This lesson examines the critical area of asset quality—analysing the risk in a bank’s loan portfolio .
6.1 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 .
6.2 Loan Portfolio Analysis
Key elements of loan portfolio analysis include:
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Portfolio Composition:Â Analysing the types of loans (mortgages, commercial, consumer) to understand the risk profile.
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Credit Risk Concentration:Â Identifying concentrations in sectors (e.g., real estate, energy) or geographic regions.
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Impaired Loans: Loans that are past due, non-accrual, or restructured .
6.3 Reserve Adequacy
Assessing whether the loan loss reserve is adequate to cover expected losses. This includes analysing provisioning levels, allowances, charge-offs, and recoveries .
6.4 The Impact of Differing Accounting Policies
The analysis of asset quality is significantly affected by differing accounting standards and policies, such as provisioning and asset valuation policies .