may need to be used as part of a multi-criteria analysis that also includes other aspects such as inter-generation equity (see section 8.5.3).
    In less developed countries, where government funds are typically very limited, foreign aid, including concessional loans, may be used to help make good any shortfall in the level of public investment needed for SARD.

  55. 8. COMPARATIVE FINANCIAL SYSTEMS
    Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow intertemporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely. In the United States and the United Kingdom competitive markets dominate the financial landscape, whereas in France, Germany, traditionally played why do different countries have such different financial systems? Is one system better than all the others? Do different systems merely represent alternative ways of satisfying similar needs? Is the current trend toward market-based systems desirable? Franklin Allen and Douglas Gale argue that the view that market-based systems are best is simplistic. A more nuanced approach is necessary. For example, financial markets may be bad for risk sharing; competition in banking may be inefficient; financial crises can be good as well as bad; and separation of ownership and control can be optimal. Financial institutions are not simply veils, disguising the allocation mechanism without affecting it, but are crucial to overcoming market imperfections. An optimal financial system relies on both financial market and financial intermediaries.

    REFERENCES
    Ahmed, A. S., C. Takeda, and S. Thomas (1999) Bank Loan Loss Provisions: A Re-examination
    of Capital Management, Earnings Management and Signalling Effects, Journal of
    Accounting and Economics 28, 1-25.

    Bamber, L., J. Jiang, K. Petroni, and I. Wang (2010) Comprehensive Income: Who’s Afraid of Performance Reporting? The Accounting Review 85,97-12

    Commercial Banks’ Investment Securities: An Empirical Analysis, Journal of Accounting
    and Economics 20, 207-225

    Little, I.M.D., and J. A. Mirrlees. 1974. “Risk, Uncertainty and Profit.” In Project Appraisal
    and Planning for Developing Countries. London: Heinemann.

    Mariano, C. 2001. Risk Analysis Software Packages Evaluation Report. Unpublished report under RETA 5932 manila: ADB

  56. Risk Analysis
    Risk analysis is the systematic study of uncertainties and risks we encounter in business, public policy, and many other areas.  Risk analysts seek to identify the risks faced by monetary institution, understand how and when they arise, and estimate the impact (financial or otherwise) of adverse outcomes.  Risk managers start with risk analysis, then seek to take actions that will mitigate or hedge these risks.
    Some institutions, such as banks and investment management firms, are in the business of taking risks every day.  Risk analysis and management is clearly crucial for these institutions.  One of the roles of risk management in these firms is to quantify the financial risks involved in each investment, trading, or other business activity, and allocate a risk budget across these activities.  Banks in particular are required by their regulators to identify and quantify their risks, often computing measures such as Value at Risk (VaR), and ensure that they have adequate capital to maintain solvency should the worst (or near-worst) outcomes occur.
    Risk analysis can also be defined in many different ways on how it relates to other concepts. Therefore, risk analysis can be broadly defined as to include risk assessment, risk characterization, risk communication, risk management and policy relating to risk. Risk analysis can be divided into two components
    Risk assessment which comprises of identifying, evaluating and measuring the probability and severity of risk.
    Risk management which comprises of deciding what to do about risk.
    Risk can be qualitative or quantitative.
    Qualitative risk analysis uses broad terms (e.g moderate, severe, catastrophic) to identify and evaluate risk or presents a wriiten descrition of of the risk,
    Quantitative risk analysis is the practice of creating a mathematical model of a project or process that explicitly includes uncertain parameters that we cannot control, and also decision variables or parameters that we can control.  A quantitative risk model calculates the impact of the uncertain parameters and the decisions we make on outcomes that we care about — such as profit and loss, investment returns, environmental consequences, and the like.  Such a model can help business decision makers and public policy makers understand the impact of uncertainty and the consequences of different decisions.
    Quantitative risk analysis calculates the numerical probabilities over the possible consequences. It seeks to numerically assess probabilities for the potential consequences of risk, and is often called probabilistic risk analysis or probabilistic assessment (PRA). The analysis often seeks to describe the consequences in numerical units such as naira, time, etc. PRA often seeks to answer three questions;
    What can happen?
    How likely is it that it will happen?
    If it does happen, what are the consequences?

  57. Bank Capital Adequacy
    Bank capital adequacy or capital adequacy is also the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. These requirements are put in place to ensure that these institutions do not take on excess leverage and become insolvent. Capital requirement governs the ration of equity to debt, recorded on the liabilities and equity side of a firm’s balance sheet
    Bank capital adequacy or capital adequacy ratios are the measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt.
    Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet. The loans a bank has made are weighted, in a broad brush manner, according to their degree of riskiness, e.g. loans to Governments are given a 0 percent weighting whereas loans to individuals are weighted at 100 percent.
    Off-balance sheet contracts, such as guarantees and foreign exchange contracts, also carry credit risks. These exposures are converted to credit equivalent amounts which are also weighted in the same way as on-balance sheet credit exposures. On-balance sheet and off balance sheet credit exposures are added to get total risk weighted credit exposures.
    The minimum capital adequacy ratios that apply are:
    tier one capital to total risk weighted credit exposures to be not less than 4 percent;
    total capital (tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 percent.
    The reason why minimum capital adequacy ratios are critical is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. Capital adequacy ratios ensure the efficiency and stability of a nation’s financial system by lowering the risk of banks becoming insolvent. If a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system.
    During the process of winding-up, funds belonging to depositors are given a higher priority than the bank’s capital, so depositors can only lose their savings if a bank registers a loss exceeding the amount of capital it possesses. Thus the higher the bank’s capital adequacy ratio, the higher the degree of protection of depositor's monies.
    Tier One and Tier Two Capital
    Tier one capital is the capital that is permanently and easily available to cushion losses suffered by a bank without it being required to stop operating. A good example of a bank’s tier one capital is its ordinary share capital.
    Tier two capital is the one that cushions losses in case the bank is winding up, so it provides a lesser degree of protection to depositors and creditors. It is used to absorb losses if a bank loses all its tier one capital.
    When measuring credit exposures, adjustments are made to the value of assets listed on a lender’s balance sheet. All the loans the bank has issued are weighted based on their degree of risk. For example, loans issued to the government are weighted at 0 percent, while those given to individuals are assigned a weighted score of 100 percent.

  58. Credit Exposures
    Off-balance sheet agreements, such as foreign exchange contracts and guarantees, have credit risks. Such exposures are converted to their credit equivalent figures and then weighted in a similar fashion to that of on-balance sheet credit exposures. The off-balance and on-balance sheet credit exposures are then lumped together to obtain the total risk weighted credit exposures.
    Capital adequacy ratios measure the amount of a bank's capital in relation to the amount of its risk weighted credit exposures. The risk weighting process takes into account, in a stylised way, the relative riskiness of various types of credit exposures that banks have, and incorporates the effect of off-balance sheet contracts on credit risk. The higher the capital adequacy ratios a bank has, the greater the level of unexpected losses it can absorb before becoming insolvent.
    Bank Earnings
    Bank earnings deliver valuable information from firms to stakeholders, and are very significant in decision-making of investors. As earnings are widely measured in many circumstances, their quality has drawn the interest of scholars, standard setters, and professionals. Every business entity is judged by its earnings as one of the most important parameter to measure the financial performance of the organization. Also in the context of banks, the quality of earnings is an important benchmark to determine the ability to earn consistently in the future and to maintain quality, sustainability and growth in performance. High quality reported earnings reveal present operating profitability, express upcoming performance and exactly represent the inherent value of the firm.
    Earning Management in Banks
    Loan loss provisions are an expense item an the income statement, reflecting management’s current assessment of the likely level of future losses from defaults on outstanding loan. The recording of loan loss provision reduces net income. Commercial bank regulators view accumulated loan loss provisions, the loan loss allowance account on the balance sheet, as a type of capital that can be used to absorb losses. A higher loan loss allowance balance allow the bank to absorb greater unexpected losses without failing symmetrically, if the loan loss allowance is less than expected losses, the bank’s capital ratio will understate its ability to sustain unexpected losses.

  59. Balance sheet Management
    Balance sheet management has to do with a bank or a company’s financial activities and it’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows a bank flexibility in terms of timing the raising of capital. The following points can be kept in mind while capital planning:
    The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
    Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.
    Asset- Liability Management
    Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximizing the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximized given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimized.
    Tracking the continuous changes in the way the banking business is conducted and the ever-changing external environment is an important constituent of the ALM function. These factors affect risk at a strategic level, and hence need to be continuously monitored. While these days a lot of information is available that enables such tracking, the frequency and intensity of unforeseen events and their effects has also heightened. It needs to be ensured that such unforeseen events do not affect the bank too adversely.
    Ensuring efficient use of capital is the other important function of ALM. Growth of loans and advances need not necessarily lead to a proportionate growth in Risk-Weighted Assets (RWA). Some ways of limiting the growth in RWA without affecting loan growth are:

  60. Giving more performance guarantees rather than financial guarantees.
    Getting borrowers rated so that the risk weight and hence required capital comes down.
    Covering the export credit portfolio through ECGC (Export Credit Guarantee Corporation).
    Covering medium and small sector loans through CGT-MSE (Credit Guarantee fund Trust for Micro and Small Enterprises).
    Transfer pricing can be used as an instrument for transmitting organisational strategy and policy to various departments and branches of the bank. It can also be used to make these individual units aware of the costs associated with their activities, and thereby more aware of their profitability. This helps keep the unit goals in line with organisational goals.
    Management of the various risks faced by a bank requires availability, accuracy, adequacy and timeliness of information. It also requires top management involvement, and their commitment to ALM.
    The chief financial officer of a bank needs to evaluate the market risk faced by the bank on the basis of its effect on the balance sheet as a whole, rather than just on the basis of its effect on the trading book. Market risk affects banks in two ways- firstly, by affecting its earnings through its Net Interest Income, and secondly, by affecting the networth through the market value of its risk sensitive assets and liabilities. A bank’s exposure to interest rate risk, which is a major part of its market risk, can be evaluated through:
    Duration of assets and liabilities
    Modified duration of assets and liabilities
    Gap analysis: An analysis of the gap between a bank’s Risk Sensitive Assets (RSA) and Risk Sensitive Liabilities (RSL).
    Modified Duration Gap

    Capital versus Balance Sheet Management
    Capital management is responsible for managing the capital position of a bank or insurance company in relation to the risks that are being run. This means that capital management has to focus both on the actual amount of capital that a bank or insurance company holds (i.e. available capital) as well as on the risks that are being taken, which are reflected on the balance sheet and ultimately determine the amount of capital that needs to be held (i.e. required capital). This means that, in order to manage capital, one needs to manage the interaction between capital and the rest of the balance sheet. Hence, capital management and balance sheet management are interdependent and heavily intertwined. What makes capital management so difficult is that the available capital can be managed solely by the capital management department the balance sheet. The rest of the balance sheet is shaped by activities that are employed by many other departments, but is a crucial variable in managing capital well, as this is the basis for required capital. This is the main challenge of any capital manager and his success depends on his own ability to direct and convince other departments, as well as on the support he gets from the chief executive officer (CEO). In this perspective, it is good to point out that capital management, similar to risk management, has an advisory role and functions as a co-pilot to the CEO, who ultimately makes all the decisions.
    Balance sheet management is made up of four main areas of,
    Interest rate risk management
    Liquidity risk management
    Capital management
    Management of discretionary investment portfolios.

  61. Liquidity Concepts and Policies
    Liquidity at a bank is a measure of its ability to readily find the cash it may need to meet demands upon it. Liquidity can come from direct cash holdings in currency or on account at the Federal Reserve or other central bank. More commonly it comes from holding securities that can be sold quickly with minimal loss. This typically means highly creditworthy securities, including government bills, which have short-term maturities. Indeed if their maturity is short enough the bank may simply wait for them to return the principal at maturity. Short-term, very safe securities also tend to trade in liquid markets, meaning that large volumes can be sold without moving prices too much and with low transaction costs (usually based on a bid/ask spread between the price dealers will pay to buy — the bid — and that at which they will sell — the ask.)
    However, a bank’s liquidity situation, particularly in a crisis, will be affected by much more than just this reserve of cash and highly liquid securities. The maturity of its less liquid assets will also matter, since some of them may mature before the cash crunch passes, thereby providing an additional source of funds. Or they may be sold, even though this incurs a potentially substantial loss in a fire sale situation where the bank must take whatever price it can get. On the other side, banks often have contingent commitments to pay out cash, particularly through lines of credit offered to its retail and business customers. (A home equity line is a retail example, while many businesses have lines of credit that allow them to borrow within set limits at any time.) Of course, the biggest contingent commitment in most cases is the requirement to pay back demand deposits at any time that the depositor wants.
    Liquidity concepts and policies can be seen as discussed below;
    Even commentators who support the LCR recognize some validity in these concerns, as does the liquidity Coverage Ratio
    As outlined by the Basel Committee itself, the Committee and national supervisors have worked considerably on ways to adapt the effective standard to take account of the most significant local differences, such as the lack of large, liquid financial markets in many developing nations, discussed below. Further, the Committee has endorsed the approach of running more detailed liquidity stress tests at the national level, as a complement to the LCR, since it is a single measure that clearly cannot capture every nuance of liquidity needs. These actions mitigate the two main concerns, but do not eliminate them. For example, if the LCR inappropriately penalizes certain financial activities, this will not be eliminated by adding a more detailed stress test, since the LCR will still remain in force.
    More of the criticism of the LCR has been of specifics and not the broad concept. The main areas of concern are:
    • The 30-day time period
    • The specific weightings assigned to assets, liabilities, and off-balance sheet items
    • The assumption of large liquid financial markets, especially for government bonds
    • The breakdown between Level 1 and Level 2 assets
    • The overall calibration

    30-day time period
    The LCR judges the ability of banks to survive a 30-day cash crunch. This presumably reflects a belief about the length of time that would be necessary for central banks and other authorities to counter a severe crisis. It seems a reasonable estimate, giving sufficient time for strong reactions without building in an excessive buffer of time, but one could certainly argue for a shorter or longer time period. It is not clear how a change would affect the overall levels of liquidity required, especially as different weightings would likely be chosen for the sources and uses of cash if the time period differed.

  62. Liquidity Risk
    The liquidity risk arises from funding of long-term assets by short-term liabilities, thereby making the liabilities subject to rollover or refinancing risk. Liquidity risk is usually of an individual nature, but in certain situations may compromise the liquidity of the financial system. As in overall terms it is about a situation that is very dependent on the individual characteristics of each financial institution, defining the liquidity policy is the primary responsibility of each bank, in terms of the way it operates and its specialization. The liquidity risk is closely linked to other dimensions of the financial structure of the financial institution, like the interest rate and market risks, its profitability, and solvency, for example. The interest rate risk that results from mismatches of maturities or the dates for interest rate adjustments may appear as either market or refinancing (and/or reinvestment) risk.
    Funding Liquidity
    Among the financial institutions, banks are very unique in the sense that they are the cheapest source of liquidity in the economy. The responsibility of a bank is to mobilize liquidity as well as to manage the liquidity in such a way that would alienate mismatches between future cash outflows and inflows. Hence, banks deplore more liquid short –term deposits in financing high profitable long-term portfolio of loans (illiquid assets) to generate profits that would make up for any default. On the long-run, the degree of uncertainty with respect to these mismatches is clearly much higher in the banking system which is suffice to say that for a smooth and efficient banking operation, banks are required to have access to sufficient funding in the form of liquidity in order to service their financial obligations as they fall due.
    Literally, funding liquidity refers to the ability of a financial intermediary to raise cash on demand within a short notice
    Liquidity requirements
    In the Basel III rules, regulators have, for the first time, designed global standards for the minimum liquidity levels to be held by banks. Prior to this there were a few countries that had quantitative minimum requirements, but the large majority, including the US, relied on subjective regulatory judgment as to when liquidity levels were so low that a bank should be forced to remedy them. In practice, very little was done to force banks to shore up liquidity.

  63. Lending policies
    The Companies and Allied Matters Act, the Central Bank of Nigeria Act and the various prudential guidelines issued by the Central Bank of Nigeria (CBN), governs the Banking industry in Nigeria. The CBN, which under the leadership of the Governor, is responsible for formulating and implementing monetary policy and fostering the liquidity, solvency and proper functioning of the financial system. The Central Bank of Nigeria (CBN) publishes information on Nigeria‘s commercial banks and non-banking financial institutions, interest rates and other publications and guidelines. The Central Bank of Nigeria acts as the main regulator of commercial banks in Nigeria.
    The CBN operates under a monetary policy programming framework that includes monetary aggregates (liquidity and credit) targets that are consistent with a given level of inflation and economic growth, for instance, the banks objective for the fiscal year, e.g was to achieve inflation rate below 5% using quarterly reserve targets. To this end, the CBN set a ceiling for reserve money and a floor for the net foreign assets. This was the mainstay of monetary policy at least until the introduction of the Central Bank Reserve Ratio.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    Lending authority of each loan officer;
    Lending authority of a loan or executive committee, if any;
    Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    Maintenance and review of complete and current credit files on each borrower;
    Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    7. Investment instruments and policies
    Investment instruments and risks related to them are described. Under the “risk“ term is meant not reaching the expected return on an invested capital and/or loss of the invested capital up to its total loss, while different causes may be basis of this risk lying in investment instruments, markets or issuers – according to the structure of investment instrument. Since these risks are not always foreseeable, the following description must not be considered as final. The risk arising from financial standing of the issuer of the investment instrument is dependent on individual case; the investor should therefore pay close attention to it. Description of investment instruments follows usual features of investment instruments. The decisive factor is the structure of a specific investment instrument.

  64. Investment Instruments
    Investment instruments can be broadly divided into two which are
    Money Market instruments which include certificate of deposit, repurchase agreement, commercial paper, Eurodollar deposit, treasury bills, money fund etc
    Capital Market instruments which include derivatives, preference shares, equities or common stock and debt instrument
    Investment Policy
    The concept of investment policy is interpreted broadly in the Policy Framework for Investment. It refers not only to laws, regulations and policies relating to the admission of investors, the rules once established and the protection of their property, but also to the goals and expectations concerning the contribution of investment to sustainable development, such as those outlined in national development plans.
    Transparency and Predictability
    A fair, transparent, clear and predictable regulatory framework for investment is a critical determinant of investment decisions and their contribution to development. It is especially important for SMEs that tend to face particular challenges to entering, and abiding by the rules of, the formal economy. It is also important for foreign investors who may have to function with very different regulatory systems, cultures and administrative frameworks from their own. Uncertainty about the enforceability of lawful rights and obligations raises the cost of capital, thereby weakening firms’ competitiveness and reducing investment.
    Non-discrimination
    Non-discrimination is a central tenet of an attractive investment climate. The non-discrimination principle provides that all investors in like circumstances are treated equally, irrespective of their ownership. It can feature as a general principle in the Constitution or at lower regulatory levels, such as in the investment law, and may vary greatly in its scope of application. One of the concepts derived from the principle of non-discrimination in the context of foreign investment is that of national treatment, which requires that a government treat foreign-owned or -controlled enterprises no less favourably than domestic enterprises in like situations.

  65. Comparative financial systems
    The financial system is among the key institutional features structuring the business system, and it varies on a number of dimensions, but the critical feature deals with the processes by which capital is made available and priced
    The financial system can be classified into;
    Capital-based financial systems: which is characterized by;
    Mobilize and distribute capital through large and liquid market
    Financial claims are traded and priced through the usual commodity-market process
    Short-termism is enhanced
    Only weak commitment to the growth of any single firm
    A strong market for corporate control is encouraged
    Credit-based financial systems: which is characterized by;
    Exhibit weak and fairly illiquid and thin capital market
    Capital market play only a minor role in mobilizing and pricing investment fund
    Dominant institutions are either large, ‘universal’ banks or a combination of commercial banks and long-term credit banks.
    Banks or the state allocate capital through administrative processes to particular sectors and activities(such as imports industries or the heavy manufacturing sector)
    The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Governments usually play a significant role in the financial system. They are major borrowers, particularly during times of war, recession, or when large infrastructure projects are being undertaken. They sometimes also save significant amounts of funds.
    In addition to their roles as borrowers or savers, governments usually play a number of other important roles. Central banks typically issue fiat money and are extensively involved in the payments system. Financial systems with unregulated markets and intermediaries, such as the US in the late nineteenth century, often experience financial crises. A financial system is much more than all of this, however. An important pre-requisite of the ability to write contracts and enforce rights of various kinds is a system of accounting. In addition to allowing contracts to be written, an accounting system allows investors to value a company more easily and to assess how much it would be prudent to lend to it. Accounting information is only one type of information (albeit the most important) required by financial systems. The incentives to generate and disseminate information are crucial features of a financial system.
    Without significant amounts of human capital it will not be possible for any of these components of a financial system to operate effectively. Well trained lawyers, accountants and financial professionals such as bankers are crucial for an effective financial system, as the experience of Eastern Europe demonstrates.

  66. Comparative financial systems
    The financial system is among the key institutional features structuring the business system, and it varies on a number of dimensions, but the critical feature deals with the processes by which capital is made available and priced
    The financial system can be classified into;
    Capital-based financial systems: which is characterized by;
    Mobilize and distribute capital through large and liquid market
    Financial claims are traded and priced through the usual commodity-market process
    Short-termism is enhanced
    Only weak commitment to the growth of any single firm
    A strong market for corporate control is encouraged
    Credit-based financial systems: which is characterized by;
    Exhibit weak and fairly illiquid and thin capital market
    Capital market play only a minor role in mobilizing and pricing investment fund
    Dominant institutions are either large, ‘universal’ banks or a combination of commercial banks and long-term credit banks.
    Banks or the state allocate capital through administrative processes to particular sectors and activities(such as imports industries or the heavy manufacturing sector)
    The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Governments usually play a significant role in the financial system. They are major borrowers, particularly during times of war, recession, or when large infrastructure projects are being undertaken. They sometimes also save significant amounts of funds.
    In addition to their roles as borrowers or savers, governments usually play a number of other important roles. Central banks typically issue fiat money and are extensively involved in the payments system. Financial systems with unregulated markets and intermediaries, such as the US in the late nineteenth century, often experience financial crises. A financial system is much more than all of this, however. An important pre-requisite of the ability to write contracts and enforce rights of various kinds is a system of accounting. In addition to allowing contracts to be written, an accounting system allows investors to value a company more easily and to assess how much it would be prudent to lend to it. Accounting information is only one type of information (albeit the most important) required by financial systems. The incentives to generate and disseminate information are crucial features of a financial system.
    Without significant amounts of human capital it will not be possible for any of these components of a financial system to operate effectively. Well trained lawyers, accountants and financial professionals such as bankers are crucial for an effective financial system, as the experience of Eastern Europe demonstrates.

  67. References
    Abiola Sekoni (2015), The Basic Concepts and Feature of Bank Liquidity and Its Risk, IIUM Institute of Islamic Banking and Finance
    Basel Committee on Bank Supervision (2006), International Convergence of Capital Measurement and Capital Standards: A Revised Framework.
    DIC: Capital Measures and Capital Category defination.
    Douglas J. Elliott (2014), Bank Liquidity Requirements: An Introduction and Overview, The Brookings Institution
    Haimes, Y.Y (2004), Risk Modelling, Assessment and Management
    Hubbard, D.W (2009), Why Its Broken and How to Fix It
    Manish Kumar and Ghanshyam Chand Yadav (2013), LIQUIDITY RISK MANAGEMENT IN BANK: A CONCEPTUAL FRAMEWORK, AIMA Journal of Management & Research, May 2013, Volume 7, Issue 2/4, ISSN 0974 – 497
    PWC Financial Services Regulatory Practices, (2014), Basel Leverage Ratio: No cover for US
    PWC Financial Services Regulatory Practices, (2014)Basel Leverage Ratio: No cover for US
    Rausand, M. (2011), Risk Assessment: Theory, Methods and Application
    Society for Risk Analysis, ‘About the society for Risk Analysis’
    Trenca Ioan and Păun Dragoş (),POLICIES OF THE COMMERCIAL BANKS LIQUIDITY MANAGEMENT IN THE CRISIS CONTEXT

  68. RISK ANALYSIS
    Risk analysis is the process of defining and analyzing the dangers to individuals, businesses, and government agencies posed by potential natural and human-caused adverse events. It can be broadly defined to include risk assessment, risk characterization, risk communication, risk management, and policy relating to risk, in the context of risks of concern to individuals, to public- and private-sector organizations, and to society at a local, regional, national, or global level. Thus, risk analysis has to do with risk assessment (identifying, evaluating, and measuring the probability and severity of risks) and risk management (deciding what to do about risks). Risk analysis can be qualitative or quantitative. Qualitative in the sense that it uses broad terms (e.g. severe, moderate, catastrophic, etc.) to identify and analyze risks or presents a written description of the risk. Qualitative risk assessment does not build a precise mathematical model of risk but assigns relative and broad classifications to the likelihood and consequences for each risk. A common qualitative model is the risk matrix, which cross references classifications of likelihood of occurrence with classifications of severity of consequences of occurrence to determine a broad classification of risk level, under the general principle that greater probability and greater severity each imply greater risk. A risk matrix is sometimes called a pseudo-quantitative method because the classifications may be determined from numbers (for example, the likelihood category Unlikely may correspond to a probability of occurrence between 0.1 and 0.3). However, Quantitative risk analysis tries to numerically assess the probabilities for the potential consequences of risk and is often called probabilistic risk assessment (PRA) or deterministic risk. It tries to describe risk in quantifiable units like in Naira, numbers, etc. Portfolio risk is a kind of quantitative risk analysis as it looks at the probabilities associated with the fall or rise of a portfolio investment. PRA tries to answer the following questions:
    I. What can happen? Alternatively, what can go wrong?
    II. What is the probability (how likely) that it will happen?
    III. If it does happen, what are the consequences?
    BANK CAPITAL ADEQUACY
    Bank Capital Adequacy also known as Capital Requirement or Regulatory Capital is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. It is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. It is the percentage ratio of a financial institution’s total capital (tier 1 and tier 2 capital) to its risk-weighted assets (loans) and used to measure its financial strength, stability and ensure that they do not take on excess leverage and become insolvent. Two types of capital are measured: Tier one capital and Tier two capital. Tier one capital (primary capital) being the actual contributed equity plus retained earnings (it can absorb losses without a bank being required to cease trading) and Tier two capital being preference shares and subordinated debts (it can absorb losses in the event of winding up and so provides a lesser degree of protection to depositors.

  69. According to the Capital Adequacy Standard set by the Bank for International Settlements (BIS), banks must have a primary capital base equal to at least 8 percent of their assets following the Basel II, which stipulates that total capital ratio should not be less than 8%. However, in Nigeria, the capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking license, respectively. In addition, tier 1 capital should constitute at least 75% of the bank’s qualifying capital. These requirements govern the ratio of equity to debt, which is recorded in the liabilities and equity side of the balance sheet. They do not govern the asset side of the balance sheet, that is governed by the reserve requirements (the proportion of assets it must hold in cash or very liquid assets).
    According to the CBN, a minimum regulatory capital adequacy ratio (CAR) of 15% will be applicable to banks with international authorization and Systemically Important Banks (SIBs) while a CAR of 10% will be applicable to other banks.
    A bank shall compute its regulatory capital adequacy ratio in the following manner:

    Where total risk-weighted assets are calculated as the sum of:
    1) risk-weighted on-balance sheet and off-balance sheet assets computed according to Standardized Approach for credit risk
    2) 12.5 times the sum of the capital charges determined for market risk and operational risk; and
    Qualifying capital is broadly classified as Tier 1 and Tier 2 capital. Elements of Tier 2 capital will be limited to a maximum of one-third (i.e. 33.33%) of Tier 1 capital, after making deductions for goodwill, deferred tax asset (DTA) and other intangible assets but before deductions of investments.
    The aim of these requirements is to protect the financial institutions themselves, their customers, the government (which is liable for the cost of deposit insurance in the event of a bank failure) and the economy. This is done by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems.

    BANK EARNINGS
    Bank earnings refer to the net revenue of banks gotten from its operations. The essential purpose of a bank’s earnings, both current and accumulated, are to absorb losses and augment capital. Earnings are the initial safeguard against the risks of engaging in the banking business, and represents the first line of defense against capital depletion resulting from shrinkage in asset value. Earnings performance should also allow the bank to remain competitive by providing the resources required to implement management’s strategic initiatives. Banks earnings are determined by the interaction of some critical ratios, which are:
    Net Income to Average Assets Ratio – known as Return on Assets (ROA) and it consists of bottom line after-tax net income, including securities gains/losses and extraordinary items, as a percentage of average assets. The ROA is a common starting point for analyzing earnings because it gives an indication of the return on the bank’s overall activities. A typical ROA level is different, depending on the size, location, activities, and risk profile of the bank. An inordinately high ROA is often an indicator that the bank is engaged in risker operations. For example, a "community" bank with a few branches may regularly achieve an ROA ratio that exceeds those realized by large wholesale banks.

  70. Net Interest Income (TE) to Average Assets Ratio – known as the NII Ratio and it measures annualized total interest income, plus the tax benefit on tax-exempt income, less total interest expense, divided by average assets. TE adjustments are made to enable meaningful comparisons for banks that have tax-exempt income. This ratio typically represents the bank’s largest revenue component. While a higher NII ratio is generally favorable, it can also be reflective of a greater degree of risk within the asset base. For example, a high NII ratio could indicate management is making a large number of “high-interest, high-risk” loans (for example, subprime loans). Although an increase in the NII ratio would be evident, this would not necessarily be an improvement. The NII ratio can be broken down into two sub-component ratios: Interest Income (According to the Capital Adequacy Standard set by the Bank for International Settlements (BIS), banks must have a primary capital base equal to at least 8 percent of their assets following the Basel II, which stipulates that total capital ratio should not be less than 8%. However, in Nigeria, the capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking license, respectively. In addition, tier 1 capital should constitute at least 75% of the bank’s qualifying capital. These requirements govern the ratio of equity to debt, which is recorded in the liabilities and equity side of the balance sheet. They do not govern the asset side of the balance sheet, that is governed by the reserve requirements (the proportion of assets it must hold in cash or very liquid assets).
    According to the CBN, a minimum regulatory capital adequacy ratio (CAR) of 15% will be applicable to banks with international authorization and Systemically Important Banks (SIBs) while a CAR of 10% will be applicable to other banks.
    A bank shall compute its regulatory capital adequacy ratio in the following manner:

    Where total risk-weighted assets are calculated as the sum of:
    1) risk-weighted on-balance sheet and off-balance sheet assets computed according to Standardized Approach for credit risk
    2) 12.5 times the sum of the capital charges determined for market risk and operational risk; and
    Qualifying capital is broadly classified as Tier 1 and Tier 2 capital. Elements of Tier 2 capital will be limited to a maximum of one-third (i.e. 33.33%) of Tier 1 capital, after making deductions for goodwill, deferred tax asset (DTA) and other intangible assets but before deductions of investments.
    The aim of these requirements is to protect the financial institutions themselves, their customers, the government (which is liable for the cost of deposit insurance in the event of a bank failure) and the economy. This is done by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems.

    BANK EARNINGS
    Bank earnings refer to the net revenue of banks gotten from its operations. The essential purpose of a bank’s earnings, both current and accumulated, are to absorb losses and augment capital. Earnings are the initial safeguard against the risks of engaging in the banking business, and represents the first line of defense against capital depletion resulting from shrinkage in asset value. Earnings performance should also allow the bank to remain competitive by providing the resources required to implement management’s strategic initiatives. Banks earnings are determined by the interaction of some critical ratios, which are:

  71. Net Income to Average Assets Ratio – known as Return on Assets (ROA) and it consists of bottom line after-tax net income, including securities gains/losses and extraordinary items, as a percentage of average assets. The ROA is a common starting point for analyzing earnings because it gives an indication of the return on the bank’s overall activities. A typical ROA level is different, depending on the size, location, activities, and risk profile of the bank. An inordinately high ROA is often an indicator that the bank is engaged in risker operations. For example, a "community" bank with a few branches may regularly achieve an ROA ratio that exceeds those realized by large wholesale banks.
    Net Interest Income (TE) to Average Assets Ratio – known as the NII Ratio and it measures annualized total interest income, plus the tax benefit on tax-exempt income, less total interest expense, divided by average assets. TE adjustments are made to enable meaningful comparisons for banks that have tax-exempt income. This ratio typically represents the bank’s largest revenue component. While a higher NII ratio is generally favorable, it can also be reflective of a greater degree of risk within the asset base. For example, a high NII ratio could indicate management is making a large number of “high-interest, high-risk” loans (for example, subprime loans). Although an increase in the NII ratio would be evident, this would not TE) to Average Assets and Interest Expense to Average Assets.
    Net Interest Income (TE) to Average Earnings Assets Ratio – known as the Net Interest Margin (NIM) and is comprised of annualized total interest income on a TE basis, less total interest expense, divided by average earnings assets. This ratio indicates how well management employed the earning asset base. The NIM is more useful than the NII for measuring the profitability of the bank’s primary activities (buying and selling money) because the denominator focuses strictly on assets that generate income rather than the entire asset base.
    The sub-components of the NIM – the ratios of Interest Income to Average Earnings Assets and Interest Expense to Average Earning Assets – can be analyzed to determine the root causes of NIM changes. These ratios may change for a variety of reasons, for example, management may have restructured the balance sheet, the interest rate environment may have changed, or bank loan and deposit pricing became more or less competitive.
    Non-Interest Income (TE) to Average Assets Ratio – comprised of annualized income from bank services and sources other than interest-bearing assets, divided by average assets, this ratio analyses the level, trend and overall contribution of noninterest income to the bank’s earnings. If the contribution represents a major portion of the bank’s total revenue, specific sources should be identified and whether they are “core” vs “nonrecurring sources”. Noninterest income is largely of a fee nature; service charges on deposits, trust department income, mortgage servicing fees, and certain types of loan and commitment fees. The results of trading operations and a variety of miscellaneous transactions are also included. In some institutions, noninterest income is being relied upon more heavily as banks are attempting to diversify their earnings streams.

  72. Non-Interest Expense to Average Assets Ratio – known as the Overhead ratio (OH) and is calculated by annualizing expenses related to salaries and employees benefits, expenses of premises and fixed assets, and other noninterest expenses, divided by average assets. Examples of the type of costs that may lead to an inordinately high level of overhead expenses include: excessive salaries and bonuses, sizable management fees paid to the bank holding company, and high net occupancy expenses caused by the purchase or construction of a new bank building. Other related ratios such as average personnel expense per employee, average assets per employee, and the efficiency ratio (noninterest expense divided by the total revenue less interest expense) may provide useful information. The level of these ratios and the overall effect on earnings performance should be analyzed.
    Provision for Loan and Lease Losses (PLLL) to Average Assets Ratio – this shows the annualized percentage of PLLL in relation to average assets. Material changes in the volume of PLLL (either positively or negatively) are considered here. Higher provisions should result if the loan mix changes significantly from loans with lower to higher historical loss experience (e.g., from one-to-four family mortgage loans to commercial loans) or if economic conditions have declined and have produced a deterioration of loan quality. In situations where the economy is improving and loan quality is stabilizing or improving, lower PLLLs may be appropriate.
    Realized Gains/Losses on Securities to Average Assets Ratio – this shows the annualized percentage of net realized gains or losses on available-for-sale and held-to-maturity securities in relation to average assets. The level, trend, and overall contribution that securities transactions have on earnings performance are looked at here. Bank management may purchase and sell securities for many reasons, but most banks limit investment activity to ensure adequate liquidity is available to meet unanticipated funding needs and to invest excess funds (i.e., when loan demand is low). If the bank actively manages their portfolio, then, this securities activity should be considered part of the bank’s core operations. Even if actively selling securities might not be part of the bank’s core operations, they might engage in it if the management needs to restructure the portfolio to maintain or change portfolio duration, to maintain or change portfolio diversification, or to take advantage of some tax implications or some other combination of these reasons.
    BALANCE SHEET MANAGEMENT
    Balance sheet management is the process of planning, coordinating, and directing business activities that directly determine the assets, liabilities, and equity of a company. It covers regulatory policy for investment securities, bank-owned life insurance (BOLI), liquidity risk, and interest rate risk for banks. This study covers the four main areas of balance sheet management, namely interest rate risk management, liquidity risk management, capital management and management of discretionary investment portfolios.

  73. LIQUIDITY CONCEPTS AND POLICIES
    Liquidity can be referred to as a measure of the ability and ease with which assets can be converted to cash on short notice, or by having access to credit, in response to meeting cash and collateral obligations at a reasonable cost. Liquidity is the ability to meet anticipated and contingent cash needs with minimal or no loss. Liquidity can come from direct cash holdings in currency or on account at the Federal Reserve or other central bank. More commonly, it comes from holding securities that can be sold quickly with minimal loss. This typically means highly creditworthy securities, including government bills, which have short-term maturities. Indeed, if their maturity is short enough the bank may simply wait for them to return the principal at maturity. A minimum criterion of liquidity is the ability to both meet commitments when due and to undertake new transactions when desirable. Liquidity is important because banks are inherently fragile if they do not have sufficient safety nets.
    Liquidity can be broadly classified into three categories; namely Central bank liquidity, market liquidity and funding liquidity. Central bank liquidity constitutes deposits of financial institutions held at the central bank. It is the ability of the Central bank to supply the liquidity needed in the system mostly referred to the supply of base money to the system. These deposits required by the central bank are often known as reserve balances. Reserves are held by banks to meet the prudential guidelines or statutory requirements. On the other hand, market liquidity involves buying and selling of assets without unduly affecting the assets price. In other words, an asset’s market liquidity is the ease at which an asset can be sold quickly without incurring unacceptable losses. Lastly, funding liquidity describes the ability to raise cash or its equivalent, quickly either through collaterized loans, asset sales or by borrowing. A bank, is therefore, liquid if it is able to meet funding needs as at when the demand arises and if at all times outflow of funds from the bank are less than or equal to inflows into the bank. Short of this, there will be a liquidity mix match, which can lead to a crises or a run on the bank.
    Maintaining a sufficient level of liquidity in the banking system depends on the ability of the banking system to daily satisfy both expected and contingent demand for money, without negatively impacting on daily operations of the institutions or constituting a systemic risk. Illiquidity arises from assets and liabilities mismatch as well as gaps between receipts and payments. Lack of liquidity can force a bank to borrow at very high rates, which worsens the already illiquid position of the bank, and if not effectively managed can result in insolvency.
    Liquidity is therefore, a prerequisite for the viability of any financial institution to meet short-term obligations upon request or as at when due. Central Banks require deposit money banks (DMBs) to keep a minimum liquidity ratio that ensures that the banks are able to meet current liabilities and settle outstanding obligations as they fall due. Liquidity ratio is measured as a ratio of liquid assets to current liabilities. Liquid assets include cash, short-term investment securities and government bonds while current liabilities on the other hand include, customer’s deposits, borrowings etc. The liquidity ratio specified by CBN is 30% and it is calculated as

  74. CBN also uses the Cash Reserve Ratio (CSR), which requires that banks hold a certain percentage of their deposits as reserves with the Central Bank, in order to regulate the liquidity in the banking system. Banks source and maintain liquidity through two major ways; asset management, which is the holding and management of near-liquid assets (customer deposits, bank reserves, treasury bills etc.) and liability management, which is when a bank’s main source of funding is predominately from borrowing which is continually rolled over. Liability management is a much risker way of sourcing for liquidity.
    Liquidity Risk is the risk that banks cannot meet their financial obligations as they fall due, which can lead to a sudden of confidence in the financial system and potential default.
    Liquidity policies are policies or policy instruments put in place or used by the central bank in order to regulate the liquidity in the banking system as a whole. They include
    • Liquidity Ratio – which banks are required statutorily to hold a fraction of current liabilities as liquid assets. It is an indicator of the liquidity in the system.
    • Cash Reserve Ratio (CRR) – is a specified minimum fraction of customer deposits required of DMBs to be held as reserves either in cash or with the central bank. During periods of excess liquidity (or inflation), CRR is raised in order to curb or reduce the fraction which the banks lend out to the public thus reducing speculation and buying pressures on the domestic currency in the forex market.
    • Loan to Deposit Ratio – if this ratio is low, it means that the banks are not creating enough interest bearing assets and may not be earning enough to remain in the future in the foreseeable future. On the other hand, when the loan to deposit ratio is too high, it signifies that banks are issuing more of their deposits in interest bearing loans and may not have sufficient liquidity to meet any unexpected demands on funding.
    • Foreign Currency Trading Position – Reducing the amount of foreign currency trading position of banks can be effective in controlling excess liquidity in the banking system. The Net open position of a bank is a percentage of shareholders’ funds that banks are allowed to use to trade in foreign exchange in the interbank market. The effect of a reduction in the trading position is a reduction on the amount of income that banks can generate from trading foreign exchange. The reverse (i.e. increase in NOP) will have the opposite effect on banking system liquidity.
    • rDAS Introduction – Retail Dutch Auction System was introduced by the central bank to reduce the pressure on the foreign exchange and tighten loopholes arising from speculative demand. rDAS involves actual customer bid for payment of imports. The transmission mechanism of rDAS on banking system liquidity is through the reduction of the spread that banks make from speculative purchase of foreign exchange via the system of wholesale dutch auction.

  75. LENDING POLICIES
    Lending policies refer to a financial institution’s statement of its philosophy, standards, and guidelines, based on the institution and the regulatory laws guiding the institution/industry that its employees must observe in granting or denying a loan request. The central bank gives a broad set of rules which the financial institutions must adhere to when giving out or denying a loan. A commercial bank must follow three basic principles as a guide when providing loan services. They are Safety; Suitability; and Profitability.
    1. Safety: banks lay great emphasis on the basic lending, which consists of character, capacity, capital, collateral, and credibility. They have to have, to a reasonable level, certainty that the amount granted can be repaid from profits and cash flow generated from the operations of the individuals and corporate customers. Banks require information about the character of the person, his previous relationship with the bank and his credit records.
    2. Suitability: banks ensure that the suitability of an advance ever. When the requirements of a borrower, it is absolutely necessary for the bank to ensure that the purpose of the loan is not in conflict with the economic and monetary policies of the government.
    3. Profitability: the aim of any commercial banks is to maximize their wealth. Therefore any facility granted are expected to yield some profit to the bank, however, what determines the amount of profit is the interest rate charged.
    There are two major lending policies of banks: the explicit lending policies are those formulated by the monetary authorities and circulated using the central bank’s circulars and the implicit policies which are those formulated by the commercial banks themselves and mostly designed to relevant constraints like sectoral performances, deposit base, existing exposure etc.
    According to Reeds and Company, commercial banks have lending policies to establish the direction and use of funds flows to stock holders and depositors, to control the composition and size of loan portfolio and to determine the general circumstances appropriate to make the loan. A lending policy if properly articulated could provide a guide for safe, sound and profitable banking activities, if on the other hand the lending policy is not properly formulated it could lead to the banks liquidation. Due to improper lending, most banks make provision for bad debts but on the other hand what is known as recovery procedures in savoring doubtful debts. They include the systematic action by its specialized units either legal or other wise to this effect.

    INVESTMENT INSTRUMENTS AND POLICIES
    An investment policy is any government regulation or law that encourages or discourages foreign investment in the local economy while, investment instruments are used to achieve a particular objective i.e. provide an efficient flow and transfer of investment. Investment instruments include: Bank Deposits, Money Market funds, treasury bills, certificates of deposits, commercial papers, exchange traded funds, tri-party repos, repurchase agreements, enhanced cash funds, short-term bonds, etc.

  76. COMPARATIVE FINANCIAL SYSTEMS
    Comparative financial systems refers comparing the different kinds of financial systems available. According to the traditional approach, financial systems can be classified into two; Capital-market-based financial systems and credit-based financial systems.
    Features of a Capital market-based financial system include:
    i. Mobilize and distribute capital through large and liquid markets.
    ii. Financial claims are traded and priced through the usual commodity-market process.
    iii. Short-termism is enhanced.
    iv. Only weak commitment to the growth of any single firm.
    v. A strong market for corporate control is encouraged
    Features of a Credit-based financial market include:
    i. Exhibit weak and fairly illiquid and thin capital markets.
    ii. Capital markets play only a minor role in mobilizing and pricing investment funds.
    iii. Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks co-ordinated by state agencies and ministries, as in France, Japan and some other countries.
    iv. Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector)
    v. Interlocking and ‘Haus banks’
    This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”. According to Whitley one effect of a credit-based system is collaboration between economic actors. However, others have claimed that a credit-based financial system is inherently superior, and that economic performance can be enhanced by adopting the superior system.

  77. RISK ANALYSIS
    Risk analysis is the systematic study of uncertainties and risks we encounter in business, public policy, and many other ventures. Risk analysts seek to identify the risks faced by an institution or business unit, understand how and when they arise, and estimate the impact (financial or otherwise) of adverse outcomes. Risk managers start with risk analysis, then seek to take actions that will mitigate or hedge these risks.
    Risk is the possibility; likelihood or chance that something unpleasant or unwelcomed will happen that is capable of damaging an asset, or all of the original investment or the possibility of financial loss. More precisely, risk is the possibility of damage or any other negative occurrence that is caused by external or internal vulnerabilities, which may be avoided through preemptive action. Risk is commonly associated with uncertainty, as the event may or may not happen. It is an essential part of business, because enterprises cannot function without taking risks as business grows through risk taking. Hence, risk is related with opportunities and threat, which may harmfully affect an action or expected outcome.
    Risk analysis is the process that allows management to demonstrate that it has met its obligation of due diligence when making a decision about moving forward with a new project, capital expenditure, investment strategy, or other such business process. Risk analysis examines the factors that come into play when trying to determine if a project should be approved or not by weighing the risk involved in tangible impacts such as capital outlay, development costs, and long-term costs such as continued operations and maintenance and also addresses intangible impacts, such as customer connivance or regulatory compliance.
    Most times risk analysis are conducted whenever money or resources are to be spent in a business or project and the reason is to justify the decision to move forward with a new project or capital expenditure. The documentation of this process can be used by management to demonstrate that they have been performing their due diligence responsibilities.
    For risk analysis and project impact analysis, the need to demonstrate due diligence is an important output of the process. However, the overriding reason to conduct these processes is that it makes good business sense. The organization proceeds on certain paths based on need and the ability of the organization to meet those specific business or mission needs. The risk analysis process provides management with a consistent tool to be used to determine where the organization's limited resources will provide the best return on investment.
    Since risk analysis is the process of defining and analyzing the dangers to individuals, businesses and government agencies posed by potential natural and human-caused adverse events, it report can be used to align technology-related objectives with a company's business objectives. A risk analysis report can be either quantitative or qualitative. In quantitative risk analysis, an attempt is made to numerically determine the probabilities of various adverse events and the likely extent of the losses if a particular

  78. event takes place. Qualitative risk analysis, which is used more often, does not involve numerical probabilities or predictions of loss. Instead, the qualitative method involves defining the various threats, determining the extent of vulnerabilities and devising countermeasures should an attack occur.
    There are three kinds of methods used for determining the level of risk of our business. The methods can be: Qualitative Methods ,Quantitative Methods , Semi-quantitative Methods. Qualitative Methods: This is the kind of risk analysis method most often used for decision making in business projects; entrepreneurs base themselves on their judgment, experience and intuition for decision making. These methods can be used when the level of risk is low and does not warrant the time and resources necessary for making a full analysis. These methods are also used when the numerical data available are not adequate for a more quantitative analysis that would serve as the basis for a subsequent and more detailed analysis of the entrepreneur’s global risk. The qualitative methods include: Brainstorming Questionnaire and structured interviews Evaluation for multidisciplinary groups Judgment of specialists and experts (Delphi Technique)
    Semi-Quantitative Methods: Word classifications are used, such as high, medium or low, or more detailed descriptions of likelihood and consequences. These classifications are shown in relation to an appropriate scale for calculating the level of risk. We need to give careful attention to the scale used in order to avoid misunderstandings or misinterpretations of the results of the calculation. Quantitative Methods: Quantitative methods are considered to be those that enable us to assign values of occurrence to the various risks identified, that is, to calculate the level of risk of the project. Los quantitative methods include: Analysis of likelihood ,Analysis of consequences , Computer simulation The development of these measurements can be effected by means of different mechanisms, among which we note particularly the Monte Carlo Method, which is characterized by: – A broad vision in order to show a range of possible scenarios – Simplicity in putting it into practice – Suitable for performing computer simulations.

  79. BANK CAPITAL ADEQUACY
    Capital adequacy ratios are measures of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. An international standard which recommends minimum capital adequacy ratios has been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent. Applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt. Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet.

  80. BANK CAPITAL ADEQUACY
    Capital adequacy ratios are measures of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. An international standard which recommends minimum capital adequacy ratios has been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent. Applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt. Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet.

  81. Capital Adequacy Ratio (CAR) is basically the proportion of the bank’s tier 1& tier 2 equity (Qualifying capital or Equity) as a proportion of its risk weighted assets (loans). It is the proportion of a bank’s own equity in relation to its risk exposure. If a bank for example, has N200billion risk weighted assets and has a qualifying capital of N60billion then its CAR is N60billion/N200billion which is equal to 30%.
    The capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking licence, respectively.
    In the computation of CAR recommended by BCBS, Tier 2 capital should not constitute more than 50% of the qualifying capital, that is, 100% of Tier 1. However, banks designated as SIBs would be required to maintain a minimum CAR of 15% out of which Tier 2 capital should not constitute more than 25% of the qualifying capital.
    In other words, Tier 1 capital should be at least 75% of the bank’s qualifying capital. In addition, SIBs in Nigeria would be required to set aside Higher Loss Absorbency (HLA) or additional capital surcharge of 1% to their respective minimum required CAR.
    CAR helps regulators protect depositors from banks who lend aggressively and in doing so do not get back most of the money lent. This is because when a bank makes large loan losses that wipe out its total equity, it may lead to an immediate bankruptcy thus making depositors loose their money.
    Different countries have methods of determining what constitutes Tier 1 & 2 capital as well as risk weighted assets. According to CBN Guidance Note, to determine a bank's CAR, the CBN (being the financial regulator), must first ascertain, from its balance sheet, the bank's total capital. This is derived by a summation of the bank's Tier 1 Capital (comprising of its paid-up share capital, stocks, retained profits, share premiums, etc.) and Tier 2 Capital (comprising of its revaluated debts [recently valued tangible assets], general loan-loss reserve [sum set aside to service outstanding debts], capital instruments, subordinated debts etc). Thereafter, the ascertained capital is divided by the bank's total credit exposures (its loans, performance bonds, losses carried forward from the previous financial year, etc,). A percentage of the ascertained figure, which is currently pegged at 10%/15% depending on whether the Bank is a Systematically Important bank or not, is referred to as the Bank's CAR.
    Capital adequacy can also be related to as capital reserve of commercial banks with central bank of Nigeria (CBN) and is also the possession by a firm of sufficient capital for the business it is doing. Most times the CBN gives the other banks which are the commercial bank the minimum capital ratio to be reserved. The higher the capital adequacy ratio (CAR), the higher the level of protection available to depositors and applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system in Nigeria. The buffer theory of Calem and Rob (1996) predicts that when a bank approaches the regulatory minimum capital ratio it may have an incentive to boost capital and reduce risk in order to avoid the regulatory costs triggered by a breach of the capital requirements. However, poorly capitalized banks may also be tempted to take more risk in the hope that

  82. higher expected returns will help them to increase their capital and this is one of the ways risks relating to lower capital adequacy affects banking operations. But also gives some protection to depositors in the event of a winding-up, depositors' funds rank in priority before capital, so depositors would only lose money if the bank makes a loss which exceeds the amount of capital it has therefore the larger the capital adequacy ratio , the better. Al-Sabbah (2004) found capital adequacy as the most significant and positive determinant of banks’ profitability in Jordan. Study also examines the degree of significance of the capital adequacy ratio in influencing the financial deeds of Nigerian banks. The adequate capital of a bank is more crucial especially in the light of the global financial meltdown where it serves as bail out measures and is now being employed by the regulatory authorities to keep the financial system afloat. Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. An international standard which recommends minimum capital adequacy ratios has been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent.

    BANK EARNINGS
    Earnings of banks must consistently cover expenses if an effective and stable system of banking facilities is to be maintained. An increasing number of banks failed to preserve the necessary balance between income and outgo, at least a balance adequate to absorb losses, and were consequently compelled to discontinue operations. During the drastic liquidation some banks generally suffered severe losses which had to be charged off against current earnings, reserves and capital. Even so, the allowances made for losses were admittedly insufficient. In the sweeping banking reorganization stringent measures of capital rehabilitation had to be taken in all too many cases. Furthermore, as earning and expense reports for the last two years attest, unab¬sorbed losses in considerable volume were carried forward for adjustment under more favorable conditions.
    Despite a general improvement in banking conditions, reflecting the effects of various monetary policies, bank¬ing reforms, widespread business recovery and a phenom¬enal growth of deposits, the difficulty of balancing income and outgo for many banks has been only moderately alleviated. Earnings have been seriously affected by de¬clining interest yields on marketable assets which banks have come to hold in increasing volume. In addition, slack demands for business and personal accommodation have confronted banks everywhere, and progressive con¬cessions on interest charges to borrowers have been forced. While operating expenses have been severely reduced, thanks to the elimination of interest on demand deposits by law and Federal regulation of interest paid on time deposits, considerable resistance to further reduc¬tion apparently exists. As suggested above, moreover, some past losses remain to be absorbed, and reserves for future contingencies provided. This current struggle of banking institutions to cover their expenses out of earn¬ings and to rehabilitate their capital and reserves impera¬tively challenges analysis, both by those interested in

  83. the practical side of banking and by banking theorists.
    The extent to which past earnings are used to ex- plain current and future earnings is an important measure of earnings predictability and this can lead to more accurate valuation, as it enables investors to more accurately anticipate expected future cash flows. The extents to which investors depend on disclosed or reported financial information to predict future cash flows is a function of the quality of information contained in those financial statements (Kantudu and Tanko, 2008). The quality of financial statements is also dependent on the accounting standards employed in their preparation (Yahaya and Adenola, 2011). The accounting standards issued by the authoritative body in different country influences the content of the financial statement to a large extent, thereby making it difficult to compare financial reports of companies prepared with different accounting standard in different countries. To enhance comparability, the need for a uniform set of international accounting standards is considered imperative. According to Arum (2013), the issues affiliated with financial statement comparability will be reduced by the embracing of a single set of international accounting standards. This will in the long run help to improve the quality of accounting information disclosed.

    BALANCE SHEET MANAGEMENT
    A bank’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows bank flexibility in terms of timing the raising of capital. It can thus, factor in market conditions and unforeseen events. The following points can be kept in mind while capital planning:
    > The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
    > Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.

  84. Asset- Liability Management
    Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximising the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximised given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimised. Tracking the continuous changes in the way the banking business is conducted and the ever-changing external environment is an important constituent of the ALM function. These factors affect risk at a strategic level, and hence need to be continuously monitored. While these days a lot of information is available that enables such tracking, the frequency and intensity of unforeseen events and their effects has also heightened. It needs to be ensured that such unforeseen events do not affect the bank too adversely.Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole. Balance sheet shows the capital position of a company. Before delving into the details of capital management, it is useful to understand the function of capital in the broader context of a balance sheet. This also means that one needs to become familiar with the different departments within a bank or insurance company that are responsible for managing parts of the balance sheet and can therefore implicitly impact capital management and vice versa. Balance sheet help Capital management to be responsible for managing the capital position of a bank or insurance company in relation to the risks that are being run. This means that capital management has to focus both on the actual amount of capital that a bank or insurance company holds (i.e. available capital) as well as on the risks that are being taken, which are reflected on the balance sheet and ultimately determine the amount of capital that needs to be held (i.e. required capital). This means that, in order to manage capital, one needs to manage the interaction between capital and the rest of the balance sheet. Hence, capital management and balance sheet management are interdependent and heavily intertwined. What makes capital management so difficult is that the available capital can be managed solely by the capital management department, but the capital management department has much less influence over the rest of the balance sheet. The rest of the balance sheet is shaped by activities that are employed by many other departments, but is a crucial variable in managing capital well, as this is the basis for required capital. This is the main challenge of any capital manager and his success depends on his own ability to direct and convince other departments, as well as on the support he gets from the chief executive officer (CEO). In this perspective, it is good to point out that capital management, similar to risk management, has an advisory role and functions as a co-pilot to the CEO, who ultimately makes all the decisions.

  85. LIQUIDITY CONCEPTS AND POLICIES
    Liquidity concept here will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets. The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. Liquidity is when property of assets is being easily turned into money rapidly and at a fairly predictable price. The three main types are central bank liquidity, market liquidity and funding liquidity. Central bank liquidity is the ability of the central bank to supply the liquidity needed to the financial system and it is typically measured as the liquidity supplied to the economy by the central bank, i.e. the flow of monetary base from the central bank to the financial system. It relates to “central bank operations liquidity”, which refers to the amount of liquidity provided through the central bank auctions to the money market according to the “monetary policy stance”. The latter reflects the prevailing value of the operational target, i.e. the control variable of the central bank. In practice, the central bank strategy determines the monetary policy stance, that is, decides on the level of the operational target (usually the key policy rate). In order to implement this target, the central bank uses its monetary policy instruments (conducts open market operations) to affect the liquidity in the money markets so that the interbank rate is closely aligned to the operational target rate set by the prevailing monetary policy stance.
    The causes of liquidity risk lie on departures from the complete markets and symmetric information paradigm, which can lead to moral hazard and adverse se¬lection. To the extent that such conditions persist, liquidity risk is endemic in the financial system and can cause a vicious link between funding and market liquidity, prompting systemic liquidity risk. It is exactly this type of market risk that typi-cally alerts policy makers, because of its potential to destabilize the financial system. In such cases emergency liquidity provisions can be a tool to restore balance.

    LENDING POLICIES
    Lending policies are policies regulating the lending rate in an economy and should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the

  86. 1. Risk Analysis:
    Risk analysis is the review of the risks associated with a particular event or action. It is applied to projects, information technology, security issues and any action where risks may be analyzed on a qualitative and quantitative basis.
    Risks analysis is the process of assessing the likehood of an adverse event occurring within the corporate, government or environmental sector or the study of the underlying uncertainty of a given event of action and refers to the uncertainty of forecasted cash flow streams, variance of portfolio/stock returns, the probability of a projects success or failure and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects.
    The risk analysis section of financial system (sector) analyzes issues relating to there risks associated with trading and positioning securities and derivative financial instruments. These risks include both private and systemic exposures associated with price infatuations’ and potential counterparty defaults. The section conducts policy analysis and developmental research on matters concerning the regulation of the following
    – Markets for securities
    – Commodities and derivative instruments
    – The trading activities of banking organizations
    – The clearance and settlement of trades and
    – Margins on securities and stock-index futures and options.
    Financial or monetary risk analysis is mainly concerned with review of uncertainty associated with any financial activities.
    2. Bank Capital Adequacy
    Bank capital adequacy also known as regulatory capital or capital adequacy or capital requirement is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio (CAR) of equity that must be held as a percentage of risk-weighed assets. These requirement are put into place to ensure that these institution do not take on excess leverage and become insolvent. Capital requirement govern the ratio of equity to debt, recorded on liabilities and equity side of firm’s balance sheet.
    A part of bank regulation is to make sure that firms operating in the industry are prudently managed. The aim is to protect the firms themselves, their customers, the government (which is liable for the cost of deposit insurance in the event of bank failure) and the economy by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems.

  87. 3. Bank Earnings
    Earning typically refer to after tax net income. Bank earning are the determinant of share price, because earnings and the circumstances relating to them can indicate whether the business or bank will be profitable and successful in the long run. Bank earnings are perhaps the single most studies number in a bank’s profitability compared to analyst estimates and company guidance. Earning are the amount of profit that a company produces during a specific period, which is usually defined as a quarter (the calendar months) or a year.
    Bank earnings refers to the interest or profit banks received from loans, bank charges and other banking activities, it mainly determined by the interaction of nine (9) critical ratio which we define in the following way
    – Ratio 1: Interest Expense / average liabilities = the average interest rate paid on total average liabilities.
    – Ratio 2: Provision for loan losses / interest income – the loan loss provision rate
    – Ratio 3: Interest income /Total revenue = the percent of revenue derived from interest income
    – Ratio 4: Non-interest expense / total revenue less interest expense = commonly known as the efficient ratio
    – Ratio 5: Income Tax – pretax earning the effective tax rate
    – Ratio 6: Total revenue / average assets = the rate of asset turnover
    – Ratio 7: Average common equity / average assets = The common equity ratio
    – Ratio 8: preferred charges/ average common equity = the reduction in return on common equity
    – Ratio 9: Average common equity: average common shares outstanding: the book value

    4. Balance sheet Management
    A balance sheet is a financial statement that summarize a company’s assets, liabilities and shareholders equity at a specific point in time. These three balance sheet segments give instructors an idea as to what the company owns and owes, as well as the amount invested by shareholders. Whereas
    Balance sheet management is the process of planning, coordinating and directing business activities that directly determine the assets, liabilities, and equity of a company. Balance sheet management covers regulating policy for investment securities, bank-owned life insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate and liquidity risk for the national banking system as a whole. Balance sheet management is aimed at the determination of the optimal com[position of different funding elements like debt and equity for a company.

  88. 5. Liquidity Concepts and Policies
    Liquidity concept mean how quickly you can get your hands on your cash or Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the assets price. An asset is said to be liquid if it is easy to sell or convert into cash without any loss in its value.
    Liquidity policy: it is a policy implemented and responsible for establishing prudent liquidity risk management and risk control procedure. For a corporate entity, liquidity risk is the risk that it cannot meet its financial obligations as they fall due. This can lead to a sudden loss of confidence in the entity and potentially, immediate default. The reserve Bank has imposed minimum prudential standards on registered banks, addressing the degree of liquidity risk that they take on and their approach to managing that risk.
    There are three main components of the Reserve Banks liquidity policy:
    – Minimum ratio requirements calculated from bank’s financial data.
    – Rules and guidance on the risk management processes that banks should have in place to manage liquidity risk
    – Requirements for regular reporting to the Reserve Bank of data on their liquidity positions.
    6. Lending Policies:
    Lending policies is a financial policy that clearly identify or address the business of lending comprehensively and shall be used as guidance for lending transactions. In the financial system, each bank’s lending policy shall cover the following, in consistency with the scope, nature and complexity of its lending transactions.
    i. Levels of Authority: The banks lending policies shall clearly identify the levels of lending authorities of each department and unit involved in lending transactions. The existing banking laws, expertise and qualifications of employees shall be taken into consideration when assigning decision-making and loan application assessment authorities to the banks business units and individual employees.
    ii. Lending Limits and loan Concentration: The bank’s policy shall identify limits, regular monitoring and reporting requirements with respect to all known loan concentrations (loan types, related parties, economic sectors, geographic regions etc). determination of limits should incorporate the required level of return on each type of loan and the outcome of sensitivity evaluation of the loan portfolio as well as borrowed funds used to finance loans.
    iii. Types and areas of Lending: Each bank shall develop and pit in place individual lending, monitoring and control policies for each types of loan, in consistency with the lending strategy and nature of different types of loans.
    iv. Loan Maturities and Term: The maturity/term of a loan (principal and interest) shall be predicated on the purpose, type, source of repayment of the loan, seasonal/periodic nature of the borrowers business as well as realistic cash flow projections.
    v. Setting interest rates on Loan: The Lending policy shall identify the economic and market conditions as well as various factors used to determine the interest rates for individual loans and different types thereof.
    Others include
    i. Discount
    ii. Appraised and acceptance of collateral (means of insuring performance of credit obligations).
    iii. Financial information on borrowers etc.

  89. 7. Investment Instruments and policies:
    Investment instruments: These are documents such as a share certificate, promissory note or bond, used as a means to acquired equity capital or loan capital. also called financing instrument. Financial instrument are assets that can be traded. They provide an efficient flow and transfer of capital real or virtual instruments representing a legal agreement involving any kind of monetary value. Investment or financial instruments may be divided into two types.
    i. Cash Instrument: The value of cash instruments are directly influenced and determined by the markets. These are securities that are easily transferable. Cash instruments may also be deposits and loans agreed upon by borrowers and lenders.
    ii. Derivatives Instruments: The value and characteristics of derivative instruments are based on the vehicles underlying components such as assets, interest rates of indices. These can be over-the-counter (OTC) derivatives or exchange-trades derivatives.
    Financial instruments may also be divided according to asset class which depends on whether they are debt-based or equity-based
    i. Short-term debt-based financial instrument last for one year or less. The securities can be commercial paper while cash of this kind can be deposit
    ii. Long-term debt based of financial instrument last for more than a year.
    Investment policy: is any government regulation or law that encourages or discourages foreign investment in the local economy, eg. Currency exchange limits. As globalization integrates the economics of neighboring aid of trading states, they are typically forced to trade off such rules as part of a common tax, tariff and trade regime, eg. As defined by a free trade part.
    Investment policy in many nations is tied to immigration policy, either due to a desire to prevent human capital flight by forcing investors to keep local assets in local investment or by a desire to attract immigrates by offering passports in a safe haven nation eg. Canada, in exchange for a substantial investment on a business that will create jobs there.
    8. Comparative Financial System:
    A financial system is a channel to which funds is transfer or more from agents with surpluses and agents with deficits. A financial system (within the scope of finance) is a system that allows the exchange of funds between lenders, investors, and borrowers. A financial system operated at national, global and firm-specific levels. They consist of complex, closely related services, markets and institutions intended to provide an efficient and regular linkage between investors and depositors.
    Comparative financial system: Is a complete financial statement that an entity issues, revealing information for more than one accounting period.
    The financial statements that may be included in this package are:
    – The income statement (showing results for multiple periods)
    – The balance sheet (showing the financial position of the entity as of more than one balance sheet date)
    – The statement of cash flows (showing the cash flows for more than one period)
    Another variation on the comparative concept is to report information for each of the 12 preceding months on a rolling basis. A comparative financial statement provides a comparison of an entity’s financial performance over multiple periods, so that you can determine trends.

    Reference
    – Allen, Franklin; Gale, Douglas (2000 – 01 0 01). Comparing financial system: MIT Press.
    – Accounting for financial instrument”: http://www.fasb.org.retrived 2016-01-01
    – Gurusany .S. *2008). Financial service and system; 2nd edition, p.3 Mcgran-title education.

  90. 1. RISK ANALYSIS
    Risk analysis is the systematic analysis of the degree of risk attaching to capital projects. Risk reflects the variability of expected future return from a capital investment, and as such, the evaluation of risk attached to every investment is very necessary in order to make a good investment decision. Therefore, some statistical and probability techniques can be used to evaluate the investment project and to assist in such decision. Every investment project is associated with risk, and the profitability of every project hinge on the levels of return from investment and the level of risk associated with such investment project. There are different types of this risk which can be summarized as follows:
    1. Financial Risk: Financial risk are the risk associated with financial transactions which could be inform of risk in company loans in case of default. Financial risk is understood to include only downside risk, which means that the potential for financial loss and uncertainty about its extent.
    2. Asset-Backed Risk: This is the risk that varies from one assets to the other, and if valuated tends to support some assets that has more profitability, hence, asset-backed security will significantly impact the value of the supported security. Such risk include interest rate, term modification, and repayment risk. For some investment, the maturity period tends to be faster while some takes time, those that takes time may yield higher returns on investment but also means higher interest rate to the institutions in which the loans had been obtained. More also, the time frame of the returns in necessary to meet up with the term of payment.
    3. Credit Risk: Credit risk is also known as default risk. This is the risk that is associated with borrowed money in terms of default payment. This risk ranges from losses of collateral securities, principal, decreased cash flow, interest and increase in the collection costs. An investor must evaluate the cash flow of the investment to hedge against this risk.
    4. Foreign Investment Risk: Foreign investment risk is the risk that is associated with changes in international value of foreign bond due to extreme change in value due to differing accounting, reporting, auditing standard, nationalization, confiscatory taxation and economic conflict, political and diplomatic changes. Valuation, liquidity and regulatory issues may add to foreign investment risk.
    5. Liquidity Risk: This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). There are two types of liquidity risk:
    (a) Asset liquidity: An asset cannot be sold due to lack of liquidity in the market – essentially a sub-set of market risk. This can be accounted for by widening bid-offer spread, making explicit liquidity reserves, lengthening holding period for variance calculation.
    (b) Funding Liquidity: Risk that liabilities cannot be met when they fall due and can only be met at an uneconomic price.
    6. Market Risk: The four standard market risk factors are equity risk, interest rate risk, currency risk, and commodity risk:
    a) Equity risk is the risk that stock prices in general (not related to a particular company of industry) or the implied volatility will change.
    b) Interest rate risk is that interest rate or the implied volatility will change, which affects, for example, the value of an asset held in that currency.

  91. (2) BANK CAPITAL ADEQUACY
    Capital adequacy ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR), is the ratio of a bank’s capital to its risk. National regulators such as the Central Bank of Nigeria (CBN) track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory capital requirements. CAR can be used as a measure of a bank's capital base, and can also be expressed as a percentage of a bank's risk weighted credit exposures. This ratio is used to protect depositors and promote stability and efficiency of financial systems around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors. Capital adequacy ratios (CARs) are a measure of the amount of a bank's core capital expressed as a percentage of its risk-weighted asset.
    Also known as capital-to-risk weighted assets ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of financial system around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors
    CAR=(Tier One Capital+Tier Two Capital)/(Risk Weighted Assets)
    The reason why minimum capital adequacy ratios are critical is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. Capital adequacy ratios ensure the efficiency and stability of a nation’s financial system by lowering the risk of banks becoming insolvent. If a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system. During the process of winding-up, funds belonging to depositors are given a higher priority than the bank’s capital, so depositors can only lose their savings if a bank registers a loss exceeding the amount of capital it possesses. Thus the higher the bank’s capital adequacy ratio, the higher the degree of protection of depositor's monies.
    Tier one capital: is the capital that is permanently and easily available to cushion losses suffered by a bank without it being required to stop operating. A good example of a bank’s tier one capital is its ordinary share capital.
    Tier two capital: is the one that cushions losses in case the bank is winding up, so it provides a lesser degree of protection to depositors and creditor. It is used to absorb losses if a bank loses all its tier one capital.
    When measuring credit exposures, adjustments are made to the value of assets listed on a lender’s balance sheet. All the loans the bank has issued are weighted based on their degree of risk. For example, loans issued to the government are weighted at 0 percent, while those given to individuals are assigned a weighted score of 100 percent

  92. 3 BANK EARNINGS
    Earnings of banks must consistently cover expenses if an effective and stable system of banking facilities is to be maintained. An increasing number of banks failed to preserve the necessary balance between income and outgo, at least a balance adequate to absorb losses, and were consequently compelled to discontinue operations. During the drastic liquidation some banks generally suffered severe losses which had to be charged off against current earnings, reserves and capital. Even so, the allowances made for losses were admittedly insufficient. In the sweeping banking reorganization stringent measures of capital rehabilitation had to be taken in all too many cases. Furthermore, as earning and expense reports for the last two years attest, unabsorbed losses in considerable volume were carried forward for adjustment under more favorable conditions.
    Despite a general improvement in banking conditions, reflecting the effects of various monetary policies, banking reforms, widespread business recovery and a phenomenal growth of deposits, the difficulty of balancing income and outgo for many banks has been only moderately alleviated. Earnings have been seriously affected by declining interest yields on marketable assets which banks have come to hold in increasing volume. In addition, slack demands for business and personal accommodation have confronted banks everywhere, and progressive concessions on interest charges to borrowers have been forced. While operating expenses have been severely reduced, thanks to the elimination of interest on demand deposits by law and Federal regulation of interest paid on time deposits, considerable resistance to further reduction apparently exists. As suggested above, moreover, some past losses remain to be absorbed, and reserves for future contingencies provided. This current struggle of banking institutions to cover their expenses out of earnings and to rehabilitate their capital and reserves imperatively challenges analysis, both by those interested in the practical side of banking and by banking theorists.
    The extent to which past earnings are used to ex-plain current and future earnings is an important measure of earnings predictability and this can lead to more accurate valuation, as it enables investors to more accurately anticipate expected future cash flows. The extents to which investors depend on disclosed or reported financial information to predict future cash flows is a function of the quality of information contained in those financial statements (Kantudu and Tanko, 2008). The quality of financial statements is also dependent on the accounting standards employed in their preparation (Yahaya and Adenola, 2011). The accounting standards issued by the authoritative body in different country influences the content of the financial statement to a large extent, thereby making it difficult to compare financial reports of companies prepared with different accounting standard in different countries. To enhance comparability, the need for a uniform set of international accounting standards is considered imperative. According to Arum (2013), the issues affiliated with financial statement comparability will be reduced by the embracing of a single set of international accounting standards. This will in the long run help to improve the quality of accounting information disclosed.

  93. 4 BALANCE SHEET MANAGEMENT
    Balance Sheet is a comprehensive summary of a company’s assets and liabilities at a particular point in time. This is the summary statement showing the assets, liabilities, and equity of the company as of that point in time.
    Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company. The Purpose of Balance Sheet Management is to position a company to have adequate resources for current operations and for financing future growth. Initially pioneered by financial institutions during the 1970s as interest rates became increasingly volatile, asset and liability management (ALM) is the practice of managing risk that arise due to mismatches between the assets and liabilities.
    The process is at the crossroads between risk management and strategic planning. It is not just about offering solutions to mitigate or hedge the risks arising from the interaction of assets and liabilities but is focused on a long-term perspective: success in the process of maximizing assets to meet complex liabilities may increase profitability. Thus modern ALM includes the allocation and management of assets, equity, interest rate and credit risk management including risk overlays, and the calibration of firm wide tools within these risk frameworks for optimization and management in the local regulatory and capital environment.
    Often an ALM approach passively matches assets against liabilities (fully hedged) and leaves surplus to be actively managed. The exact roles and perimeter around ALM can vary significantly from one bank (or other financial institutions) to another depending on the business model adopted and can encompass a broad area of risks. The traditional ALM programs focus on interest rate risk and liquidity risk because they represent the most prominent risks affecting the organization balance-sheet (as they require coordination between assets and liabilities). The ALM function scope covers both a prudential component (management of all possible risks and rules and regulation) and an optimization role (management of funding costs, generating results on balance sheet position), within the limits of compliance (implementation and monitoring with internal rules and regulatory set of rules). ALM intervenes in these issues of current business activities but is also consulted to organic development and external acquisition to analyze and validate the funding terms options, conditions of the projects and any risks (i.e., funding issues in local currencies).

  94. 5 LIQUIDITY CONCEPT AND POLICIES
    The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. In this definition, two issues should be noted. First, liquidity can be understood in terms of flows (as opposed to stocks), in other words, it is a flow concept. In our framework, liquidity will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets. Second, liquidity refers to the ability of realising these flows. Inability of doing so would render the financial entity illiquid. As will become obvious below, this ability can be hindered because of asymmetries in information and the existence of incomplete markets.
    The role of the bank in the context of the maturity transformation that occurs in the banking book (as traditional activity of the bank is to borrow short and lend long) lets inherently the institution vulnerable to liquidity risk and can even conduct to the so-call risk of 'run of the bank' as depositors, investors or insurance policy holders can withdraw their funds/ seek for cash in their financial claims and thus impacting current and future cash-flow and collateral needs of the bank (risk appeared if the bank is unable to meet in good conditions these obligations as they come due). This aspect of liquidity risk is named funding liquidity risk and arises because of liquidity mismatch of assets and liabilities (unbalance in the maturity term creating liquidity gap). Even if market liquidity risk is not covered into the conventional techniques of ALM (market liquidity risk as the risk to not easily offset or eliminate a position at the prevailing market price because of inadequate market depth or market disruption), these 2 liquidity risk types are closely interconnected. In fact, reasons for banking cash inflows are:
    • when counterparties repay their debts (loan repayments): indirect connection due to the borrower's dependence on market liquidity to obtain the funds
    • when clients place a deposit: indirect connection due to the depositor's dependence on market liquidity to obtain the funds
    • when the bank purchases assets to hold on its own account: direct connection with market liquidity (security's market liquidity as the ease of trading it and thus potential rise in price)
    • when the bank sells debts it has held on its own account: direct connection
    Measuring liquidity position via liquidity gap analysis is still one of the most common tool used and represents the foundation for scenario analysis and stress-testing. To do so, ALM team is projecting future funding needs by tracking through maturity and cash-flow mismatches gap risk exposure (or matching schedule). In that situation, the risk depends not only on the maturity of asset-liabilities but also on the maturity of each intermediate cash-flow, including prepayments of loans or unforeseen usage of credit lines.

  95. Actions to Perform in Liquidity Management
    A) Determining the number and length of each relevant time interval (time bucket)
    B) Defining the relevant maturities of the assets and liabilities where a maturing liability will be a cash outflow while a maturing asset will be a cash inflow (based on effective maturities or the 'liquidity duration': estimated time to dispose of the instruments in a crisis situation such as withdrawal from the business). For non-maturity assets (such as overdrafts, credit card balances, drawn and undrawn lines of credit or any other off-balance sheet commitments), their movements as well as volume can be predict by making assumptions derived from examining historic data on client's behavior.
    C) Slotting every asset, liability and off-balance sheet items into corresponding time bucket based on effective or liquidity duration maturity
    In dealing with the liquidity gap, the bank main concern is to deal with a surplus of long-term assets over short-term liabilities and thus continuously to finance the assets with the risk that required funds will not be available or into prohibitive level. Before any remediation actions, the bank will ensure first to:
    1. Spread the liability maturity profile across many time intervals to avoid concentration of most of the funding in overnight to few days’ time buckets (standard prudent practices admit that no more than 20% of the total funding should be in the overnight to one-week period)
    2. Plan any large size funding operation in advance
    3. Hold a significant productions of high liquid assets (favorable conversion rate into cash in case distressed liquidity conditions)
    Put limits for each time bucket and monitor to stay within a comfortable level around these limits (mainly expressed as a ratio where mismatch may not exceed a certain threshold of the total cash outflows for a given time interval)
    Non-Maturing Specific Liquidity Management
    As these instruments do not have a contractual maturity, the bank needs to dispose of a clear understanding of their duration level within the banking books. This analysis for non-maturing liabilities such as non interest-bearing deposits (savings accounts and deposits) consists of assessing the account holders behavior to determine the turnover level of the accounts or decay rate of deposits (speed at which the accounts 'decay', the retention rate is representing the inverse of a decay rate).
    Calculation to define (example):
    • Average opening of the accounts : a retail deposit portfolio has been open for an average of 8,3 years
    • Retention rate : the given retention rate is 74,3%
    • Duration level : translation into a duration of 6,2 years
    Various assessment approaches may be used:
    1. To place these funds in the longest-dated time bucket as deposits remain historically stable over time due to large numbers of depositors.
    2. To divide the total volume into 2 parts: a stable part (core balance) and a floating part (seen as volatile with a very short maturity)
    3. To assign maturities and re-pricing dates to the non-maturing liabilities by creating a portfolio of fixed income instruments that imitates the cash-flows of the liabilities positions.
    The 2007 crisis however has evidence fiercely that the withdrawal of client deposits is driven by two major factors (level of sophistication of the counterparty: high-net-worth clients withdraw their funds quicker than retail ones, the absolute deposit size: large corporate clients are leaving faster than SMEs) enhancing simplification in the new deposit run-off models.

  96. Remediation actions
    A. A surplus of assets creates a funding requirement, i.e. a negative mismatch that can be financed
    o By long-term borrowings (typically costlier): long-term debt, preferred stock, equity or demand deposit
    o By short-term borrowings (cheaper but with higher uncertainty level in term of availability and cost): collateralized borrowings (repo), money market
    o By asset sales: distressed sales (at loss) but sales induce drastic changes in the bank's strategy
    B. A surplus of liabilities over assets creates the need to find efficient uses for those funds, i.e. a positive mismatch that is not a wrong signal (generally a rare scenario in a bank as the bank always has a target return on capital to achieve and so requires funds to be put to work by acquiring assets) but only means that the bank is sacrificing profits unnecessarily to achieve a liquidity position that is too liquid. This excess of liquidity can be deployed in money market instruments or risk-free assets such as government T-bills or bank certificate of deposit (CDs) if this liability excess belongs to bank's capital (the ALM desk will not take the risk of putting capital in a credit-risk investment).
    Measuring Liquidity Risk
    The liquidity measurement process consists of evaluating:
    1. Liquidity consumption (as the bank is consumed by illiquid assets and volatile liabilities)
    2. Liquidity provision (as the bank is provided by stable funds and by liquid assets)
    2 essential factors are to take into consideration:
    • Speed: the speed of market deterioration in 2008 fosters the need to daily measurement of liquidity figures and quick data availability
    • Integrity
    But daily completeness of data for an internationally operating bank should not represent the forefront of its pre-occupation as the seek for daily consolidation is a lengthy process that may put away the vital concern of quick availability of liquidity figures. So the main focus will be on material entities and business as well as off-balance sheet position (commitments given, movements of collateral posted)
    For the purposes of quantitative analysis, since no single indicator can define adequate liquidity, several financial ratios can assist in assessing the level of liquidity risk. Due to the large number of areas within the bank's business giving rise to liquidity risk, these ratios present the simpler measures covering the major institution concern. In order to cover short-term to long-term liquidity risk they are divided into 3 categories:
    1. Indicators of operating cash-flows
    2. Ratios of liquidity
    3. Financial strength (leverage)
    6 LENDING POLICIES
    Lending institution's statement of its philosophy, standards, and guidelines that its employees must observe in granting or refusing a loan request. These policies determine which sector of the industry or business will be approved loans and which will be avoided, and must be based on the country's relevant laws and regulations. A set of guideline and criteria developed by a bank and used by its employees to determine whether an applicant for a loan should be granted or refused the loan

  97. 7 INVESTMENT INSTRUMENT AND POLICIES
    Investors can choose from a wide range of assets for their investment portfolios. The two basic types of investment instruments are fixed-income and equity. Fixed-income assets provide relative safety of capital and regular interest payments, while equity provides the potential for long-term capital appreciation. The asset mix depends on short-term cash flow needs, long-term financial objectives and tolerance for market risk
    Types of Investment Instruments
    Cash
    Cash instruments include savings and checking accounts, certificates of deposit and money market accounts. These safe and liquid investments earn modest returns on investment. They also provide financial flexibility because you can use them for emergencies, living expenses and buying other assets at attractive prices.
    Bonds
    Companies and governments issue bonds to raise capital for operational and strategic needs. Bond investors receive regular interest payments and get the principal back on maturity. Bond prices rise when interest rates fall and fall when rates rise. Government bonds are safer than corporate bonds. U.S. Treasuries are risk-free because the U.S. government backs them. Credit rating agencies assign risk ratings to bonds based on several factors, including a bond issuer's financial strength and ability to fulfill its debt obligations. Low-rated bonds have to pay higher interest rates to compensate investors for taking on the higher risk.
    Equity
    Companies issue stock to raise capital for various needs. Stocks trade on regulated exchanges, such as the New York Stock Exchange, or on over-the-counter markets. Investment portfolios benefit from rising stock prices but suffer during periods of market volatility. This is why diversification across different industries is so important. Some companies pay dividends, which are cash distributions to shareholders from after-tax profits. The main risk of equity investments is that deteriorating business conditions lead to falling profits and stock prices.
    Mutual Funds
    Mutual funds offer diversification at reasonable costs because the fund companies are able to spread the fees and expenses over a large asset base. Stock funds invest in stocks, bond funds invest in bonds and balanced funds invest in a mix of stocks and bonds. There is further specialization within these categories. For example, technology stock funds invest only in technology stocks, while international funds invest in certain regions of the world. The disadvantage is that you have no control over investment decisions but must pay fees and other expenses regardless of performance. Exchange-traded funds are similar conceptually to mutual funds, except that they trade like stocks on exchanges and track market indexes and sub-indexes. ETFs offer convenience and sector diversification at lower costs than regular mutual funds.
    Commodities
    You can invest in gold, silver and other commodities. Some use gold and other precious metal assets to hedge against inflation and as a storage of value during periods of economic uncertainty. Commodity prices are volatile, and there is the risk of significant capital loss in a short period. Individual investors can gain exposure to this sector cost-effectively through commodity mutual funds and exchange-traded funds.

  98. Others
    Other investment instruments include real estate and small businesses. Residential and commercial real estate investments can offer investors attractive rates of return, especially during periods of economic expansion. Small businesses, such as franchise outlets or retail stores, could be a worthwhile investment of both time and money. You can also invest in derivatives, such as options and futures, to speculate or to hedge positions in stocks and other assets.
    Investment Policy Statement (IPS)
    An investment policy statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance and liquidity requirements are included in an IPS.

  99. 8 COMPARATIVE FINANCIAL SYSTEM
    Comparative Financial Systems
    According to Whitley, the financial system is among the key institutional features structuring business systems. Financial systems vary on a number of dimensions. But the critical feature deals with the processes by which capital is made available and priced. Whitley use the traditional dichotomy to classify financial system:
    Capital-market-based financial systems versus Credit-based financial systems.
    Characteristics of capital-market-based financial systems:
    • Mobilize and distribute capital through large and liquid markets
    • Financial claims are traded and priced through the usual commodity-market process
    • Short-termism is enhanced
    • Only weak commitment to the growth of any single firm
    • A strong market for corporate control is encouraged
    Characteristics of credit-based financial systems
    • Exhibit weak and fairly illiquid and thin capital markets
    • capital markets play only a minor role in mobilizing and pricing investment funds
    • Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks co-ordinated by state agencies and ministries, as in France, Japan and some other countries
    • Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector)
    • Interlocking and ‘Haus banks’
    This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”.

  100. NAME: UKANDU JENNIFER
    1. RISK ANALYSIS
    The systematic analysis of the degree of risk attaching to capital projects. Risk reflects the variability of expected future return from a capital investment, and as such the statistical technique of probability may be applied to assist a decision. Therefore, some statistical and probability techniques can be used to evaluate the investment project and to assist in such decision. Every investment project is associated with risk, and the profitability of every project hinge on the levels of return from investment and the level of risk associated with such investment project. There are different types of this risk which can be summarized as follows:
    1. Financial Risk: Financial risk are the risk associated with financial transactions which could be inform of risk in company loans in case of default. Financial risk is understood to include only downside risk, which means that the potential for financial loss and uncertainty about its extent.
    2. Asset-Backed Risk: This is the risk that varies from one assets to the other, and if valuated tends to support some assets that has more profitability, hence, asset-backed security will significantly impact the value of the supported security. Such risk include interest rate, term modification, and repayment risk. For some investment, the maturity period tends to be faster while some takes time, those that takes time may yield higher returns on investment but also means higher interest rate to the institutions in which the loans had been obtained. More also, the time frame of the returns in necessary to meet up with the term of payment.
    3. Credit Risk: Credit risk is also known as default risk. This is the risk that is associated with borrowed money in terms of default payment. This risk ranges from losses of collateral securities, principal, decreased cash flow, interest and increase in the collection costs. An investor must evaluate the cash flow of the investment to hedge against this risk.
    4. Foreign Investment Risk: Foreign investment risk is the risk that is associated with changes in international value of foreign bond due to extreme change in value due to differing accounting, reporting, auditing standard, nationalization, confiscatory taxation and economic conflict, political and diplomatic changes. Valuation, liquidity and regulatory issues may add to foreign investment risk.
    5. Liquidity Risk: This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). There are two types of liquidity risk:
    (a) Asset liquidity: An asset cannot be sold due to lack of liquidity in the market – essentially a sub-set of market risk. This can be accounted for by widening bid-offer spread, making explicit liquidity reserves, lengthening holding period for variance calculation.
    (b) Funding Liquidity: Risk that liabilities cannot be met when they fall due and can only be met at an uneconomic price.
    6. Market Risk: The four standard market risk factors are equity risk, interest rate risk, currency risk, and commodity risk:
    a) Equity risk is the risk that stock prices in general (not related to a particular company of industry) or the implied volatility will change.
    b) Interest rate risk is that interest rate or the implied volatility will change, which affects, for example, the value of an asset held in that currency.

  101. (2) BANK CAPITAL ADEQUACY
    Capital adequacy ratios are a measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. An international standard which recommends minimum capital adequacy ratios has been developed to ensure banks can absorb a reasonable level of losses before becoming insolvent. Applying minimum capital adequacy ratios serves to protect depositors and promote the stability and efficiency of the financial system. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt. Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet. The loans a bank has made are weighted, in a broad brush manner, according to their degree of riskiness, e.g. loans to Governments are given a 0 percent weighting whereas loans to individuals are weighted at 100 percent. Off-balance sheet contracts, such as guarantees and foreign exchange contracts, also carry credit risks. These exposures are converted to credit equivalent amounts which are also weighted in the same way as on-balance sheet credit exposures. On-balance sheet and off balance sheet credit exposures are added to get total risk weighted credit exposures. The minimum capital adequacy ratios that apply are: tier one capital to total risk weighted credit exposures to be not less than 4 percent; total capital (tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 percent.

  102. An international standard has been developed which recommends minimum capital adequacy ratios for international banks. The purpose of having minimum capital adequacy ratios is to ensure that banks can absorb a reasonable level of losses before becoming insolvent, and before depositors funds are lost. Applying minimum capital adequacy ratios serves to promote the stability and efficiency of the financial system by reducing the likelihood of banks becoming insolvent. When a bank becomes insolvent this may lead to a loss of confidence in the financial system, causing financial problems for other banks and perhaps threatening the smooth functioning of financial markets. Accordingly applying minimum capital adequacy ratios in New Zealand assists in maintaining a sound and efficient financial system here. It also gives some protection to depositors. In the event of a winding-up, depositors' funds rank in priority before capital, so depositors would only lose money if the bank makes a loss which exceeds the amount of capital it has. The higher the capital adequacy ratio, the higher the level of protection available to depositors. This article provides an explanation of the capital adequacy ratios applied by the Reserve Bank and a guide to their calculation. For more detail, the Reserve Bank policy document Capital Adequacy Framework, issued in January 1996, available from the Reserve Bank Library, should be consulted. Development of Minimum Capital Adequacy Ratios The "Basle Committee" (centred in the Bank for International Settlements), which was originally established in 1974, is a committee that represents central banks and financial supervisory authorities of the major industrialised countries (the G10 countries). The committee concerns itself with ensuring the effective supervision of banks on a global basis by setting and promoting international standards. Its principal interest has been in the area of capital adequacy ratios. In 1988 the committee issued a statement of principles dealing with capital adequacy ratios. This statement is known as the "Basle Capital Accord". It contains a recommended approach for calculating capital adequacy ratios and recommended minimum capital adequacy ratios for international banks. The Accord was developed in order to improve capital adequacy ratios (which were considered to be too low in some banks) and to help standardise international regulatory practice. It has been adopted by the OECD countries and many developing countries. The Reserve Bank applies the principles of the Basle Capital Accord in New Zealand

  103. 3 BANK EARNINGS
    Earnings of banks must consistently cover expenses if an effective and stable system of banking facilities is to be maintained. An increasing number of banks failed to preserve the necessary balance between income and outgo, at least a balance adequate to absorb losses, and were consequently compelled to discontinue operations. During the drastic liquidation some banks generally suffered severe losses which had to be charged off against current earnings, reserves and capital. Even so, the allowances made for losses were admittedly insufficient. In the sweeping banking reorganization stringent measures of capital rehabilitation had to be taken in all too many cases. Furthermore, as earning and expense reports for the last two years attest, unabsorbed losses in considerable volume were carried forward for adjustment under more favorable conditions.
    Despite a general improvement in banking conditions, reflecting the effects of various monetary policies, banking reforms, widespread business recovery and a phenomenal growth of deposits, the difficulty of balancing income and outgo for many banks has been only moderately alleviated. Earnings have been seriously affected by declining interest yields on marketable assets which banks have come to hold in increasing volume. In addition, slack demands for business and personal accommodation have confronted banks everywhere, and progressive concessions on interest charges to borrowers have been forced. While operating expenses have been severely reduced, thanks to the elimination of interest on demand deposits by law and Federal regulation of interest paid on time deposits, considerable resistance to further reduction apparently exists. As suggested above, moreover, some past losses remain to be absorbed, and reserves for future contingencies provided. This current struggle of banking institutions to cover their expenses out of earnings and to rehabilitate their capital and reserves imperatively challenges analysis, both by those interested in the practical side of banking and by banking theorists.
    The extent to which past earnings are used to ex-plain current and future earnings is an important measure of earnings predictability and this can lead to more accurate valuation, as it enables investors to more accurately anticipate expected future cash flows. The extents to which investors depend on disclosed or reported financial information to predict future cash flows is a function of the quality of information contained in those financial statements (Kantudu and Tanko, 2008). The quality of financial statements is also dependent on the accounting standards employed in their preparation (Yahaya and Adenola, 2011). The accounting standards issued by the authoritative body in different country influences the content of the financial statement to a large extent, thereby making it difficult to compare financial reports of companies prepared with different accounting standard in different countries. To enhance comparability, the need for a uniform set of international accounting standards is considered imperative. According to Arum (2013), the issues affiliated with financial statement comparability will be reduced by the embracing of a single set of international accounting standards. This will in the long run help to improve the quality of accounting information disclosed.

  104. 4 BALANCE SHEET MANAGEMENT
    Balance Sheet is a comprehensive summary of a company’s assets and liabilities at a particular point in time. This is the summary statement showing the assets, liabilities, and equity of the company as of that point in time.
    Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company. The Purpose of Balance Sheet Management is to position a company to have adequate resources for current operations and for financing future growth. Initially pioneered by financial institutions during the 1970s as interest rates became increasingly volatile, asset and liability management (ALM) is the practice of managing risk that arise due to mismatches between the assets and liabilities.
    The process is at the crossroads between risk management and strategic planning. It is not just about offering solutions to mitigate or hedge the risks arising from the interaction of assets and liabilities but is focused on a long-term perspective: success in the process of maximizing assets to meet complex liabilities may increase profitability. Thus modern ALM includes the allocation and management of assets, equity, interest rate and credit risk management including risk overlays, and the calibration of firm wide tools within these risk frameworks for optimization and management in the local regulatory and capital environment.
    Often an ALM approach passively matches assets against liabilities (fully hedged) and leaves surplus to be actively managed. The exact roles and perimeter around ALM can vary significantly from one bank (or other financial institutions) to another depending on the business model adopted and can encompass a broad area of risks. The traditional ALM programs focus on interest rate risk and liquidity risk because they represent the most prominent risks affecting the organization balance-sheet (as they require coordination between assets and liabilities). The ALM function scope covers both a prudential component (management of all possible risks and rules and regulation) and an optimization role (management of funding costs, generating results on balance sheet position), within the limits of compliance (implementation and monitoring with internal rules and regulatory set of rules). ALM intervenes in these issues of current business activities but is also consulted to organic development and external acquisition to analyze and validate the funding terms options, conditions of the projects and any risks (i.e., funding issues in local currencies).

  105. 5 LIQUIDITY CONCEPT AND POLICIES
    The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. In this definition, two issues should be noted. First, liquidity can be understood in terms of flows (as opposed to stocks), in other words, it is a flow concept. In our framework, liquidity will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets. Second, liquidity refers to the ability of realising these flows. Inability of doing so would render the financial entity illiquid. As will become obvious below, this ability can be hindered because of asymmetries in information and the existence of incomplete markets.
    The role of the bank in the context of the maturity transformation that occurs in the banking book (as traditional activity of the bank is to borrow short and lend long) lets inherently the institution vulnerable to liquidity risk and can even conduct to the so-call risk of 'run of the bank' as depositors, investors or insurance policy holders can withdraw their funds/ seek for cash in their financial claims and thus impacting current and future cash-flow and collateral needs of the bank (risk appeared if the bank is unable to meet in good conditions these obligations as they come due). This aspect of liquidity risk is named funding liquidity risk and arises because of liquidity mismatch of assets and liabilities (unbalance in the maturity term creating liquidity gap). Even if market liquidity risk is not covered into the conventional techniques of ALM (market liquidity risk as the risk to not easily offset or eliminate a position at the prevailing market price because of inadequate market depth or market disruption), these 2 liquidity risk types are closely interconnected.

  106. 6 LENDING POLICIES
    Lending institution's statement of its philosophy, standards, and guidelines that its employees must observe in granting or refusing a loan request. These policies determine which sector of the industry or business will be approved loans and which will be avoided, and must be based on the country's relevant laws and regulations. A set of guideline and criteria developed by a bank and used by its employees to determine whether an applicant for a loan should be granted or refused the loan
    7 INVESTMENT INSTRUMENT AND POLICIES
    Investors can choose from a wide range of assets for their investment portfolios. The two basic types of investment instruments are fixed-income and equity. Fixed-income assets provide relative safety of capital and regular interest payments, while equity provides the potential for long-term capital appreciation. The asset mix depends on short-term cash flow needs, long-term financial objectives and tolerance for market risk
    Types of Investment Instruments
    Cash
    Cash instruments include savings and checking accounts, certificates of deposit and money market accounts. These safe and liquid investments earn modest returns on investment. They also provide financial flexibility because you can use them for emergencies, living expenses and buying other assets at attractive prices.
    Bonds
    Companies and governments issue bonds to raise capital for operational and strategic needs. Bond investors receive regular interest payments and get the principal back on maturity. Bond prices rise when interest rates fall and fall when rates rise. Government bonds are safer than corporate bonds. U.S. Treasuries are risk-free because the U.S. government backs them. Credit rating agencies assign risk ratings to bonds based on several factors, including a bond issuer's financial strength and ability to fulfill its debt obligations. Low-rated bonds have to pay higher interest rates to compensate investors for taking on the higher risk.
    Equity
    Companies issue stock to raise capital for various needs. Stocks trade on regulated exchanges, such as the New York Stock Exchange, or on over-the-counter markets. Investment portfolios benefit from rising stock prices but suffer during periods of market volatility. This is why diversification across different industries is so important. Some companies pay dividends, which are cash distributions to shareholders from after-tax profits. The main risk of equity investments is that deteriorating business conditions lead to falling profits and stock prices.
    Mutual Funds
    Mutual funds offer diversification at reasonable costs because the fund companies are able to spread the fees and expenses over a large asset base. Stock funds invest in stocks, bond funds invest in bonds and balanced funds invest in a mix of stocks and bonds. There is further specialization within these categories. For example, technology stock funds invest only in technology stocks, while international funds invest in certain regions of the world. The disadvantage is that you have no control over investment decisions but must pay fees and other expenses regardless of performance. Exchange-traded funds are similar conceptually to mutual funds, except that they trade like stocks on exchanges and track market indexes and sub-indexes. ETFs offer convenience and sector diversification at lower costs than regular mutual funds.

  107. Commodities
    You can invest in gold, silver and other commodities. Some use gold and other precious metal assets to hedge against inflation and as a storage of value during periods of economic uncertainty. Commodity prices are volatile, and there is the risk of significant capital loss in a short period. Individual investors can gain exposure to this sector cost-effectively through commodity mutual funds and exchange-traded funds.
    Others
    Other investment instruments include real estate and small businesses. Residential and commercial real estate investments can offer investors attractive rates of return, especially during periods of economic expansion. Small businesses, such as franchise outlets or retail stores, could be a worthwhile investment of both time and money. You can also invest in derivatives, such as options and futures, to speculate or to hedge positions in stocks and other assets.
    Investment Policy Statement (IPS)
    An investment policy statement (IPS) is a document drafted between a portfolio manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance and liquidity requirements are included in an IPS.
    8 COMPARATIVE FINANCIAL SYSTEM
    A financial system is a channel to which funds is transfer or more from agents with surpluses and agents with deficits. A financial system (within the scope of finance) is a system that allows the exchange of funds between lenders, investors, and borrowers. A financial system operated at national, global and firm-specific levels. They consist of complex, closely related services, markets and institutions intended to provide an efficient and regular linkage between investors and depositors.
    Comparative financial system: Is a complete financial statement that an entity issues, revealing information for more than one accounting period.
    The financial statements that may be included in this package are:
    I. The income statement (showing results for multiple periods)
    II. The balance sheet (showing the financial position of the entity as of more than one balance sheet date)
    III. The statement of cash flows (showing the cash flows for more than one period)
    Another variation on the comparative concept is to report information for each of the 12 preceding months on a rolling basis. A comparative financial statement provides a comparison of an entity’s financial performance over multiple periods, so that you can determine trends.

  108. 1. Balance sheet Management
    Balance sheet management has to do with a bank or a company’s financial activities and it’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows a bank flexibility in terms of timing the raising of capital. The following points can be kept in mind while capital planning:
    1. The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
    2. Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.
    Asset- Liability Management
    Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximizing the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximized given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimized.
    Tracking the continuous changes in the way the banking business is conducted and the ever-changing external environment is an important constituent of the ALM function. These factors affect risk at a strategic level, and hence need to be continuously monitored. While these days a lot of information is available that enables such tracking, the frequency and intensity of unforeseen events and their effects has also heightened. It needs to be ensured that such unforeseen events do not affect the bank too adversely.

  109. Bank Capital Adequacy
    Bank capital adequacy or capital adequacy is also the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. These requirements are put in place to ensure that these institutions do not take on excess leverage and become insolvent. Capital requirement governs the ration of equity to debt, recorded on the liabilities and equity side of a firm’s balance sheet
    Bank capital adequacy or capital adequacy ratios are the measure of the amount of a bank's capital expressed as a percentage of its risk weighted credit exposures. Two types of capital are measured – tier one capital which can absorb losses without a bank being required to cease trading, e.g. ordinary share capital, and tier two capital which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors, e.g. subordinated debt.
    Measuring credit exposures requires adjustments to be made to the amount of assets shown on a bank's balance sheet. The loans a bank has made are weighted, in a broad brush manner, according to their degree of riskiness, e.g. loans to Governments are given a0 percent weighting whereas loans to individuals are weighted at 100 percent.
    Off-balance sheet contracts, such as guarantees and foreign exchange contracts, also carry credit risks. These exposures are converted to credit equivalent amounts which are also weighted in the same way as on-balance sheet credit exposures. On-balance sheet and offbalance sheet credit exposures are added to get total risk weighted credit exposures.
    The minimum capital adequacy ratios that apply are:
    • tier one capital to total risk weighted credit exposures to be not less than 4 percent;
    • total capital (tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8 percent.
    The reason why minimum capital adequacy ratios are critical is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors’ funds. Capital adequacy ratios ensure the efficiency and stability of a nation’s financial system by lowering the risk of banks becoming insolvent. If a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system.

  110. 3. Bank Earnings
    Bank earnings deliver valuable information from firms to stakeholders, and are very significant in decision-making of investors. As earnings are widely measured in many circumstances, their quality has drawn the interest of scholars, standard setters, and professionals. Every business entity is judged by its earnings as one of the most important parameter to measure the financial performance of the organization. Also in the context of banks, the quality of earnings is an important benchmark to determine the ability to earn consistently in the future and to maintain quality, sustainability and growth in performance. High quality reported earnings reveal present operating profitability, express upcoming performance and exactly represent the inherent value of the firm.
    Earning Management in Banks
    Loan loss provisions are an expense item an the income statement, reflecting management’s current assessment of the likely level of future losses from defaults on outstanding loan. The recording of loan loss provision reduces net income. Commercial bank regulators view accumulated loan loss provisions, the loan loss allowance account on the balance sheet, as a type of capital that can be used to absorb losses. A higher loan loss allowance balance allow the bank to absorb greater unexpected losses without failing symmetrically, if the loan loss allowance is less than expected losses, the bank’s capital ratio will understate its ability to sustain unexpected losses.

  111. 1. Risk Analysis
    Risk analysis is the systematic study of uncertainties and risks we encounter in business, public policy, and many other areas. Risk analysts seek to identify the risks faced by monetary institution, understand how and when they arise, and estimate the impact (financial or otherwise) of adverse outcomes. Risk managers start with risk analysis, then seek to take actions that will mitigate or hedge these risks.
    Some institutions, such as banks and investment management firms, are in the business of taking risks every day. Risk analysis and management is clearly crucial for these institutions. One of the roles of risk management in these firms is to quantify the financial risks involved in each investment, trading, or other business activity, and allocate a risk budget across these activities. Banks in particular are required by their regulators to identify and quantify their risks, often computing measures such as Value at Risk (VaR), and ensure that they have adequate capital to maintain solvency should the worst (or near-worst) outcomes occur.
    Risk analysis can also be defined in many different ways on how it relates to other concepts. Therefore, risk analysis can be broadly defined as to include risk assessment, risk characterization, risk communication, risk management and policy relating to risk. Risk analysis can be divided into two components
    a. Risk assessment which comprises of identifying, evaluating and measuring the probability and severity of risk.
    b. Risk management which comprises of deciding what to do about risk.
    Risk can be qualitative or quantitative.
    Qualitative risk analysis uses broad terms (e.g moderate, severe, catastrophic) to identify and evaluate risk or presents a written description of the risk,
    Quantitative risk analysis is the practice of creating a mathematical model of a project or process that explicitly includes uncertain parameters that we cannot control, and also decision variables or parameters that we can control. A quantitative risk model calculates the impact of the uncertain parameters and the decisions we make on outcomes that we care about — such as profit and loss, investment returns, environmental consequences, and the like. Such a model can help business decision makers and public policy makers understand the impact of uncertainty and the consequences of different decisions.
    Quantitative risk analysis calculates the numerical probabilities over the possible consequences. It seeks to numerically assess probabilities for the potential consequences of risk, and is often called probabilistic risk analysisor probabilistic assessment (PRA). The analysis often seeks to describe the consequences in numerical units such as naira, time, etc

  112. 5. Liquidity Concepts and Policies
    Liquidity at a bank is a measure of its ability to readily find the cash it may need to meet demands upon it. Liquidity can come from direct cash holdings in currency or on account at the Federal Reserve or other central bank. More commonly it comes from holding securities that can be sold quickly with minimal loss. This typically means highly creditworthy securities, including government bills, which have short-term maturities. Indeed if their maturity is short enough the bank may simply wait for them to return the principal at maturity. Short-term, very safe securities also tend to trade in liquid markets, meaning that large volumes can be sold without moving prices too much and with low transaction costs (usually based on a bid/ask spread between the price dealers will pay to buy — the bid — and that at which they will sell — the ask.)
    However, a bank’s liquidity situation, particularly in a crisis, will be affected by much more than just this reserve of cash and highly liquid securities. The maturity of its less liquid assets will also matter, since some of them may mature before the cash crunch passes, thereby providing an additional source of funds. Or they may be sold, even though this incurs a potentially substantial loss in a fire sale situation where the bank must take whatever price it can get. On the other side, banks often have contingent commitments to pay out cash, particularly through lines of credit offered to its retail and business customers. (A home equity line is a retail example, while many businesses have lines of credit that allow them to borrow within set limits at any time.) Of course, the biggest contingent commitment in most cases is the requirement to pay back demand deposits at any time that the depositor wants.
    Liquidity concepts and policies can be seen as discussed below;
    Even commentators who support the LCR recognize some validity in these concerns, as does the liquidity Coverage Ratio
    As outlined by the Basel Committee itself, the Committee and national supervisors have worked considerably on ways to adapt the effective standard to take account of the most significant local differences, such as the lack of large, liquid financial markets in many developing nations, discussed below. Further, the Committee has endorsed the approach of running more detailed liquidity stress tests at the national level, as a complement to the LCR, since it is a single measure that clearly cannot capture every nuance of liquidity needs. These actions mitigate the two main concerns, but do not eliminate them. For example, if the LCR inappropriately penalizes certain financial activities, this will not be eliminated by adding a more detailed stress test, since the LCR will still remain in force.

  113. 6. Lending policies
    The Companies and Allied Matters Act, the Central Bank of Nigeria Act and the various prudential guidelines issued by the Central Bank of Nigeria (CBN), governs the Banking industry in Nigeria. The CBN, which under the leadership of the Governor, is responsible for formulating and implementing monetary policy and fostering the liquidity, solvency and proper functioning of the financial system. The Central Bank of Nigeria (CBN) publishes information on Nigeria‘s commercial banks and non-banking financial institutions, interest rates and other publications and guidelines. The Central Bank of Nigeria acts as the main regulator of commercial banks in Nigeria.
    The CBN operates under a monetary policy programming framework that includes monetary aggregates (liquidity and credit) targets that are consistent with a given level of inflation and economic growth,for instance, the banks objective for the fiscal year, e.g was to achieve inflation rate below 5% using quarterly reserve targets. To this end, the CBN set a ceiling for reserve money and a floor for the net foreign assets. This was the mainstay of monetary policy at least until the introduction of the Central Bank Reserve Ratio.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies.

  114. community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    i. Lending authority of each loan officer;
    ii. Lending authority of a loan or executive committee, if any;
    iii. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    iv. Guidelines under which unsecured loans will be granted;
    v. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    vi. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    vii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    viii. Maintenance and review of complete and current credit files on each borrower;
    ix. Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    x. Limitations on the maximum volume of loans in relation to total assets;
    xi. Limitations on the extension of credit through overdrafts;
    xii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiii. Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    xiv. Guidelines addressing the bank's loan review and grading system ("Watch list");
    xv. Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    xvi. Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation. Examiners should also encourage management to develop specific guidelines for each lending department or function. As with overall lending policies, it is not the FDIC's intent to suggest universal or standard loan policies for specific types of credit. The establishment of these policies is the responsibility of each bank's Board and management. Therefore, the following discussion of basic principles applicable to various types of credit will not include or allude to acceptable ratios, levels, comparisons or terms. These matters should, however, be addressed in each bank's lending policy, and it will be the examiner's responsibility to determine whether the policies are realistic and being followed.

  115. The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans. Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies are of vital importance if the bank is to be continuously operated in an acceptable manner.

    INVESTMENT INSTRUMENTS AND POLICIES
    By using opportunities in local and international market the Bank always develop effective investment solutions towards protection of invested capital, reaching current yield and further capital appreciation via following investing tools.
     Money market instruments
    Money market instruments Arm Swiss Bank clients can allocate their funds for a short term period in the following money market instruments, allowing more flexible and efficient cash management.
    • Government securities (buying and selling, forward contracts)
    • Forex trading (buying and selling, currency swaps, forward contracts)
    • Repurchase agreements
    • Gold bullions
     Stocks
    Stock signifies an investor’s right of ownership in a corporation, granting them a number of privileges, prerogatives and authorities. We offer stocks to customers who anticipate high revenues while accepting an equivalent level of risk. Stockholders can anticipate solid returns from fluctuations of stock prices under favorable market conditions.
     Bonds
    Bonds provide a certain return on invested capital at a set date in the future. They are less volatile than stocks, offering greater capital security and assured income. Unlike stockholders, whose returns are uncertain, bondholders have the advantage of more predictable returns.
     Investment funds shares
    Investment funds generate income by issuing shares and investing them in other instruments of the market. The collective investments of the funds’ shareholders are managed by a professional fund

  116. manager, based on a continuous analysis of the securities market. As investment funds use a range of financial instruments, they provide investors with a level of diversification not available to an individual investor and – unlike stocks and bonds – offer a high return with a moderate risk level.
     Futures contracts
    A futures contract is an agreement to buy or sell an underlying asset – e.g. energy, foreign currency, metals and agricultural products – at a pre-determined price in the future. Futures contracts do not assume physical delivery of the underlying asset. The difference between the market price of the underlying asset in the physical (real) market on the futures contract's expiry date – or on a date when an offset deal is concluded – and the pre-determined price is paid to the succeeded party. Futures contracts reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flows more effectively.
     Currency options
    A currency option is a contract between two parties which gives the buyer of the option a right but not an obligation – to purchase the underlying currency from the seller at a pre-determined price and date in the future against a premium. Like futures contracts, currency options reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flows more effectively.
    Investment policy in the PFI relates to a country’s laws, regulations and practices that directly enable or discourage investment and that enhance the public benefit from investment. It covers, for instance, policies for transparent and non-discriminatory treatment of investors, expropriation and compensation laws and dispute settlement practices.
    The quality of a country’s investment policies directly influences the decisions of investors, be they small or large, domestic or foreign. Transparency, property protection and non-discrimination are core investment policy principles that underpin efforts to create a quality investment environment for all.
    Investors are also concerned with the way that investment policy is formulated and changed. They will avoid circumstances where policies are modified at short notice, where governments do not consult with industry on proposed changes and where laws, regulations and procedures are not clear, readily available and predictable.
    The PFI Investment Policy chapter identifies through eight questions the most important issues relevant for judging the effectiveness of a country’s investment policies and practices. The issues are often directly relevant to the specific needs of foreign investors, but they apply in most instances to domestic investors as well. This section of the Toolkit offers additional detail on why these investment policy questions are important, and specific guidance on the topics to scrutinize in order to form an opinion on how well a country’s investment policies perform good practices.

  117. The eight PFI questions on Investment Policy relate to:
    i. Laws and regulations
    ii. Effective ownership registration
    iii. Intellectual property rights
    iv. Contract enforcement and dispute resolution
    v. Expropriation laws and review processes
    vi. Non-discriminatory treatment for national and international investors
    vii. International co-operation and periodic review
    viii. International arbitration instruments

    COMPARATIVE FINANCIAL SYSTEMS
    Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow inter temporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. These functions are common to the financial systems of most developed economies. Yet the form of these financial systems varies widely. In the United States and the United Kingdom competitive markets dominate the financial landscape, whereas in France, Germany, traditionally played why do different countries have such different financial systems? Is one system better than all the others? Do different systems merely represent alternative ways of satisfying similar needs? Is the current trend toward market-based systems desirable? Franklin Allen and Douglas Gale argue that the view that market-based systems are best is simplistic. For example, financial markets may be bad for risk sharing; competition in banking may be inefficient; financial crises can be good as well as bad; and separation of ownership and control can be optimal. Financial institutions are not simply veils, disguising the allocation mechanism without affecting it, but are crucial to overcoming market imperfections. An optimal financial system relies on both financial markets and financial intermediaries. The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Fifty years ago, the financial system could be neatly bifurcated in this way. Rich households and large firms used the equity and bond markets, while less wealthy households and medium and small firms used banks, insurance companies and other financial institutions. Governments usually play a significant role in the financial system. They are major borrowers, particularly during times of war, recession, or when large infrastructure projects are being undertaken. They sometimes also have significant amounts of funds. For example, when countries such as Norway and many Middle Eastern States have access to large

  118. amounts of natural resources (oil), the government may acquire large trust funds on behalf of the population. In addition to their roles as borrowers or savers, governments usually play a number of other important roles. Central banks typically issue fiat money and are extensively involved in the payments system. Financial systems with unregulated markets and intermediaries, such as the US in the late nineteenth century, often experience financial crises (Gorton (1988) and Calomiris and Gorton (1991)). The desire to eliminate these crises led many governments to intervene in a significant way in the financial system. Central banks or some other regulatory authority are charged with regulating the banking system and other intermediaries, such as insurance companies. So in most countries governments play an important role in the operation of financial systems. This intervention means that the political system, which determines the government and its policies, is also relevant for the financial system. There are some historical instances where financial markets and institutions have operated in the absence of a well-defined legal system, relying instead on reputation and other implicit mechanisms. However, in most financial systems the law plays an important role. It determines what kinds of contacts are feasible, what kinds of governance mechanisms can be used for corporations, the restrictions that can be placed on securities and so forth. Hence, the legal system is an important component of a financial system. A financial system is much more than all of this, however. An important pre-requisite of the ability to write contracts and enforce rights of various kinds is a system of accounting. In addition to allowing contracts to be written, an accounting system allows investors to value a company more easily and to assess how much it would be prudent to lend to it. Accounting information is only one type of information (albeit the most important) required by financial systems. The incentives to generate and disseminate information are crucial features of a financial system. Without significant amounts of human capital it will not be possible for any of these components of a financial system to operate effectively. Well-trained lawyers, accountants and financial professionals such as bankers are crucial for an effective financial system, as the experience of Eastern Europe demonstrates.

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    of Capital Management, Earnings Management and Signalling Effects, Journal of Accounting and Economics 28, 1-25.

    Al-Sabbah, Noor (2004), “Determinants of capital adequacy ratio in Jordanian and Evidence”, Journal of Monetary Economics, Vol. 32, pp. 513- 542

    Arum (2013) earnings quality. Contemporary Accounting Research, 28(5), 1610-1644.
    Calem PS, Rob R (1996). “The Impact of Capital-Based Regulation on Bank Risk-Taking: A Dynamic Model, Board of Governors of the Federal Reserve System,” Finance and Economics Discussion
    Series 96/12 (February), 36.
    D. W. Hubbard, The Failure of Risk Management: Why It's Broken and How to Fix It (2009).
    Norrman, O., & Vaigur, D. (2013). Individual characteristics and earnings quality: Executive reputation and board director gender. Master’s thesis. Stockholm School of Economics.
    Kantudu and Tanko (2008) Assessment of the Effects of Firms Characteristics on Earnings Management of Listed Firms in Nigeria. Asian Economic and Financial Review, 5(2), 218-228
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  120. 1. RISK ANALYSIS
    Risk analysis is the process of defining and analyzing the dangers to individuals, businesses and government agencies posed by potential natural and human-caused adverse events. Risk analysis is the review of the risks associated with a particular event or action. It is applied to projects, information technology, security issues and any action where risks may be analyzed on a quantitative and qualitative basis. Furthermore risk is the possibility; likelihood or chance that something unpleasant or unwelcomed will happen that is capable of damaging an asset, or all of the original investment or the possibility of financial loss. More precisely, risk is the possibility of damage or any other negative occurrence that is caused by external or internal vulnerabilities, which may be avoided through preemptive action. Risk is commonly associated with uncertainty, as the event may or may not happen. It is an essential part of business, because enterprises cannot function without taking risks as business grows through risk taking. Hence, risk is related with opportunities and threat, which may harmfully affect an action or expected outcome.
    Risk Analysis Methods
    There are three kinds of methods used for determining the level of risk of our business. The methods can are
    A. Qualitative Methods: This is the kind of risk analysis method most often used for decision making in business projects; entrepreneurs base themselves on their judgment, experience and intuition for decision making. These methods can be used when the level of

  121. "

    risk is low and does not warrant the time and resources necessary for making a full analysis.
    B. Quantitative Methods: These methods can be used when the level of risk is low and does not warrant the time and resources necessary for making a full analysis.
    C. Semi-quantitative Methods: Word classifications are used, such as high, medium or low, or more detailed descriptions of likelihood and consequences. These classifications are shown in relation to an appropriate scale for calculating the level of risk.

    2. BANK CAPITAL ADEQUACY
    Bank capital adequacy (also known as regulatory capital or capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. These requirements are put into place to ensure that these institutions do not take on excess leverage and become insolvent. Capital requirements govern the ratio of equity to debt, recorded on the liabilities and equity side of a firm's balance sheet. They should not be confused with reserve requirements, which govern the assets side of a bank's balance sheet-in particular, the proportion of its assets it must hold in cash or highly-liquid assets.
    The capital adequacy ratio (CAR) for banks in Nigeria currently stands at 10% and 15% for national/regional banks and banks with international banking licence respectively. A key part of bank regulation

  122. is to make sure that firms operating in the industry are prudently managed. The aim is to protect the firms themselves, their customers, the government (which is liable for the cost of deposit insurance in the event of a bank failure) and the economy, by establishing rules to make sure that these institutions hold enough capital to ensure continuation of a safe and efficient market and able to withstand any foreseeable problems.
    3. BANK EARNINGS
    Earnings typically refer to after-tax net income. Earnings are the main determinant of share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statements, because they show a company's profitability compared to analyst estimates and company guidance.
    Earnings of banks must consistently cover expenses if an effective and stable system of banking facilities is to be maintained. An increasing number of banks failed to preserve the necessary balance between income and outgo, at least a balance adequate to absorb losses, and were consequently compelled to discontinue operations. During the drastic liquidation some banks generally suffered severe losses which had to be charged off against current earnings, reserves and capital. Even so, the allowances made for losses were admittedly insufficient. In the sweeping banking reorganization stringent measures of capital rehabilitation had to be taken in all too many cases. Furthermore, as earning and expense reports for the last two years attest, unab¬sorbed losses in considerable volume were carried forward for adjustment under more favorable conditions.
    Despite a general improvement in banking conditions, reflecting the effects of various monetary policies, bank¬ing reforms, widespread business recovery and a phenom¬enal growth of deposits, the difficulty of balancing income and outgo for many banks has been only moderately alleviated. Earnings have been seriously affected by de-clining interest yields on marketable assets which banks have come to hold in increasing volume. In addition, slack demands for business and personal accommodation have confronted banks everywhere, and progressive con¬cessions on interest charges to borrowers have been forced. While operating expenses have been severely reduced, thanks to the elimination of interest on demand deposits by law and Federal regulation of interest paid on time deposits, considerable resistance to further reduc¬tion apparently exists. As suggested above, moreover, some past losses remain to be absorbed, and reserves for future contingencies provided. This current struggle of banking institutions to cover their expenses out of earn¬ings and to rehabilitate their capital and reserves impera¬tively challenges analysis, both by those interested in the practical side of banking and by banking theorists.
    4. BALANCE SHEET MANAGEMENT
    Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and

  123. interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole.
    A bank’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows a bank flexibility in terms of timing the raising of capital. It can thus, factor in market conditions and unforeseen events. The following points can be kept in mind while capital planning:
    > The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
    > Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.
    5. LIQUIDITY CONCEPTS AND POLICIES
    Liquidity is fundamental to the well-being of financial institutions particularly banking. It determines the growth and development of banks as it ensures proper functioning of financial markets. Inadequacy of liquidity causes adverse effect on the market values of asset. Therefore studying and understanding liquidity has very important practical implications. However, understanding the term liquidity is an arduous task due the diversity in its meanings and connotations. This paper attempts to examine different liquidity definitions and the concepts as well as discusses sources of liquidity and its risk. Financial liquidity is an elusive notion, yet of paramount importance for the well- functioning of the financial system. Three main liquidity notions, namely central bank liquidity, market liquidity and funding liquidity are defined and discussed. Their complex and dynamic linkages can give us a good understanding of the liquidity workings in the financial system and reveal positive or negative effects for financial stability, depending on the levels of liquidity risk prevailing.
    The causes of liquidity risk lie on departures from the complete markets and symmetric information paradigm, which can lead to moral hazard and adverse se¬lection. To the extent that such conditions persist, liquidity risk is endemic in the financial system and can cause a vicious link between funding and market liquidity, prompting systemic liquidity risk. It is exactly this type of market risk that typi¬cally alerts policy makers, because of its potential to destabilise the financial system. In such cases emergency liquidity provisions can be a tool to restore balance.

    6. LENDING POLICIES

  124. 6. LENDING POLICIES
    Lending policies can be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans. Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies, are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    i. Lending authority of each loan officer;
    ii. Lending authority of a loan or executive committee, if any;
    iii. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    iv. Guidelines under which unsecured loans will be granted;
    v. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    vi. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    vii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    viii. Maintenance and review of complete and current credit files on each borrower;
    ix. Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    x. Limitations on the maximum volume of loans in relation to total assets;
    xi. Limitations on the extension of credit through overdrafts;
    xii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiii. Guidelines, which at a minimum, address the goals for

  125. 6. LENDING POLICIES
    Lending policies can be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans. Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies, are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    i. Lending authority of each loan officer;
    ii. Lending authority of a loan or executive committee, if any;
    iii. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    iv. Guidelines under which unsecured loans will be granted;
    v. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    vi. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    vii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    viii. Maintenance and review of complete and current credit files on each borrower;
    ix. Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    x. Limitations on the maximum volume of loans in relation to total assets;
    xi. Limitations on the extension of credit through overdrafts;
    xii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiii. Guidelines, which at a minimum, address the goals for

  126. portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    xiv. Guidelines addressing the bank's loan review and grading system ("Watch list");
    xv. Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    xvi. Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation. Examiners should also encourage management to develop specific guidelines for each lending department or function. As with overall lending policies, it is not the FDIC's intent to suggest universal or standard loan policies for specific types of credit. The establishment of these policies is the responsibility of each bank's Board and management. Therefore, the following discussion of basic principles applicable to various types of credit will not include or allude to acceptable ratios, levels, comparisons or terms. These matters should, however, be addressed in each bank's lending policy, and it will be the examiner's responsibility to determine whether the policies are realistic and being followed.
    7. INVESTMENT INSTRUMENT AND POLICIES
    By using opportunities in local and international market the Bank always develop effective investment solutions towards protection of invested capital, reaching current yield and further capital appreciation via following investing tools.
     Money market instruments
    Money market instruments ArmSwissBank clients can allocate their funds for a short term period in the following money market instruments, allowing more flexible and efficient cash management.
    • Government securities (buying and selling, forward contracts)
    • Forex trading (buying and selling, currency swaps, forward contracts)
    • Repurchase agreements
    • Gold bullions
     Stocks
    Stock signifies an investor’s right of ownership in a corporation, granting them a number of privileges, prerogatives and authorities. We offer stocks to customers who anticipate high revenues while accepting an equivalent level of risk. Stockholders can anticipate solid returns from fluctuations of stock prices under favorable market conditions.
     Bonds
    Bonds provide a certain return on invested capital at a set date in the future. They are less volatile than stocks, offering greater capital security and assured income. Unlike stockholders, whose returns are uncertain, bondholders have the advantage of more predictable returns.

  127.  Investment funds shares
    Investment funds generate income by issuing shares and investing them in other instruments of the market. The collective investments of the funds’ shareholders are managed by a professional fund manager, based on a continuous analysis of the securities market. As investment funds use a range of financial instruments, they provide investors with a level of diversification not available to an individual investor and – unlike stocks and bonds – offer a high return with a moderate risk level.
     Futures contracts
    A futures contract is an agreement to buy or sell an underlying asset – e.g. energy, foreign currency, metals and agricultural products – at a pre-determined price in the future. Futures contracts do not assume physical delivery of the underlying asset. The difference between the market price of the underlying asset in the physical (real) market on the futures contract's expiry date – or on a date when an offset deal is concluded – and the pre-determined price is paid to the succeeded party. Futures contracts reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flows more effectively.
     Currency options
    A currency option is a contract between two parties which gives the buyer of the option a right but not an obligation – to purchase the underlying currency from the seller at a pre-determined price and date in the future against a premium. Like futures contracts, currency options reduce exposure to price fluctuation risks and can assist exporters/importers and other financial organizations to manage their financial flows more effectively.
    8. COMPARATIVE FINANCIAL SYSTEMS
    The purpose of a financial system is to channel funds from agents with surpluses to agents with deficits. In the traditional literature there have been two approaches to analyzing this process. The first is to consider how agents interact through financial markets. The second looks at the operation of financial intermediaries such as banks and insurance companies. Fifty years ago, the financial system could be neatly bifurcated in this way. Rich households and large firms used the equity and bond markets, while less wealthy households and medium and small firms used banks, insurance companies and other financial institutions. Table 1, for example, shows the ownership of corporate equities in 1950. Households owned over 90 percent. By 2000 it can be seen that the situation had changed dramatically.
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  128. AN ASSIGNMENT SUBMITTED IN PARTIAL FULFILMENT OF ECON 521 (MONETARY ECONOMICS) BY OKAFOR ONYINYECHI CHRISTIANA PG/MSC/2016/82427

    RISK ANALYSIS
    Risk analysis is the systematic analysis of the degree of risk attaching to capital projects. Risk reflects the variability of expected future return from a capital investment, and as such, the evaluation of risk attached to every investment is very necessary in order to make a good investment decision. Therefore, some statistical and probability techniques can be used to evaluate the investment project and to assist in such decision. Every investment project is associated with risk, and the profitability of every project hinge on the levels of return from investment and the level of risk associated with such investment project. There are different types of this risk which can be summarized as follows:
    .Financial Risk: Financial risk are the risk associated with financial transactions which could be inform of risk in company loans in case of default. Financial risk is understood to include only downside risk, which means that the potential for financial loss and uncertainty about its extent.
    . Asset-Backed Risk: This is the risk that varies from one assets to the other, and if valuated tends to support some assets that has more profitability, hence, asset-backed security will significantly impact the value of the supported security. Such risk include interest rate, term modification, and repayment risk. For some investment, the maturity period tends to be faster while some takes time, those that takes time may yield higher returns on investment but also means higher interest rate to the institutions in which the loans had been obtained. More also, the time frame of the returns in necessary to meet up with the term of payment.
    .Credit Risk: Credit risk is also known as default risk. This is the risk that is associated with borrowed money in terms of default payment. This risk ranges from losses of collateral securities, principal, decreased cash flow, interest and increase in the collection costs. An investor must evaluate the cash flow of the investment to hedge against this risk.
    . Foreign Investment Risk: Foreign investment risk is the risk that is associated with changes in international value of foreign bond due to extreme change in value due to differing accounting, reporting, auditing standard, nationalization, confiscatory taxation and economic conflict, political and diplomatic changes. Valuation, liquidity and regulatory issues may add to foreign investment risk.
    . Liquidity Risk: This is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). There are two types of liquidity risk:
    (a) Asset liquidity: An asset cannot be sold due to lack of liquidity in the market – essentially a sub-set of market risk. This can be accounted for by widening bid-offer spread, making explicit liquidity reserves, lengthening holding period for variance calculation.
    (b) Funding Liquidity: Risk that liabilities cannot be met when they fall due and can only be met at an uneconomic price.
    .Market Risk: The four standard market risk factors are equity risk, interest rate risk, currency risk, and commodity risk:
    a) Equity risk is the risk that stock prices in general (not related to a particular company of industry) or the implied volatility will change.
    b) Interest rate risk is that interest rate or the implied volatility will change, which affects, for example, the value of an asset held in that currency.

  129. BANK CAPITAL ADEQUACY
    Bank Capital Adequacy also known as Capital Requirement or Regulatory Capital is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. It is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. It is the percentage ratio of a financial institution’s total capital (tier 1 and tier 2 capital) to its risk-weighted assets (loans) and used to measure its financial strength, stability and ensure that they do not take on excess leverage and become insolvent. Two types of capital are measured: Tier one capital and Tier two capital. Tier one capital (primary capital) being the actual contributed equity plus retained earnings (it can absorb losses without a bank being required to cease trading) and Tier two capital being preference shares and subordinated debts (it can absorb losses in the event of winding up and so provides a lesser degree of protection to depositors.

  130. BANK EARNINGS
    Earnings typically refer to after-tax net income. Earnings are the main determinant of share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statements, because they show a company's profitability compared to analyst estimates and company guidance. Bank Earnings are the amount of profit that a bank produces during a specific period, which is usually defined as a quarter (three calendar months) or a year. Every quarter, analysts wait for the earnings of the banks they follow to be released. Bank earnings are studied because they represent a direct link to bank performance. A bank that beats estimates is outperforming its peers; thus, the CEO will be praised and the Board will pat itself on the back. A bank that misses earnings is under-performing its peers; so the CEO will be blamed and the Board may elect a new CEO.
    Measures and Uses of Bank Earnings: There are many different measures and uses of bank earnings. Some analysts like to calculate bank earnings before taxes. This is referred to as pre-tax income, earnings before taxes, or EBT. Some analysts like to see bank earnings before interest and taxes. This is referred to as earnings before interest and taxes, or EBIT. Still other analysts, mainly in industries with a high level of fixed assets, prefer to see earnings before interest, taxes, depreciation and amortization, also known as EBITDA. All three measures provide varying degrees of profitability.
    Earnings Per Share: Earnings per share is a commonly cited ratio used to show the bank's profitability on a per-share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. The price-to-earnings ratio, calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of banks in the same industry. A bank with a high price compared to the earnings it makes is considered overvalued. Likewise, a bank with a low price compared to the earnings it makes is undervalued.
    Earnings Manipulation: While earnings may appear to be the holy grail of performance measures, they can still be manipulated. Some banks intentionally manipulate earnings higher. These banks are said to have a poor or weak quality of earnings. Earnings per share can also be manipulated higher, even when earnings are down, with share buybacks. Banks do this by repurchasing shares with retained earnings or debt.

  131. BALANCE SHEET MANAGEMENT
    Balance Sheet is a comprehensive summary of a company’s assets and liabilities at a particular point in time. This is the summary statement showing the assets, liabilities, and equity of the company as of that point in time. Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company. The Purpose of Balance Sheet Management is to position a company to have adequate resources for current operations and for financing future growth. Initially pioneered by financial institutions during the 1970s as interest rates became increasingly volatile, asset and liability management (ALM) is the practice of managing risk that arise due to mismatches between the assets and liabilities. The process is at the crossroads between risk management and strategic planning. It is not just about offering solutions to mitigate or hedge the risks arising from the interaction of assets and liabilities but is focused on a long-term perspective: success in the process of maximizing assets to meet complex liabilities may increase profitability. Thus modern ALM includes the allocation and management of assets, equity, interest rate and credit risk management including risk overlays, and the calibration of firm wide tools within these risk frameworks for optimization and management in the local regulatory and capital environment. Often an ALM approach passively matches assets against liabilities (fully hedged) and leaves surplus to be actively managed. The exact roles and perimeter around ALM can vary significantly from one bank (or other financial institutions) to another depending on the business model adopted and can encompass a broad area of risks. The traditional ALM programs focus on interest rate risk and liquidity risk because they represent the most prominent risks affecting the organization balance-sheet (as they require coordination between assets and liabilities). The ALM function scope covers both a prudential component (management of all possible risks and rules and regulation) and an optimization role (management of funding costs, generating results on balance sheet position), within the limits of compliance (implementation and monitoring with internal rules and regulatory set of rules). ALM intervenes in these issues of current business activities but is also consulted to organic development and external acquisition to analyze and validate the funding terms options, conditions of the projects and any risks (i.e., funding issues in local currencies).

  132. Liquidity Concepts and policies
    The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets. In this definition, two issues should be noted. First, liquidity can be understood in terms of flows (as opposed to stocks), in other words, it is a flow concept. In this framework, liquidity will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets. Second, liquidity refers to the ability of realising these flows. Inability of doing so would render the financial entity illiquid. As will become obvious below, this ability can be hindered because of asymmetries in information and the existence of incomplete markets.
    a) Central bank liquidity
    Central bank liquidity is the ability of the central bank to supply the liquidity needed to the financial system. It is typically measured as the liquidity supplied to the economy by the central bank, i.e. the flow of monetary base from the central bank to the financial system. It relates to ‘central bank operations liquidity’, which refers to the amount of liquidity provided through the central bank auctions to the money market according to the ‘monetary policy stance’. The latter reflects the prevailing value of the operational target, i.e. the control variable of the central bank. In practice, the central bank strategy determines the monetary policy stance, that is, decides on the level of the operational target (usually the key policy rate). In order to implement this target, the central bank uses its monetary policy instruments (conducts open market operations) to affect the liquidity in the money markets so that the interbank rate is closely aligned to the operational target rate set by the prevailing monetary policy stance.
    b) Funding liquidity
    The Basel Committee of Banking supervision defines funding liquidity as the ability of banks to meet their liabilities, unwind or settle their positions as they come due. Similarly, the IMF provides a definition of funding liquidity as the ability of solvent institutions to make agreed upon payments in a timely fashion. However, references to funding liquidity have also been made from the point of view of traders or investors, where funding liquidity relates to their ability to raise funding (capital or cash) in short notice. All definitions are compatible. This can be clearly seen in practice, where funding liquidity, being a flow concept, can be understood in terms of a budget constraint. Namely, an entity is liquid as long as inflows are bigger or at least equal to outflows.

  133. liquidity management

    In finance, liquidity management takes one of two forms based on the definition of liquidity. One type of liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. The other definition of liquidity applies to large organizations, such as financial institutions. Banks are often evaluated on their liquidity, or their ability to meet cash and collateral obligations without incurring substantial losses. In either case, liquidity management describes the effort of investors or managers to reduce liquidity risk exposure.
    a) Liquidity Management in Business
    Investors, lenders and managers all look to a company's financial statements, using liquidity measurement ratios to evaluate liquidity risk. This is usually done by comparing liquid assets and short-term liabilities. Companies that are over-leveraged must take steps to reduce the gap between their cash on hand and their debt obligations.
    All companies and governments that have debt obligations face liquidity risk, but the liquidity of major banks is especially scrutinized. These organizations are subjected to heavy regulation and stress tests to assess their liquidity management because they are considered economically vital institutions. Here, liquidity risk management uses accounting techniques to assess the need for cash or collateral to meet financial obligations.
    b) Liquidity Management in Investing
    Investors still use liquidity ratios to evaluate the value of a company's stocks or bonds, but they also care about a different kind of liquidity management. Those who trade assets on the stock market can't just buy or sell any asset at any time; the buyers need a seller, and the sellers need a buyer.
    When a buyer cannot find a seller at the current price, he or she must usually raise his or her bid to entice someone to part with the asset. The opposite is true for sellers, who must reduce their ask prices to entice buyers. Assets that cannot be exchanged at a current price are considered illiquid.
    Investors and traders manage liquidity risk by not leaving too much of their portfolios in illiquid markets. In general, high-volume traders in particular want liquid markets, such as the forex currency market.

  134. LENDING POLICIES
    A policy is a deliberate plan of action to guide decisions and achieve rational outcome(s). A bank’s lending policy is a statement of philosophy, standards, and guidelines that its employees must observe in granting or refusing a lending request. Minimum information requirements are outlined as well as the verification process and have to be followed before releasing any facility. There are also post lending policies which include monitoring and control of the existing facilities as well as procedures on how to collect from delinquent loans. Types of policies tend to be similar across the commercial banks’ sector, however requirements under each individual policy are unique to each commercial bank. Credit loss recognition policy ensures timely identification of losses arising from credit facilities. This policy also ensures non-accrual of income on delinquent loans, when to define credit losses as well as when to write off a bad debt. New business policy outline the minimum standards required for any facility to be offered to a new bank customer. Mortgage lending policy outlines the minimum information requirements to be obtained, the appraisal process, determining affordability, term of loan, the valuation of the collateral as well as loan to value ratio. Personal unsecured loan policy outlines minimum documentation to be availed and how it’s verified, method of assessment and credit bureau search. Post approval policy procedures outline collection procedures as well as delinquent customer management. Business lending policies are categorized as retail or corporate. There are some commercial banks whose focus is corporate customers and their policies are designed to suit the same customer segment, this applies for bank’s whose main target customers are the mass market. Business policies will identify the target market, business vintage, documentation, verification, credit bureau checks as well as debt management once a facility is granted. More customers prefer where minimum documentation is sought and the process of appraisal is fast and lenient such that many applicants are able to qualify. Where the process is too rigorous customers tend to move away to other lenders and this may decrease a significant amount of income that is generated from interest on credit facilities.

  135. INVESTMENT INSTRUMENTS AND POLICIES
    The financial world is full of terminology which those persons who routinely operate outside of it may need to have clarified. We can find explanations for some of the instruments traded in the securities market. Investment Instruments includes the following;
    Securities– an investment instrument that has financial value and can be traded. This instrument entitles the owner to specified types of financial benefits. The main classes of securities include:
    1. equity
    2. stocks
    3. debt instruments
    4. mutual funds
    Equity: this is an investment instrument through which a corporation raises capital/money by issuing shares which entitle holders to an ownership interest in a corporation. It also entitles the holder to a proportionate share in the corporation’s assets and profits.
    Stocks: these are a share of the ownership of a company. Initially, they are sold by the original owners of a company to gain additional funds to help the company grow. The owners basically sell control of the company to the stockholders. After the initial sale, the shares can be sold and resold on the stock market.
    Bonds: this a debt investment in which an investor loans money to an entity (corporate or governmental). In this case the individual is considered the lender and the government or company is the borrower. The funds are borrowed for a defined period of time at an agreed interest rate. Bonds are used by companies, and governments to finance a variety of projects and activities. A bondholder is entitled to regular interest payments as due, as well as the return of principal when the bond matures
    Mutual funds: this an investment vehicle which pools money from investors and purchases various types of securities such as shares, bonds or money market securities based on stated investment objectives. Each investor owns shares, which represent a portion of the holdings of the fund. Also called a collective investment scheme (CIS) this fund provides almost absolute control of the investment to the company pooling and investing the money.

  136. COMPARATIVE FINANCIAL SYSTEM
    According to Whitley, the financial system is among the key institutional features structuring business systems. Financial systems vary on a number of dimensions. But the critical feature deals with the processes by which capital is made available and priced. Whitley use the traditional dichotomy to classify financial system:
    Capital-market-based financial systems versus Credit-based financial systems.
    Characteristics of capital-market-based financial systems:
    • Mobilize and distribute capital through large and liquid markets
    • Financial claims are traded and priced through the usual commodity-market process
    • Short-termism is enhanced
    • Only weak commitment to the growth of any single firm
    • A strong market for corporate control is encouraged
    Characteristics of credit-based financial systems
    • Exhibit weak and fairly illiquid and thin capital markets
    • capital markets play only a minor role in mobilizing and pricing investment funds
    • Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks co-ordinated by state agencies and ministries, as in France, Japan and some other countries
    • Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector)
    • Interlocking and ‘Haus banks’
    This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”

  137. RISK ANALYSIS:
    Definition of risk analysis: Risk analysis is the determination of risks in a given
    context. Risk management consists of risk analysis and the handling (mitigation) of risks, including changing the context.
    Risk analysis and risk management can be divided into different steps. The iterative or incremental execution of these steps together with communication between the steps is the risk analysis/risk management process.
    The risk analysis and the risk management process are often described in schemes.

    OVERVIEW
    The terms that have been defined so far can be summarized in the scheme in

    Examples of Risk Analysis

    In loading-based assessment a predetermined dynamic or static loading is analyzed that the building has to stand in addition to the classical loadings. These classical loadings include loadings due to the structures itself, the working load, and the natural environmental loads like wind, snow, and earth quakes. Obviously this approach already assumes that the threat is well known and can be reduced to characteristic loads. This approach fits well into structural engineering processes in particular when assuming in addition that high-dynamic loading can be reduced to equivalent static loads.

    In this case a few well defined scenarios are assumed, for example (among
    First scheme of the risk management and risk analysis process

    INTRODUCTION TO RISK ANALYSIS AND RISK MANAGEMENT PROCESSES
    In terms of the more comprehensive risk management and risk analysis schemes the loading- and scenario-based approaches do not make all analysis steps explicit. Typical questions that are not covered in a systematic way include: Are all possible loadings/scenarios considered in the given context (Completeness)? How are the assessment criteria derived? Are there mitigation measures beyond structural target enhancement?
    A standard scheme for the risk management process is the 5-step risk management scheme. It can be found in many applications. The versions vary slightly, but essentially look like this scheme.
    (1) Establish context: Describe the initial situation, define aims such as safety or health.
    (2) Identify hazards/risks: Define damage scenarios. This involves describing the hazard source and the exposure of persons or objects.
    (3) Analyze/compute risks: Estimate or specify the probabilities and consequences of events.
    (4) Evaluate/rank/prioritize/assess risks: Judge whether risks are acceptable or
    not. This can involve a comparison of the levels of risk with predefined criteria
    or a comparison of costs and benefits.
    (5) Treat/mitigate risks: For risks that are not acceptable, change the initial situation or find external solutions such as insurance.
    The steps are linked by an iterative or incremental (optimization and) monitoring process.

  138. BANK CAPITAL ADEQUACY
    Regulators try to ensure that banks and other financial institutions have sufficient capital to keep them out of difficulty. This not only protects depositors, but also the wider economy, because the failure of a big bank has extensive knock-on effects.
    The risk of knock-on effects that have consequences at the level of the entire financial sector is called systemic risk.
    Capital adequacy requirements have existed for a long time, but the two most important are those specified by the Basel committee of the Bank for International Settlements.
    Basel 1
    The Basel 1 accord defined capital adequacy as a single number that was the ratio of a bank’s capital to its assets. There are two types of capital, tier one and tier two. The first is primarily share capital, the second other types such as preference shares and subordinated debt. The key requirement was that tier one capital was at least 8% of assets.
    Each class of asset has a weight of between zero and 1 (or 100%). Very safe assets such as government debt have a zero weighting, high risk assets (such as unsecured loans) have a rating of one. Other assets have weightings somewhere in between. The weighted value of an asset is its value multiplied by the weight for that type of asset.
    Basel 2
    The Basel 1 accord has largely been replaced by new rules. Basel 2 is based on three “pillars”: minimum capital requirements, supervisory review process and market forces.
    The first "pillar" is similar to the Basel 1 requirement, the second is the use of sophisticated risk models to ascertain whether additional capital (i.e. more than required by pillar 1) is necessary.
    The third pillar requires more disclosure of risks, capital and risk management policies. This encourages the markets to react to the taking of high risks.
    In addition to specifying levels of capital adequacy, most countries (including the UK) have regulator run guarantee funds that will pay depositors at least part of what they are owed. It is also usual for regulators to intervene to prevent outright bank defaults.
    Basel 3
    The Basel 2 rules looked increasingly inadequate in the wake of the financial crisis, and the Basel 3 rules were considerably tighter. The main changes were:
    • The required level of tier one capital increased from 4% to 6%.
    • Required common equity increased from 2% to 4.5%.
    • In addition, a further 2.5% in common equity is required as a conservation buffer.
    • An additional variable amount of counter-cyclical (i.e. higher when the economy is strong, allowed to run down when the economy is weak) buffer is required. This will vary from 0% to 2.5%.
    • Total capital required rose to 8% — 10.5% including the conservation buffer, with the counter cyclical buffer on top of it.
    This represents a significant change in the capital structure of banks. Its impact is weakened by being phased in over an eight year period. The gradual shift was necessary as increases in capital adequacy requirements reduce banks ability to lend (more lending on the same capital base means lower ratios) which would be highly damaging at a time for economies still emerging from recession (2010).

  139. BANKS EARNINGS
    Banks make money by charging interest on loans, of course. In fact, there used to be a standard, tongue-in-cheek answer to this question: According to the “3-6-3 rule,” bankers paid a 3 percent rate of interest on deposits, charged a 6 percent rate of interest on loans, and then headed to the golf course at 3 o’clock. Like most good jokes, the 3-6-3 rule mixes a grain of truth with a highly simplified view of reality.
    To be sure, the interest margin banks earn by intermediating between depositors and borrowers continues to be the primary source of profits for most banking companies. But banks also earn substantial amounts of noninterest income by charging their customers fees in exchange for a variety of financial services. Many of these financial services are traditional banking services, transaction services like checking and cash management; safe-keeping services like insured deposit accounts and safety deposit boxes; investment services like trust accounts and long-run certificates of deposit (CDs); and insurance services like annuity contracts. In other traditional areas of banking—such as consumer lending and retail payments—the widespread application of new financial processes and pricing methods is generating increased amounts of fee income for many banks. And in recent years, banking companies have taken advantage of deregulation to generate substantial amounts of noninterest income from nontraditional activities like investment banking, securities brokerage, insurance agency and underwriting, and mutual fund sales.
    Remarkably, noninterest income now accounts for nearly half of all operating income generated by U.S. commercial banks.

  140. BALANCE SHEET MANAGEMENT A bank’s core strength comes from its common equity capital. The level of its common equity capital determines the bank’s stability. Capital planning, thus, is extremely important for a bank, as its ability to do business and take risks depends on its capital adequacy. A capital plan helps a bank forecast if its retained earnings would be enough to finance its projected growth in the coming years, or if it needs to raise capital. Planning for its capital needs in advance allows a bank flexibility in terms of timing the raising of capital. It can thus, factor in market conditions and unforeseen events. The following points can be kept in mind while capital planning:
    The understanding of the importance of efficient use of capital should not be restricted to higher management. Even an employee at the branch level and at every other operational level should understand this issue.
    Timing is a very important factor that needs to be considered while raising capital. It is easier to raise capital when the market is not flooded with similar issues. Market conditions and unexpected events can play an important part in deciding the success of an issue of capital.

    Asset- Liability Management
    Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximising the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximised given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimised.
    Tracking the continuous changes in the way the banking business is conducted and the ever-changing external environment is an important constituent of the ALM function. These factors affect risk at a strategic level, and hence need to be continuously monitored. While these days a lot of information is available that enables such tracking, the frequency and intensity of unforeseen events and their effects has also heightened. It needs to be ensured that such unforeseen events do not affect the bank too adversely.
    Ensuring efficient use of capital is the other important function of ALM. Growth of loans and advances need not necessarily lead to a proportionate growth in Risk-Weighted Assets (RWA). Some ways of limiting the growth in RWA without affecting loan growth are:
    Giving more performance guarantees rather than financial guarantees.
    Getting borrowers rated so that the risk weight and hence required capital comes down Transfer pricing can be used as an instrument for transmitting organisational strategy and policy to various departments and branches of the bank. It can also be used to make these individual units aware of the costs associated with their activities, and thereby more aware of their profitability. This helps keep the unit goals in line with organisational goals.
    Management of the various risks faced by a bank requires availability, accuracy, adequacy and timeliness of information. It also requires top management involvement, and their commitment to ALM.
    Liquidity risk is the biggest risk that a bank could face in the short-term. Even a temporary liquidity problem could spiral out of control, despite the bank being solvent.

  141. This would necessitate decisions that sacrifice profitability in order to ensure survival. Bad credit decisions on the part of banks have been known to lead to liquidity problems not just for the banks, but for entire financial markets. Hence, growth decisions should always be in sync with well-informed and well-thought out ALM decisions. Liquidity risk can hit a bank from either side, i.e. the risk might not necessarily be of shortage of liquidity, but even of excess liquidity. The bank may suddenly be flush with funds without having adequate profitable avenues to deploy them. Intra-day liquidity, too, is an important factor that needs to be managed on a continuous basis.

    A few factors that can result in excessive liquidity risk are:
    Too much dependence on short-term deposits. In a confusing economic scenario (e.g. high inflation coupled with low growth), banks may not like to take a long term view on interest rates. In case of an interest rate hike in such a scenario, banks may increase short term rates while leaving the long term rates untouched. This generally leads to a massive increase in their short term deposits, excessive dependence on bulk deposits. Though these deposits may be easier to raise, they are also faster to vanish in adverse circumstances.
    Excessive interconnectedness within the financial system can result in system-wide problems. The RBI addresses this issue through its guidelines which have inbuilt ceilings on lending to and borrowing from other players in the system.

    However, maturity transformation is an important role played by the banking sector and cannot be eliminated. It reduces the cost of capital for the economy as a whole, and as long as the shadow banking sector is not involved, the banks are adequately regulated, the liquidity risks are contained, and good liquidity standards are in place, is a an essential function that banks would need to continue to undertake.
    The CFO of a bank needs to evaluate the market risk faced by the bank on the basis of its effect on the balance sheet as a whole, rather than just on the basis of its effect on the trading book.
    CONCEPTS AND POLICIES

    Liquidity is of paramount importance being a core issue of banking (Caruana and Kodres,2008). Therefore, viability and efficiency of a bank is greatly influenced by the availability of liquidity in sufficient amount at all times. Banks must meet their due obligations and execute payments on the exact day they are due, otherwise, the banks stand the risk of being declared illiquid (Crocket, 2008).

  142. Traditionally, banks basically function as financial intermediaries and collecting
    points of fund for different groups within the society. Therefore, banks are expected to maintain adequate liquidity in order to efficiently perform their daily obligations such as meeting depositors’ demand or withdrawals, settling wholesale commitments and provision of funds when borrowers draw on committed credit facilities (FSC, 2010) . They must also ensure sufficient funds in order to be able to finance increase in assets (Bank, 2004). Hence,
    banks automatically transform short-term, liquid liabilities into long-term illiquid assets (ECB, 2002). This function serves to protect customers against liquidity problems, but, however, exposes banks themselves to such risk which in intense case is capable of causing bank ruins regardless of the soundness of the bank (ECB, 2002). Central Banks argue that such liquidity problem in a bank is capable of spreading to the other banks and thereby cause a real bank panic.

    The term liquidity is characterized by ambiguity due to so many facets and
    definitions therefore, to use it productively and purposely, it needs further and clear definitions. Literature on finance agrees that in the real sense, liquidity is easy to identify than to define. In economics literature, the understanding of liquidity represents an economic agent’s ability to exchange his/her current wealth for assets or others such as goods and services. Two important issues are emphasized in this meaning of liquidity. The first one describes liquidity as a flow concept while the second issue relates liquidity to the ability to realize these flows (ECB, 2002). Failure to achieve this would render the financial entity/firm illiquid. The Basel Committee on Banking Supervision (2006) describes liquidity as a reservoir of funds that management can readily have access to in order to meet funding requirements and business opportunities.
    However, the Swiss Takeover Board in 2007 argued that there is no precise definition for liquidity, and the issue of definition should be left open. Hence, the board suggests that, it should be the Supervisory authority’s prerogative to define liquidity in its jurisdiction and decide the criteria to be used for determining the liquidity and illiquidity of a security and a firm and should publish a report to clarify the liquidity concepts. In a similar vein, both Vento
    and Ganga (2009) and David (2007) agreed that in financial parlance, liquidity has multiple connotations. However, Vento & Ganga (2009) went further to define liquidity in a broader sense as “the amplitude of a financial firm to keep up all the time a balance between the financial inflows and outflows over time.”

  143. Most recent studies considered the banking sector as an important source of financing in an economy. There is diversification in the role of banks into financial intermediaries, facilitators and supporters. In other words, banks act as liquidity providers and financial intermediaries in a financial system. This is accomplished by mobilizing funds (short-term deposits/liabilities) from the surplus units (lenders) and making
    use of the funds for financing the deficit units (borrowers) in form of loans and investments (long-term assets). At times, banks as liquidity provider, may unexpectedly experience extreme shortages of liquidity which could be triggered by larger amount of standby credit drawn or/and unexpected reduction in the availability of deposits. Therefore,
    efficient coordination of the cash inflows and cash outflows, in order to meet the cash flow shortfalls, requires effective risk management structure for managing liquidity.
    It had been well agued by studies that banks’ liquidity acts as the grease that
    facilitates the smooth functioning of the financial system. The importance of liquidity goes beyond individual banking institution as liquidity shortages in one bank can spread to others and have repercussion on the entire financial system. Ordinarily, liquidity can be described as the easiness of acquiring value from assets which could be realized either by using creditworthiness to obtain external funding or selling owned assets in the market place. However, in banking system the term liquidity is used among many other applications to express specific conditions for a product, an institution, a market segment or even an economy. Thus, liquidity is neither an amount nor a ratio, but rather an expression of the capability of a financial institution or bank to fulfill its mandatory obligations. He submitted that in that case, liquidity represents a qualitative element of a bank’s financial position or strength.

    Some literature classified liquidity in a financial system into three main notions, such as central bank liquidity, market liquidity and funding liquidity. Some argued in favour of two notions or facets of financial (market) liquidity, i.e. funding liquidity and market liquidity. Their argument is based on the belief that the role of Central Bank as provider of liquidity during financial crisis only cushions the effects but does not guarantee success since it cannot tackle the roots of the liquidity risk. Furthermore, Central Bank lacks the ability to clearly differentiate with certainty between illiquid and insolvent banks. Nevertheless, the focus of this study is on funding liquidity (risk), since it directly relates to the ability of banking or financial institutions to perform their financial intermediation functions. That is the ability of banks to fund their positions.

    In addition, though there are complex and dynamic linkages among the different concepts of financial market liquidity, the study discusses the interaction between funding liquidity and market liquidity. The rationale is that both concepts have close relationship but they do not bear a resemblance.

  144. LENDING POLICIES
    Making loans is the principal economic function of banks. For most banks, loans account for half or more of their total assets and about half to two-thirds of their revenues.
    Risk in banking tends to be concentrated in the loan portfolio. Unrecovered loans can cause serious financial problems for the bank.

    Types of Loans Made By Banks:
    Bank loans can be grouped according to their purpose.
    1. Real Estate Loans
    2. Financial Institution Loans
    3. Agricultural Loans
    4. Commercial and Industrial Loans
    5. Loans to Individuals
    6. Miscellaneous Loans 7. Lease Financing Receivables

    Factors Determining the Growth and Mix of Bank Loans:
    •Characteristics of Market Area Served •Size of the Bank •Experience and Expertise of Management •Written Loan Policy •Expected Yield of Each Type of Loan •Regulations
    Regulation of Lending
    •The loan portfolio of any bank is influenced by regulation. For example, in the USA, real estate loans cannot exceed the bank’s capital, or 70% of its total time and savings deposits. Also, a loan to a single customer cannot exceed 15 % of banks capital.
    •The quality of a bank’s loan portfolio and the soundness of its lending policies are the areas bank examiners look at most closely when examining a bank. The possible examiner ratings are:
    1. Strong performance
    2. Satisfactory performance
    3. Fair performance
    4. Marginal performance
    5. Unsatisfactory performance

  145. Bank’s Written Loan Policy
    Bank’s written loan policy includes:
    1. Goal Statement for the Bank’s Loan Portfolio
    2. Specification of Lending Authority of Each Loan Officer and Committee
    3. Lines of Responsibility for Making Assignments and Reporting Information
    4. Operating Procedures for Reviewing, Evaluating and Making Loan Decisions
    5. Required Documentation for All Loans
    6. Lines of Authority for Maintaining and Reviewing Credit Files
    7. Guidelines for Taking and Perfecting Collateral 8. Policies and procedures for setting loan interest rates and fees and the terms for repayment of loans 9. Statement of Quality Standards 10. Statement of Upper Limit for Total Loans 11. Description of Principal Trade Area Where Loans Should Come From 12. Discussion of Preferred Procedure for Working out Problem Loans
    The customer usually fills out a loan application:
    •An interview with a loan officer usually follows right away
    •If a business or mortgage loan is applied for, a site visit is usually made by an officer of the bank to assess the property
    •The customer is asked to submit several relevant documents, such as financial statements
    •The credit analysis division of the bank analyses the application and prepares a brief summary and recommendation
    •Recommendation goes to the loan committee for approval
    •If the loan is approved, the loan officer check on the property that is pledged as collateral in order to ensure that the bank has immediate access to the collateral if the loan agreement is defaulted. This is often referred to as perfecting the bank’s claim to collateral.
    INVESTMENT INSTRUMENTS AND POLICIESAn
    Re-capitalization of RRBs/Cooperatives & Turnaround strategy allowed banks to invest their surplus in Money Market and Capital Market instruments. Major shift in the approach of the banks’ Liquidity angle to Earnings angle leads to change in the composition of investment portfolio Securities scam and collapse of banks quality of investment portfolio. These directly bear on the health of the bank.
    Banks undertake transactions in securities on their own investment account or on behalf of their clients.
    Broad Content of this policy
    • Broad investment objectives
    • Delegation of powers for investments
    • Guidelines for portfolio composition
    • Authority to put through the deals
    • Procedure for obtaining sanction
    • Procedure for investment
    • Various prudential exposure limits
    • Internal Control System
    • Accounting Standards
    • Audit Review and Reporting System

  146. OBJECTIVES
    Complying with Regulatory Requirements
    • Maximising the Yield
    • Optimising mix of current and permanent securities
    • Optimising maturity profile and maintaining adequate liquidity
    • Optimising composition and minimising credit risks
    • Minimising Tax Liabilities
    • Profit Planning

    COMPARATIVE FINANCIAL SYSTEMS
    The financial system is among the key institutional features structuring business systems
    Financial systems vary on a number of dimensions, but the critical feature deals with the processes by which capital is made available and priced. The traditional dichotomy can be used to classify financial system into, capital-market-based financial systems and credit-based financial systems.
    Characteristics of capital-market-based financial systems:
    Mobilize and distribute capital through large and liquid markets financial claims are traded and priced through the usual commodity-market process. Short-termism is enhanced only weak commitment to the growth of any single firm. A strong market for corporate control is encouraged.
    Characteristics of credit-based financial systems
    Exhibit weak and fairly illiquid and thin capital markets capital markets play only a minor role in mobilizing and pricing investment funds. Dominant institutions are either large, ‘universal’ banks (as in Germany) or a combination of commercial banks and long-term credit banks coordinated by state agencies and ministries, as in France, Japan and some other countries
    Banks and/or the state allocate capital through administrative processes to particular sectors and activities (such as export industries or the heavy manufacturing sector).
    This basic contrast between two major kinds of financial systems has “strong implications for firms and markets and is a critical feature of the institutional context of business systems”.

  147. RISK ANALYSIS: refers to the process of assessing the likelihood of an adverse event occurring within the organization, be it corporate, government, or environmental sector. It is the study of the uncertainty of forecasted cash flow streams, variance of portfolio stock returns, the probability of a project’s success or failure and possible future economic states. However, risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects. A risk analyst starts by identifying what could go wrong. The negative events that could occur are then weighed against a probability metric to measure the possibilities of the event occurring. Finally, risk analysis attempts to estimate the extent of the impact that will be made if the event happens. Risk analysis can be categorized into two broad areas namely; quantitative and qualitative approach.
    (a) Quantitative Risk Analysis Approach: Quantitative risk analysis refers to a risk model that is built using simulation or deterministic statistics to assign numerical values to risk. Inputs which are mostly assumptions and random variables are fed into a risk model. For any given range of input, the model generates a range of output or outcome. The model is analyzed using graphs, scenario analysis or sensitivity table analysis by risk managers with a view to making decisions to mitigate and deal with the risks. A monte carlo simulation can be used to generate a range of possible outcomes of a decision made or action taken. The resulting outcome from each input is recorded and the final result of the model is a probability distribution of all possible outcomes. The outcomes can be summarized on a of central tendency such as the mean and median, and assessing variability of the data through standard deviation and variance.
    Meanwhile, a scenario analysis shows the best, middle and worst outcome of any event separating the different outcomes from best to worst provides a reasonable spread of insight for a risk manager. A sensitivity table shows how outcomes vary when one or more random variables might use a sensitivity table to assess how changes to the different values of each security in a portfolio will impact the variance of the portfolio. Among risk management tools are decision trees and breakeven analysis.
    (b) Qualitative Risk-Analysis Approach: refers to an analytical method that does not identify and evaluate risks with numerical and quantitative ratings. Qualitative analysis involves a written definition of the uncertainties, an evaluation of the extent of impact if the risk ensues, and counter-measure plans in the case of a negative event occurring. Examples of qualitative risk analysis tools include SWOT Analysis, cause and effect diagrams, Decision Matrix, Game Theory, etc. A firm that wants to measure the impact of a security breach on its servers may use a qualitative risk technique or analysis to help prepare it for any lost income that may occur from a data breach. Almost all sorts of large businesses require a minimum sort of risk analysis. For example, commercial banks need to properly hedge foreign exchange exposure of oversees loans while large department stores must factor in the possibility of reduced revenues due to a global recession. It is important to know that risk analysis allows professionals to identify and mitigate risks, but not to avoid them completely.

  148. BANK CAPITAL ADEQUACY: This refers to a measure of a bank’s capital. It is expressed as a percentage of a bank’s risk weighted credit exposures. Hence, the name capital adequacy ratio (CAR) or capital-to-risk weighted asset ratio (CRAR).It is used to project depositors and promote the stability and efficiency of financial systems around the world. Basically, two types of capital are measured tier one capital and tier two capital. Capital Adequacy Ratio (CAR) can be calculated given the formular below
    CAR = Tier One Capital + Tier Two Capital
    Risk Weighted Assets
    The reason why minimum banks’ capital adequacy ratios are important is to make sure that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors funds. It helps in lowering the risk of banks becoming insolvent. This is critical because, if a bank is declared insolvent, this shakes the confidence in the financial system and unsettles the entire financial market system.
    During the process of winding-up, funds belonging to depositors are given a higher priority than their savings if a bank registers a loss exceeding the amount of capital it possesses. Thus, the higher the bank’s capital adequacy ratio, the higher the degree of protection of depositor’s monies.
    Tier One Capital: Refers to the capital that is permanently and easily available to cushion losses suffered by a bank without it being required to stop operating. An example of a bank’s tier one capital is its ordinary share capital.
    Tier Two Capital: refers to the capital that cushions losses in case the bank is winding up, so it provides a lesser degree of protection to depositors and creditors. It is used to absorb losses if a bank losses all its tier one capital.
    Again, when measuring credit exposures, adjustments are made to the value of assets listed on a lender’s balance sheet. All the loans the banks has issued are weighted based on their degree of risk. For example, loans issued to the government are weighted at zero (0) percent, while those given to individuals are assigned a weighted score of 100 percent. Off-balance sheet agreements, such as foreign exchange contracts and guarantees, have credit risks. Such exposures are converted to their credit equivalent figures and then weighted in a similar way to that of on-balance sheet credit exposures. The off-balance and on-balance sheet credit exposures are then lumped together to obtain the total risk weighted credit exposures. In USA for instance, the minimum capital adequacy ratio is applied, based on the tier assigned to the bank. The tier one capital of a bank to its total risk weighted exposure shouldn’t go under 4
    percent. The total capital, which comprises tier one capital plus tier two minus specific deductions, so the total risk-weighted credit exposure should stay above 8 percent.

  149. BANK EARNINGS This can be defined as the amount of profit that a bank or company made during a specific period, usually defined a quarter (three calendar months) or a year. Simply put, a bank or company’s earnings refers to after-tax (net) income. Earning for banks or corporate organization is the main determinant of share prices, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long-run. Earnings are perhaps the most important studied number in a bank or company’s financial ability compared to analyst estimates and bank’s guidance. It also represents a direct link to bank or company’s performance. A bank or company that beats estimates is outperforming its peers; thus, the CEO will be praised and the Board members will be happy. A bank that misses earnings is underperforming its peers, so the CEO will be blamed and the Board may elect a new CEO.
    Measures of Earnings can be categorized into three namely: earnings before taxes (EBT), earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation and amortization (EBITDA). This implies that some analysts like to calculate earnings before making the above mentioned deductions. These, three measures provide varying degrees of profitability.

    Earnings Per Share: refers to a commonly cited ratio used to show the bank’s or company’s profitability on a per-share basis. It is also used in relative valuation measures such as the price-to-earnings ratio, which is calculated as price divided by earnings per share. It is primarily used to find relative values for the earnings of banks, companies, corporate organization in the same industry.
    Conclusively, banks earn money by selling money in the form of loans, certificates of deposit (CDs) and other financial products. Banks earn money on the interest they charge on loans, and services like checking, ATM, loans and overdraft protection. Investment and securities are also other sources of earnings to the bank. EPS is calculated by net income minus dividends on preferred stock divided by average outstanding shares. When calculating, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. Any stock dividends or splits that occur must be reflected in the calculation of the weighted average number of shares outstanding.

  150. Earnings Manipulation; refers to an intentionally inflation of earnings to higher values. Banks or companies that do that are said to have a poor or weak quality of earnings. Earnings per share can also be manipulated higher, even when earnings are down, with share buy backs. Banks or companies do this by repurchasing shares with retained earnings or debt.
    Quality of Earnings: refers to the amount of earnings attributed to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. Quality of earnings is considered poor during times of high inflation. Earnings that are calculated conservatively are considered to have higher quality than those calculated by aggressive accounting policies. For instance, some companies seek to manipulate earnings down to pay lower taxes, while others find ways to artificially inflate earnings especially in times of earnings decline. Companies that manipulate earnings are said to have poor or low earnings qualities and vice versa.
    Earnings Estimates: refers to an analyst’s estimate for a company’s future quarterly or annual earnings per share (EPS) .By placing estimates on the earnings of a firm for certain periods on the earnings of a firm for certain periods (quarterly, annually, etc.) analysts can then use cash flow analysis to approximate fair value for a company which in turn will give a target share price.
    Forward Earnings: is nothing more than a figure reflecting predictions made by analysts or by the company itself. More often than not they aren’t very accurate. Forward earnings are projection and not a fact.

  151. BALANCE SHEET MANAGEMENT
    Balance sheet management refers to the process of planning, coordinating and directing business activities that directly determine the Assets, liabilities and equity of a company. The purpose of balance sheet management is to position a company or corporate organization to have adequate resources for current operations and for financing future growth.
    (a) Bank-owned Life Insurance (BOLI): National banks may purchase and hold certain types of life insurance called bank-owned life insurance (BOLI). Banks can purchase BOLI policies in connection with employee compensation and benefit plans, key person insurance, insurance to recover the cost of providing pre-and post retirement employee benefits, insurance on borrowers and insurance taken as security for loans. The office of the controller of the currency (OCC) bulletin provides an overview for the inter-agency statement on the purchase and risk management of life insurance, which provides general guidance regarding supervisory expectations, split-dollar arrangements and the use of life insurance as security for loans.
    (b) Interest Rate Risk Management: The acceptance and management of financial risk is inherent to the business of banking and banks’ roles as financial intermediaries. To meet the demands of their customers and communities and to execute business strategies, banks make loans, purchase securities, and take deposits with different maturities and interest rates. These activities may leave a bank’s earnings and capital exposed to movements in interest rates. This exposure is called interest rate risk.
    (c) Liquidity Risk Management: This is the risk to a bank’s earnings and capital arising from its inability to timely meet obligations when they come due without incurring unacceptable losses. Bank management must ensure that sufficient funds are available at a reasonable cost to meet potential demands from both funds providers and borrowers. Collateral management is also considered.
    (d) Investment Securities Management: The links in this section cover money market investments and securities purchased by banks for their own accounts. Money market generally refers to the markets for short-term credit instruments, such as commercial paper, bankers’ acceptances, negotiable
    (e) certificated of deposit, repurchase agreement and federal funds.

  152. LIQUIDITY CONCEPTS AND POLICIES
    Liquidity concept can be described as the degree to which an asset or security can be easily or quickly converted to cash in the market without affecting the asset’s price. Liquidity from a global perspective can be categorized into official and private liquidity.
    Official Liquidity is defined as the funding that is unconditionally available to settle claims through monetary authorities. Central banks create official liquidity in their domestic currency. They do so through the regular monetary operations and in periods of stress, emergency liquidity support. Official liquidity can be created as a consequence of other central bank actions, for instance changes in the terms under which standing facilities can be accessed. Instruments that can provide access to official liquidity in foreign currency as follows; foreign exchange reserves, swap lines between central banks, dedicated facilities, such as IMF programmes or Special Drawing Right (SDR).
    Private Liquidity is defined by SEC as any private fund that seeks to generate income by inventing in a portfolio of short-term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investor. By definition, private fund information is unavailable to non-shareholders. Financial institutions provide market liquidity to securities markets, for instance through market-making activity, or providing funding liquidity through inter-bank lending. The conditions under which these intermediaries can fund their balance sheets, in turn, depend on the willingness of other private sector participants to provide funding or market liquidity. This interdependence underlines the endogenous character of private liquidity.
    Liquidity Policies depends largely on the result of the interactions among three major categories of drivers;
    (i) Macroeconomic factors, including exchange rate regime choice, capital account policies and the way they affect global imbalances central bank liquidity policies including collateral policies. (ii) Other public sector policies, including financial regulation; and (iii) Financial factors that guide the behavior of financial market participants and intermediaries such as financial innovation and risk appetite.
    All these factors can have important effects on the availability and allocation of liquidity.

  153. LENDING POLICIES refers to a set of guidelines and criteria developed by a bank and used by its employees to determine whether an applicant for a loan should be granted or refused the loan. Each bank’s lending policy shall cover the following, in consistency with the scope, nature and complexity of its lending transactions.
    (a) Levels of authority: This policy clearly identify the levels of ending authorities of each department and unit involved in lending transactions. To avoid conflicts of interest, the credit risk evaluation as well as loan classification function of the bank should be separate and independent from the function responsible for overseeing the quality of the loan portfolio, as well as compliance, prudential reporting, internal requirement and limits. The banks’ management shall take efforts to prevent the bank’s promotional policy from conflicting with the lending policy.
    (b) Lending limit and Loan Concentrations: The bank’s policy shall identify limits, regular monitoring and reporting equipments with respect to all known loan concentration (loan type, related parties, economic sectors, geographic regions, ratio of total loans to total deposits: ration of total loans to total deposits and other borrowed funds, etc).
    (c) Types and areas of lending: Banks shall put in place individual lending, monitoring and control policies for each type of loan, in consistency with the lending strategy and nature of different types of loans of a need arises for types of loans not covered by the bank’s existing lending strategy, appropriate procedures shall be developed to this effect. For loans to non-residents and persons operating outside the country, the bank’s policies shall have risk assessment and monitoring procedures for the creditor’s country of origin or operations.
    (d) Loan maturity and terms: The maturity term of a loan (principal and interest) shall be predicated on the purpose, type, source of repayment of the loan, seasonal/periodic flow projections. The lending policy shall identify the criteria for loan roll-overs, annuity payments (early/premature),down payments (upfront).
    (e) Setting interest rates on loans, criteria for discount on loans, appraisal and acceptance of collateral on loans, financial information on borrowers, lending to single borrower or a group of connected borrowers, lending to bank’s related parties and persons acting on behalf of related parties shall be identified, restrictions specified as well as repayment procedures.

  154. INVESTMENT INSTRUMENTS AND POLICIES
    Investment instrument refers to documents such as a share certificates, promissory notes, or bond, used as means to acquire equity capital or loan capital. It can also be called financial instrument. Investment instruments may also be divided according to asset class, which depends on whether they are debt-based or equity-based. Short-term debt-based financial instruments last for one year or less. Securities of this kind come in the form of treasury bills and commercial paper. Cash of this kind can be deposits and certificates of deposit (CDS). Exchange-traded derivatives under short-term debt-based financial instruments can be short-term interest rate futures. OTC derivatives are forwarded rate agreements.
    Long-term debt-based financial instruments last for more than a year. Under securities,these are bonds.Cash equivalents are loans. Exchange-traded derivatives are bond futures and options on bond futures.OTC derivatives are interest rate swaps. interest rate caps and floors, interest rate options and exotic derivatives.Securities under equity-based financial instruments are stocks Exchange traded derivatives in this category include stock options and equity futures.
    Investment Policies; refers to any government regulation or lows that encourages or discourages foreign investment in the local economy. Examples are currency exchange limits. Investment policy document is drafted between a portfolio manager and a client that outlines general rules for the manager. The statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives. Specific information on matters such as asset allocation, risk tolerance and liquidity requirements are included in it.

  155. Comparative Financial Systems refers to bank-based systems against market-based system. Legal aspects of bank-based verses market-based. It talks about the roles of financial intermediation; nature and process of financial intermediation. It includes the study of theories of financial intermediation (transformation of assets, uncertainty, reduction in transaction costs, reduction of problems arising out of asymmetric information). Regulation of Banks (free banking, arguments for or against regulation, traditional regulation mechanisms, alternative to traditional regulation).Comparative financial system deals with different ways of risk management in Banking such as market risks, liquidity risk, interest rate risk, foreign exchange risk, credit risk, screening and monitoring, credit rationing, collateral. It also comprises modalities of capital budgeting, pricing of bonds and stocks, net present value and all that goes on bank-based system. In market-based financial systems such as in (England and the USA) securities markets share the centre stage with banks in getting society’s savings to forms, exerting corporate control, and easing risk managements, play a more important role relative to banks. In bank-based systems such as in (Germany and Japan) banks play a leading role in mobilizing savings, allocating capital, overseeing the investment decisions of corporate managers, and providing risk management vehicles.
    Conclusively, research has shown the irrelevance of the destruction between bank-and market-based financial system and has shown the importance of effective financial service delivery. It is of secondary order who provides these services. Research has also shown that, it is important to focus on the underlying determinants of a sound and effective financial system, such as the contractual and informational environment.

  156. 1. RISK ANALYSIS
    This is the Process of measuring the possibility of an adverse or hazardous event occurring within an establishment or corporate entity e.g. company, government, and/or environmental sector. Risk analysis examines the underlying uncertainty of a given course of action, such as predicted cash-flow returns; stock returns, the odds of success or failure of a project and possible state of the economy in the future. A risk analyst begins by identifying potential hazardous events and this compares the consequences against a probability matric to measure the likelihood of occurrence. It thus calculates the degree of impact resulting from such occurrence. Risk analysis can be conducted in two ways, namely: Quantitative method and Qualitative method.
    a. Quantitative Method: This maker use of mathematical Calculations and measurements statistical modeling and research to understand and predict the likelihood of a hazardous event. It is basically used for business and financial analysis for the performance evaluation of a financial instrument occurring. It involves building a likelihood model using simulation or predictable statistics to assign numerical values to risks. These numerical values factored into model generate a range of possible outcomes. The model can be analyzed using graphs, Scenario analysis and/or Sensitivity analysis by risk managers, in order to make decisions to reduce the likelihood of occurrence of the hazardous event. The simulation of the model can be done using Monte Carlo Simulation method, which generates a range of likelihood outcomes based on the objective of decision made or action taken. These “decisions and actions" are inputs of random numbers simulated repeatedly to produce a range of possible outcomes. These outcomes are then recorded as probability distribution, which are analyzed using graphs to show some measures of central tendency such as the Mean, Median, Standard Deviation and Variance. Also, with Scenario analysis, it shows the best, middle or worst outcomes of the distribution. This provides reasonable insights to the risk manager for decision making. Note that, the primary advantage of quantitative analysis is the precision of definite values that can be compared with each other, e.g. a company’s annual revenues.
    b. Qualitative Method: This is a non-quantitative method of measuring risk. It is usually based on logical analysis of uncertainties, evaluation of the degree or impact of a risk occurrence; followed by a counter reaction plan. It uses such tool as SWOT analysis, Cause and Effect diagrams, Decision matrix, Game theory, etc. Generally, risk analysis is used to mitigate the risk and not to prevent the risk.

  157. CAPITAL ADEQUACY RATIO (CAR)
    Then refers to a measure of bank's capital and usually expressed as a percentage of a bank risk weighted credit measures. Also referred to as the Capital-to-Risk weight asset ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of the financial system worldwide. For capital adequacy ratio, two types of capital are usually measured: the tier-one capital and tier-two capital.
    Tier-One Capital: This is the capital that’s permanently and readily available to cushion the losses suffered by a bank without it being required to cease operation, e.g. ordinary share capital. It absorbs losses without ceasing operations of the bank.
    Tier-Two Capital: this is the capital that absorbs the losses in the case of winding up of a bank such that it provides lesser degree of protection to depositors and creditors. It is usually used, if the tier-one capital is all lost by a bank.
    Therefore, the capital adequacy ratio (CAR) is given as follows:
    CAR=(Tier One Capital+Tier Two Capital)/(Risk Weighted Assets)
    In the course of insolvency, depositors’ funds are given higher priority than banks capital. Hence, the depositors’ only loses their savings if the bank record loses greater than their stock of capital. Therefore, a higher CAR of a bank means higher protection of depositors’ funds/monies.
    In Nigeria, the minimum cash reserve ratio required by commercial banks is N25bn to be held by the central banks.

  158. 3. COMPARATIVE FINANCIAL SYSTEM
    The financial system is and arrangement that facilitates the transfer of funds from the areas of surplus to areas of deficits. This transfer process could be direct (through the financial market) or indirect (through financial intermediaries, such as banks, and insurance companies). Thus, this two medium holds the locus standing for our comparative analysis of the financial system. The transfer usually starts from the household to firms, but this is an over simplification of the complex arrangements of the financial system characterized by heavy government regulation.
    Literatures on comparative financial analysis are at their early stages. The views of various scholars such as Allen (1993), Allen and Gale (1995) and Thakor (1996) have focused on two sets of issues: the normative and positive. The normative examines the effectiveness of the financial system at various functions through investment and savings, growth, risk sharing and information provision and corporate governance respectively, while the positive evaluates what drives the evolution of the financial system via the influence of law and politics on the financial system.
    • Investment and Savings: the financial system has essential function of allowing savings to be invested in firms. Scholars such as Major (1988, 1990) examined and documented how firms obtained funds and financed investments in a number of countries. Thus, he compared the sources (direct and indirect) through which obtained funds for investments in different countries, to determine which is more effective based on the data from 1970 to 1989. For France, the data are from Bartero (1994), while the United States, United Kingdom, Japan and Germany are from Corbett and Jenkinson (1996). From the data it was observed that direct financing were the most important in all countries. Indirect financing (banks) were moderately important in most countries and particularly important Japan and France. Bond markets and finance are only important in the United States, while equity markets or finance are unimportant. Bank finance is important in all countries but not as much as direct finance.
    More comparative analysis of the financial system is based on how it operates by looking at the savings and holding of financial assets. This comparison is based on the data from US, UK, Japan and Germany. It was observed that United States and Germany occupied two extremes. In the US, banks are relatively unimportant, while the reverse is true for Germany. The ratio of asset to GDP is only 53% about one-third the German ratio of 152%. On the other hand, the US ratio of equity market capitalization to GDP is 82%, three times that of Germany of 24%. Japan and the UK are interesting intermediate cases where banks and markets are both important. Banks are more important in France than markets. Thus, the US and the UK are often referred to as Market based systems, while Germany, Japan and France are often referred to as bank systems.
    Finally, another puzzling comparison between direct and indirect financing is in the context of developed and developing economies. While it is true in developed economies, that direct financing dominates indirect financing, the reverse is true for emerging economies. Singh and Hamid (1992) and Singh (1995) showed that for a range of emerging economies, indirect financing is much more important than direct financing.

  159. 4. LIQUIDITY CONCEPTS AND POLICIES
    The word liquidity has so many facets that are often counterproductive to use it without further and closer definition. In economics literature, liquidity refers to the ability of an economic agent to exchange his/her existing wealth for goods and services or for other assets. From the above definition, two important points can be noted. First, liquidity can be understood in terms of flows (as opposed to stocks, i.e. unhindered flows among the agents of the financial system, with particular interest and focus on the flows among the central banks, commercial bank and the market. Second, liquidity refers to the capacity of realizing these “flows”, such that the inability of doing so will render thee financial entity illiquid. This is usually caused by information asymmetries and incomplete markets.
    Generally, there are three types of liquidity, namely: the central bank liquidity in the financial system; funding liquidity and market liquidity.
    a. Central Bank Liquidity: This refers to the ability of the central bank to supply the liquidity needed to the financial system. It is usually measured as the liquidity supplied by the central bank to the economy i.e. the flow of the monetary base from central banks to the financial system. It relates to “central Banks operations liquidity”, which refers to the amount of liquidity provided through the central bank auctions to the money market according to “monetary policy stance”. This reflects the prevailing values of the operational target, i.e. the control variable of the central bank.
    Practically, central liquidity determines the “monetary policy stance”, usually the key policy rate. To implement this, the central bank uses its monetary policy instruments (conduct open market operations) to affect the liquidity in the money market so that the interbank rate is closely aligned to the operational target set by the prevailing monetary policy stance. More technically, Central bank liquidity, a synonym for the supply of base money, results from managing central bank assets in its balance sheet of a central bank.
    A relationship can be drawn between the central bank liquidity and monetary or macroeconomic liquidity. The latter refers to the growth of money, credit and aggregate savings. Therefore, it includes broad, monetary aggregates and in that sense includes central bank liquidity, which is important in policy making.
    b. Funding Liquidity: According to the Basel committee of banking, this refers to the ability of banks to me their liabilities, unwind or settle their positions as the time come due. Also, IMF defines it as the ability of solvent institutions to make agreed upon payment in a timely manner. Further, investors have defined it as the ability to raise funding (cash/capital) in a short notice. Thus, funding liquidity is a flow concept, thus an entity is liquid as long as inflows is greater or at least equal to the outflows. This holds true for firms, banks, investors and traders.
    Depositors are the first liquidity sources for banks. The second is the market; usually through securitization, loan syndication and secondary market for loans. Also, the bank can get liquidity from the interbank market (the most important source) and finally from the central bank.
    c. Market Liquidity: this refers to the ability to trade asset at a short notice at low cost and with little impact on its price. Market liquidity incorporates key elements of volume, time and transactions costs. This ensures that any amount of assets can be sold anytime within market hours, rapidly with minimum loss of value at competitive press.

  160. Liquidity risks are usually engendered by incomplete market and asymmetric information, which can destabilize the financial system via moral hazard and adverse selection. Liquidity crisis present in the market engendered by liquidity risks can be eliminated by greater transparency of liquidity management practices. One of those practices is supervision and regulation. These practices can tackle the root of liquidity, central bank liquidity, which cannot. It does this by minimizing asymmetric information and moral hazards through effective monitoring mechanisms of the financial system. Thus distinction between solvent and illiquid agents can be made and cushions imposed on those in most need of it. Hence market will become more complete.

  161. 5. BALANCE SHEET MANAGEMENT
    A balance sheet refers to a financial statement that takes a snapshot of what a company owns (assets) and owes (liabilities) at a given moment. Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximizing the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximized given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimized.
    In order to create a non-dilutive capital, they optimized and thus maximize profit. Optimizing the balance sheet to improve capital is a complicated endeavor, due to a number of constraints under which many banks operate:
    i. Investment securities may be pledged, which limits the bank’s ability to sell securities without unwinding secured funding.
    ii. In this low rate environment, secured funding may be at well above-market rates due to the low rate environment –recognizing the losses from unwinding this funding could undo any capital benefit from shrinking the balance sheet.
    iii. Maintaining high levels of cash liquidity can hamper any attempts to shrink the balance sheet.
    iv. Delevering may have a negative impact on earnings going forward –if we have significant earnings deterioration we could quickly undo the benefits of shrinking the Balance Sheet.
    Generally, there are two techniques to balance sheet management, namely: On-Balance Sheet tactics and Off-Balance Sheet tactics. In the former, banks generally first try to adjust their interest rate risk by changing their customer loan / deposit mix, e.g. more floating rate loans. This is usually difficult, and takes time to implement. On the other hand, off-balance sheet generally involves hedging rising rate risk by swapping interest rate and/or caps.

  162. 6. LENDING POLICIES
    Lending policies in the context loan administration should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums: General Fields of lending in which the bank will engage and the kinds or types of loans within each general field; Lending authority of each loan officer; Lending authority of a loan or executive committee, if any; Responsibility of the board of directors in reviewing, ratifying, or approving loans; Guidelines under which unsecured loans will be granted; Guidelines for rates of interest and the terms of repayment for secured and unsecured loans; Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan; Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed; Maintenance and review of complete and current credit files on each borrower; Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments; Limitations on the maximum volume of loans in relation to total assets; Limitations on the extension of credit through overdrafts; Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area; Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist; Guidelines addressing the bank's loan review and grading system ("Watch list"); Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation.

  163. 7. INVESTMENT INSTRUMENTS AND POLICIES
    Investment instruments are treasury solutions for which the yields and/or repayment of capital are not generally fixed but rather depend on certain future events or market development. Such instruments may be, for example, structured in such a way that the issuer may call them in early if the investment instrument reaches the target value; in such cases, they would even be called in automatically. General types of investment instruments include as follows: General investment risks; Bonds; Shares/Stocks; Mutual funds; structured investment instruments; Money market instruments; Security derivatives (options and futures); Currency swaps (currency derivatives); Currency futures transactions (currency derivatives); Interest Rate Swap (IRS) (interest rate derivative); Forward Rate Agreements (FRA) (interest rate derivative); Currency option transactions (currency derivatives); Interest Rate Options (interest rate derivative); Cross Currency Swap (CCS) (interest rate derivative); Commodity futures transactions (commodity derivative).
    The quality of investment policies directly influences the decisions of all investors, be they small or large, domestic or foreign. Transparency, property protection and non-discrimination are investment policy principles that underpin efforts to create a sound investment environment for all. Below are of the investment policies:
    a. What steps has the government taken to ensure that the laws and regulations dealing with investments and investors, including small and medium sized enterprises, and their implementation and enforcement are clear, transparent, readily accessible and do not impose unnecessary burdens?
    b. What steps has the government taken towards the progressive establishment of timely, secure and effective methods of ownership registration for land and other forms of property?
    c. Has the government implemented laws and regulations for the protection of intellectual property rights and effective enforcement mechanisms? Does the level of protection encourage innovation and investment by domestic and foreign firms? What steps has the government taken to develop strategies, policies and programs to meet the intellectual property needs of SMEs?
    d. Is the system of contract enforcement effective and widely accessible to all investors? What alternative systems of dispute settlement has the government established to ensure the widest possible scope of protection at a reasonable cost?
    e. Does the government maintain a policy of timely, adequate, and effective compensation for expropriation also consistent with its obligations under international law? What explicit and well-defined limits on the ability to expropriate has the government established? What independent channels exist for reviewing the exercise of this power or for contesting it?
    f. Has the government taken steps to establish non-discrimination as a general principle underpinning laws and regulations governing investment? In the exercise of its right to regulate and to deliver public services, does the government have mechanisms in place to ensure transparency of remaining discriminatory restrictions on international investment and to periodically review their costs against their intended public purpose? Has the government reviewed restrictions affecting the free transfer of capital and profits and their effect on attracting international investment?
    g. Are investment policy authorities working with their counterparts in other economies to expand international treaties on the promotion and protection of investment? Has the government reviewed existing international treaties and commitments periodically to determine whether their provisions create a more attractive environment for investment? What measures exist to ensure effective compliance with the country’s commitments under its international investment agreements?
    h. Has the government ratified and implemented binding international arbitration instruments for the settlement of investment disputes?

  164. 8. BANK EARNINGS
    Earnings in terms of income can be gross or net earnings. But for bank earnings, it refers to the after-tax or net income of a bank. Earnings are the main determinants of share price because earnings and the circumstance surrounding can indicate whether the bank operation will be profitable and/or successful in the long run. Earnings are perhaps the single most studied number in the bank’s financial statements, because they show companies profitability compared to analyst estimates and company guidance.
    Bank earnings are also said to be the amount of profit that a bank produces during a year. Every quarter, analysts wait for the earnings of the banks they follow to be released. Banks earnings are studied because they represent a direct link to bank performance. A bank that beats estimates is out performing its peers, thus, the CEO will be praised and the board will pat itself on the back. A bank that misses earning are under-performing its peers, so the CEO will be blamed and the board may elect a new CEO.
    There are many different measures and uses of bank earnings. Some analysts prefer to calculate bank earnings before taxes. This is referred to as gross income or earnings before tax (EBT). Some analysts prefer to see bank earnings before interest and taxes, i.e. earnings before interests and taxes (EBIT). Still, other analysts mainly in some banks with high level of fixed assets prefer to see earnings before interest rate, taxes, depreciation and amortization, also known as EBITDA. All these three measures provide varying levels of profitability.
    a. Bank earnings per Share
    Bank’s earnings per share are a commonly cited ratio used to show the bank’s profitability on a per share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. This ratio calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of bank in the same banking industry. A bank with a high price compared to the earnings it makes is considered overvalued. Likewise, a bank with a low price compared to the earnings, is undervalued.
    b. Bank Earnings Manipulation
    Earnings may appear to be the holy grail of performance measures, but they can still be manipulated. Some banks intentionally manipulate earnings higher. These banks are said to have a poor or weak quality of earnings. Bank earnings per share can also be manipulated higher; even when earnings are down, with share buybacks banks do this by repurchasing shares with retained earnings or debt.

  165. 1. RISK ANALYSIS
    To begin with, risk analysis can be said to be a way of measuring the possibility of an adverse or hazardous event occurring within an establishment or corporate body for instance; company, government, and/or environmental sector. Risk analysis investigates the underlying uncertainties of a given course of action, such as predicted cash-flow returns; stock returns, the odds of success or failure of a project and possible state of the economy in the future. A risk analyst begins by taking note of potential hazards and thus compares the consequences against a probability matric to measure the likelihood of occurrence. Hence, he calculates the degree of impact resulting from such occurrence. Risk analysis can be conducted in two ways: Qualitative method and Quantitative method.
    a. Qualitative Method: This can be referred to as a non-quantitative method of measuring risk. It is usually based on logical analysis of uncertainties, evaluation of the degree or impact of a risk occurrence; followed by a counter reaction plan. This method uses such tools as SWOT analysis, Cause and Effect diagrams, Decision matrix, Game theory, etc.
    b. Quantitative Method: Anything that is quantitative has to do with facts and figures hence quantitative method of risk analysis makes use of mathematical Calculations and measurements; statistical modeling and research, to understand and predict the likelihood of a hazardous event in order to mitigate it. It is basically used for business and financial analysis for the performance evaluation of a financial instrument occurring. It involves building a likelihood model using simulation or predictable statistics to assign numerical values to risks. These numerical values factored into model generate a range of possible outcomes. The model can be analyzed using graphs, Scenario analysis and/or Sensitivity analysis by risk managers, in order to make decisions to reduce the likelihood of occurrence of the hazardous event. The simulation of the model can be done using Monte Carlo Simulation method, which generates a range of likelihood outcomes based on the objective of decision made or action taken. These “decisions and actions" are inputs of random numbers simulated repeatedly to produce a range of possible outcomes. These outcomes are then recorded as probability distribution, which are analyzed using graphs to show some measures of central tendency such as the Mean, Median, Standard Deviation and Variance. Also, with Scenario analysis, it shows the best, middle or worst outcomes of the distribution. This provides reasonable insights to the risk manager for decision making. Note that, the primary advantage of quantitative analysis is the precision of definite values that can be compared with each other, e.g. a company’s annual revenues.
    Generally, it is worthy to note that risk analysis is used to mitigate the risk and not to prevent it. With adequate risk analysis, several corporate entities have been able to maximize their profits sequel to well calculated risks.

  166. CAPITAL ADEQUACY RATIO (CAR)
    This refers to a measure of a bank's capital and usually expressed as a percentage of a bank risk weighted credit measures. Also referred to as the Capital-to-Risk weight Asset Ratio (CRAR), it is used to protect depositors and promote the stability and efficiency of the financial system worldwide. For capital adequacy ratio, two types of capital are usually measured: the tier-one capital and tier-two capital.
    Tier-One Capital: This is the capital that’s permanently and readily available to cushion the shocks due to losses suffered by a bank without it being required to cease operation, e.g. ordinary share capital. It absorbs losses without ceasing operations of the bank.
    Tier-Two Capital: this is the capital that absorbs the losses in the case of winding up of a bank such that it provides lesser degree of protection to depositors and creditors. It is usually used, if the tier-one capital is all lost by a bank.
    Therefore, the capital adequacy ratio (CAR) is given as follows:
    CAR=(Tier One Capital+Tier Two Capital)/(Risk Weighted Assets)
    In the course of insolvency, depositors’ funds are given higher priority than banks capital. Hence, the depositors only lose their savings if the bank record loses greater than their stock of capital. Therefore, a higher CAR of a bank means higher protection of depositors’ funds/monies.
    At this point, it is worth saying that the Capital Adequacy Ratio can be compared to the CBN’s Cash Reserve Requirement. In Nigeria, the minimum cash reserve ratio required by commercial banks is N25bn to be held by the central bank and the higher the requirement, the lesser the risk of bankruptcy by the financial institutions and the better the depositors are protected against losing their deposit money.

  167. 3. COMPARATIVE FINANCIAL SYSTEM
    The financial system basically comprises of financial market, financial instrument and financial intermediation. Financial services include financial resource mobilization and allocation, financial intermediation and facilitation of forex transactions and foreign trade. Financial system is basically an arrangement that facilitates the transfer of funds from the areas of surplus to areas of deficits. This transfer process could be direct (through the financial market) or indirect (through financial intermediaries, such as banks, and insurance companies). Thus, this two medium holds the locus standing for our comparative analysis of the financial system. The transfer usually starts from the household to firms, but this is clearly an over simplification of the complicated arrangements of the financial system characterized by heavy government regulation. Hence, it is worthy to note that the financial system also includes a combination or composition of various financial regulations, laws, practices, claims, transactions and liabilities. Thus a financial system is a web of organized or regulated financial inter-relationship among financial institutions of different kinds between various economic units and agents viz-a-viz ; the household(consumers/savers), firms(producers/borrowers) and the government(regulators/producers/borrowers/lenders).
    Literatures on comparative financial analysis are of recent times. The views of various scholars such as Allen (1993), Allen and Gale (1995) and Thakor (1996) have focused on two sets of issues: the normative and positive. The normative examines the effectiveness of the financial system at various functions through investment and savings, growth, risk sharing and information provision and corporate governance respectively, while the positive evaluates what drives the evolution of the financial system via the influence of law and politics on the financial system.

  168. • Investment and Savings: the financial system has essential function of allowing savings to be invested in firms. Scholars such as Major (1988, 1990) investigated and documented how firms obtained funds and financed investments in several countries. Thus, he compared the sources (direct and indirect) through which obtained funds for investments in different countries, to determine which is more effective based on the data from 1970 to 1989. For France, the data are from Bartero (1994), while the United States, United Kingdom, Japan and Germany are from Corbett and Jenkinson (1996). From the data it was observed that direct financing were the most important in all countries. Indirect financing (banks) were moderately important in most countries and particularly important Japan and France. Bond markets and finance are only important in the United States, while equity markets or finance are unimportant. Bank finance is important in all countries but not as much as direct finance.
    More comparative analysis of the financial system is based on how it operates by looking at the savings and holding of financial assets. This comparison is based on the data from US, UK, Japan and Germany. It was observed that United States and Germany occupied two extremes. In the US, banks are relatively unimportant, while the reverse is true for Germany. The ratio of asset to GDP is only 53% about one-third the German ratio of 152%. On the other hand, the US ratio of equity market capitalization to GDP is 82%, three times that of Germany of 24%. Japan and the UK are interesting intermediate cases where banks and markets are both important. Banks are more important in France than markets. Thus, the US and the UK are often referred to as Market based systems, while Germany, Japan and France are often referred to as bank systems.
    Finally, another puzzling comparison between direct and indirect financing is in the context of developed and developing economies. While it is true in developed economies, that direct financing dominates indirect financing, the reverse is true for emerging economies. Singh and Hamid (1992) and Singh (1995) showed that for a range of emerging economies, indirect financing is much more important than direct financing.

  169. 4. LIQUIDITY CONCEPTS AND POLICIES
    The word liquidity has so many facets that are often counterproductive to use it without further and closer definition. In economics literature, liquidity refers to the ability of an economic agent to exchange his/her existing wealth for goods and services or for other assets. From the above definition, two important points can be noted. First, liquidity can be understood in terms of flows (as opposed to stocks, i.e. unhindered flows among the agents of the financial system, with particular interest and focus on the flows among the central banks, commercial bank and the market). Second, liquidity refers to the capacity of realizing these “flows”, such that the inability of doing so will render thee financial entity illiquid. This is usually caused by information asymmetries and incomplete markets.
    Generally, there are three types of liquidity, namely: the central bank liquidity in the financial system; funding liquidity and market liquidity.
    a. Central Bank Liquidity: This refers to the ability of the central bank to supply the liquidity needed to the financial system. It is usually measured as the liquidity supplied by the central bank to the economy i.e. the flow of the monetary base from central banks to the financial system. It relates to “central Banks operations liquidity”, which refers to the amount of liquidity provided through the central bank auctions to the money market according to “monetary policy stance”. This reflects the prevailing values of the operational target, i.e. the control variable of the central bank.
    Practically, central liquidity determines the “monetary policy stance”, usually the key policy rate. To implement this, the central bank uses its monetary policy instruments (conduct open market operations) to affect the liquidity in the money market so that the interbank rate is closely aligned to the operational target set by the prevailing monetary policy stance. More technically, Central bank liquidity, a synonym for the supply of base money, results from managing central bank assets in its balance sheet of a central bank.
    A relationship can be drawn between the central bank liquidity and monetary or macroeconomic liquidity. The latter refers to the growth of money, credit and aggregate savings. Therefore, it includes broad, monetary aggregates and in that sense includes central bank liquidity, which is important in policy making.

  170. b. Funding Liquidity: According to the Basel committee of banking, this refers to the ability of banks to meet their liabilities, unwind or settle their positions as the time come due. Also, IMF defines it as the ability of solvent institutions to make agreed upon payment in a timely manner. Further, investors have defined it as the ability to raise funding (cash/capital) in a short notice. Thus, funding liquidity is a flow concept, thus an entity is liquid as long as inflows is greater or at least equal to the outflows. This holds true for firms, banks, investors and traders.
    Depositors are the first liquidity sources for banks. The second is the market; usually through securitization, loan syndication and secondary market for loans. Also, the bank can get liquidity from the interbank market (the most important source) and finally from the central bank.
    c. Market Liquidity: this refers to the ability to trade asset at a short notice at low cost and with little impact on its price. Market liquidity incorporates key elements of volume, time and transactions costs. This ensures that any amount of assets can be sold anytime within market hours, rapidly with minimum loss of value at competitive press.
    Liquidity risks are usually engendered by incomplete market and asymmetric information, which can destabilize the financial system via moral hazard and adverse selection. Liquidity crisis present in the market engendered by liquidity risks can be eliminated by greater transparency of liquidity management practices. One of those practices is supervision and regulation. These practices can tackle the root of liquidity, central bank liquidity, which cannot. It does this by minimizing asymmetric information and moral hazards through effective monitoring mechanisms of the financial system. Thus distinction between solvent and illiquid agents can be made and cushions imposed on those in most need of it. Hence market will become more complete.

  171. 5. BALANCE SHEET MANAGEMENT
    A balance sheet refers to a financial statement or summary that summarises what a company owns (assets) and owes (liabilities) at a given moment. Asset Liability Management (ALM) is the process undertaken by a bank that ensures that resources are raised and deployed in a manner that keeps various risks at an optimal level, while maximizing the profits. This process entails identifying various risks, quantifying them, ensuring that they are adequately priced so that profit is maximized given the determined risk level, and subsequently attempting to ensure that the disruptions from these risks are minimized.
    In order to create a non-dilutive capital, they optimized and thus maximize profit. Optimizing the balance sheet to improve capital is a complicated endeavor, due to a number of constraints under which many banks operate:
    i. Investment securities may be pledged, which limits the bank’s ability to sell securities without unwinding secured funding.
    ii. In this low rate environment, secured funding may be at well above-market rates due to the low rate environment –recognizing the losses from unwinding this funding could undo any capital benefit from shrinking the balance sheet.
    iii. Maintaining high levels of cash liquidity can hamper any attempts to shrink the balance sheet.
    iv. Delevering may have a negative impact on earnings going forward –if we have significant earnings deterioration we could quickly undo the benefits of shrinking the Balance Sheet.
    Generally, there are two techniques to balance sheet management, namely: On-Balance Sheet tactics and Off-Balance Sheet tactics. In the former, banks generally first try to adjust their interest rate risk by changing their customer loan / deposit mix, e.g. more floating rate loans. This is usually difficult, and takes time to implement. On the other hand, off-balance sheet generally involves hedging rising rate risk by swapping interest rate and/or caps.

  172. 6. LENDING POLICIES
    Lending policies in the context loan administration should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums: General Fields of lending in which the bank will engage and the kinds or types of loans within each general field; Lending authority of each loan officer; Lending authority of a loan or executive committee, if any; Responsibility of the board of directors in reviewing, ratifying, or approving loans; Guidelines under which unsecured loans will be granted; Guidelines for rates of interest and the terms of repayment for secured and unsecured loans; Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan; Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed; Maintenance and review of complete and current credit files on each borrower; Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments; Limitations on the maximum volume of loans in relation to total assets; Limitations on the extension of credit through overdrafts; Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area; Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist; Guidelines addressing the bank's loan review and grading system ("Watch list"); Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation.

  173. 7. INVESTMENT INSTRUMENTS AND POLICIES
    Investment instruments are treasury solutions for which the yields and/or repayment of capital are not generally fixed but rather depend on certain future events or market development. Such instruments may be, for example, structured in such a way that the issuer may call them in early if the investment instrument reaches the target value; in such cases, they would even be called in automatically. General types of investment instruments include as follows: General investment risks; Bonds; Shares/Stocks; Mutual funds; structured investment instruments; Money market instruments; Security derivatives (options and futures); Currency swaps (currency derivatives); Currency futures transactions (currency derivatives); Interest Rate Swap (IRS) (interest rate derivative); Forward Rate Agreements (FRA) (interest rate derivative); Currency option transactions (currency derivatives); Interest Rate Options (interest rate derivative); Cross Currency Swap (CCS) (interest rate derivative); Commodity futures transactions (commodity derivative).
    The quality of investment policies directly influences the decisions of all investors, be they small or large, domestic or foreign. Transparency, property protection and non-discrimination are investment policy principles that underpin efforts to create a sound investment environment for all. Below are of the investment policies:
    a. What steps has the government taken to ensure that the laws and regulations dealing with investments and investors, including small and medium sized enterprises, and their implementation and enforcement are clear, transparent, readily accessible and do not impose unnecessary burdens?
    b. What steps has the government taken towards the progressive establishment of timely, secure and effective methods of ownership registration for land and other forms of property?
    c. Has the government implemented laws and regulations for the protection of intellectual property rights and effective enforcement mechanisms? Does the level of protection encourage innovation and investment by domestic and foreign firms? What steps has the government taken to develop strategies, policies and programs to meet the intellectual property needs of SMEs?
    d. Is the system of contract enforcement effective and widely accessible to all investors? What alternative systems of dispute settlement has the government established to ensure the widest possible scope of protection at a reasonable cost?
    e. Does the government maintain a policy of timely, adequate, and effective compensation for expropriation also consistent with its obligations under international law? What explicit and well-defined limits on the ability to expropriate has the government established? What independent channels exist for reviewing the exercise of this power or for contesting it?

  174. f. Has the government taken steps to establish non-discrimination as a general principle underpinning laws and regulations governing investment? In the exercise of its right to regulate and to deliver public services, does the government have mechanisms in place to ensure transparency of remaining discriminatory restrictions on international investment and to periodically review their costs against their intended public purpose? Has the government reviewed restrictions affecting the free transfer of capital and profits and their effect on attracting international investment?
    g. Are investment policy authorities working with their counterparts in other economies to expand international treaties on the promotion and protection of investment? Has the government reviewed existing international treaties and commitments periodically to determine whether their provisions create a more attractive environment for investment? What measures exist to ensure effective compliance with the country’s commitments under its international investment agreements?
    h. Has the government ratified and implemented binding international arbitration instruments for the settlement of investment disputes?

  175. 8. BANK EARNINGS
    Earnings in terms of income can be gross or net earnings. But for bank earnings, it refers to the after-tax or net income of a bank. Earnings are the main determinants of share price because earnings and the circumstance surrounding can indicate whether the bank operation will be profitable and/or successful in the long run. Earnings are perhaps the single most studied number in the bank’s financial statements, because they show companies profitability compared to analyst estimates and company guidance.
    Bank earnings are also said to be the amount of profit that a bank produces during a year. Every quarter, analysts wait for the earnings of the banks they follow to be released. Banks earnings are studied because they represent a direct link to bank performance. A bank that beats estimates is out performing its peers, thus, the CEO will be praised and the board will pat itself on the back. A bank that misses earning are under-performing its peers, so the CEO will be blamed and the board may elect a new CEO.
    There are many different measures and uses of bank earnings. Some analysts prefer to calculate bank earnings before taxes. This is referred to as gross income or earnings before tax (EBT). Some analysts prefer to see bank earnings before interest and taxes, i.e. earnings before interests and taxes (EBIT). Still, other analysts mainly in some banks with high level of fixed assets prefer to see earnings before interest rate, taxes, depreciation and amortization, also known as EBITDA. All these three measures provide varying levels of profitability.
    a. Bank Earnings Manipulation
    Earnings may appear to be the holy grail of performance measures, but they can still be manipulated. Some banks intentionally manipulate earnings higher. These banks are said to have a poor or weak quality of earnings. Bank earnings per share can also be manipulated higher; even when earnings are down, with share buybacks banks do this by repurchasing shares with retained earnings or debt.
    b. Bank earnings per Share
    Bank’s earnings per share are a commonly cited ratio used to show the bank’s profitability on a per share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. This ratio calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of bank in the same banking industry. A bank with a high price compared to the earnings it makes is considered overvalued. Likewise, a bank with a low price compared to the earnings, is undervalued.

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