This lesson examines the critical area of asset quality—analyzing the risk in a bank’s loan portfolio .
5.1 The Importance of Asset Quality
Asset quality is a primary driver of a bank’s financial health. Poor asset quality can lead to provisions, write-offs, and ultimately, insolvency. The aim of this section is to consider the asset quality of a bank and use key ratios to understand a bank’s business risk .
5.2 Loan Portfolio Analysis
Key elements of loan portfolio analysis include:
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Portfolio Composition: Analyzing the types of loans (mortgages, commercial, consumer) to understand the risk profile .
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Credit Risk Concentration: Identifying concentrations in sectors (e.g., real estate, energy) or geographic regions that could increase risk .
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Impaired Loans: Loans that are past due, non-accrual, or restructured. These are a key indicator of asset quality .
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Reserve Adequacy: Assessing whether the loan loss reserve is adequate to cover expected losses .
5.3 Problem Loan Definitions
Different jurisdictions have different definitions of problem loans. Common categories include:
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Past Due Loans:Â Loans where payments are overdue by more than a certain number of days (e.g., 90 days).
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Non-Accrual Loans: Loans where interest is not being accrued because the bank has concerns about collectability .
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Restructured Loans: Loans where the terms have been modified to help the borrower avoid default .
5.4 Local and International Benchmarks
Analysts should compare a bank’s asset quality ratios to both local and international benchmarks to assess relative performance .