Chapter

Appendix V. Numerical Examples

Author(s):
International Monetary Fund
Published Date:
April 2006
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Introduction

1. This appendix provides a series of numerical examples to illustrate key compilation and methodological concepts described in the Guide and to provide guidance on how to calculate FSIs. The examples are grouped together in the following three sections.

Part 1: A base data set of examples consisting of income and expense and balance sheet statements, as an illustration of how the agreed FSIs can be calculated.

Part 2: Examples illustrating the accounting rules for (1) gains and losses on financial instruments and (2) interest income on nonperforming loans.

Part 3: Examples illustrating consolidation and associated sector-level issues, including (1) an extended base data set, (2) examples illustrating the sector-wide consolidation of capital, and (3) examples illustrating accounting for goodwill in sector-wide capital.

While the focus of these examples is on the deposit-taking sector, they can also apply to other corporate sectors. This appendix therefore includes in addition the following section:

Part 4: A discussion of calculating FSIs for nonfinancial corporations.

Part 1. Base Data Set

Background

2. To illustrate the principles involved, a base data set for income and expense, balance sheet, and associated memorandum items is provided below, which is used to calculate FSIs. The data set provided is consistent with the guidance in Chapter 4 and Chapter 6. Nonetheless, some simplifying assumptions are made to put aside the consolidation issues (and the additional data needs) relating to the interbank positions and flows that are described in Chapter 5. These simplifying assumptions are relaxed in the later examples on consolidation in Part 3.

The Basic Data Set of Financial Accounts

3. In this example, the economy has three deposit takers. There are no financial relations among them, nor do they have foreign branches or investments in foreign subsidiaries and associates.1 End-period financial statements (income and balance sheet accounts) for the three resident deposit takers are presented in Tables A5.1 and A5.2, together with the aggregated income and balance sheet statements.

Table A5.1.Income and Expense Statements: Deposit Takers—Aggregated Data1(In millions of U.S. dollars; unless otherwise stated)
Deposit Taker 1 ADeposit Taker 2 BDeposit Taker 3 CAggregation A + B + C
1.Interest income4008003001,500
(i) Gross interest income4008003001,500
(ii) Less provisions for accrued interest on nonperforming assets
2.Interest expense100140100340
3.Net interest income (= 1 minus 2)3006602001,160
4.Noninterest income2507004001,350
(i) Fees and commissions receivable110300200610
(ii) Gains or losses on financial instruments50100100250
(iii) Prorated earnings5014020210
(iv) Other income4016080280
5.Gross income (= 3 plus 4)5501,3606002,510
6.Noninterest expenses5006001501,250
(i) Personnel costs300300100700
(ii) Other expenses20030050550
7.Provisions (net)508010140
(i) Loan loss provisions508010140
(ii) Other financial asset provisions
8.Net income (before extraordinary items and taxes) (= 5 minus (6 + 7))6804401,120
9.Extraordinary items
10.Income tax272176448
11.Net income after tax (= 8 minus (9 + 10))408264672
12.Dividends payable300140440
13.Retained earnings (= 11 minus 12)108124232
Table A5.2.Balance Sheets: Deposit Takers—Aggregated Data1(In millions of U.S. dollars, unless otherwise stated)
Deposit Taker 1 ADeposit Taker 2 BDeposit Taker 3 CAggregation A + B + C
Balance Sheet
14.Total assets (= 15 + 16 = 31)12,45018,2017,45038,101
15.Nonfinancial assets5005003001,300
16.Financial assets (= 17 through 22)11,95017,7017,15036,801
17.Currency and deposits200200100500
18.Loans (after specific provisions)9,20013,9005,35028,450
(i)Gross loans9,25014,4005,60029,250
(i.i)Interbank loans1,0009006002,500
(i.i.i)Resident
(i.i.ii)Nonresident1,0009006002,500
(i.ii)Noninterbank loans8,25013,5005,00026,750
(i.ii.i)Central bank
(i.ii.ii)General government4005,0002,0007,400
(i.ii.iii)Other financial corporations5002,0002,500
(i.ii.iv)Nonfinancial corporations7,0002,0009,000
(i.ii.v)Other domestic sectors3502,5002,5005,350
(i.ii.vi)Nonresidents2,0005002,500
(ii)Specific provisions50500250800
19.Debt securities2,2503,0001,3006,550
20.Shares and other equity100301200601
21.Financial derivatives200200200600
22.Other assets100100
23.Liabilities (= 28 + 29)11,05016,5016,85034,401
24.Currency and deposits10,20011,7005,15027,050
(i)Customer deposits10,20011,2003,65025,050
(ii)Interbank deposits5001,5002,000
(ii.i)Resident
(ii.ii)Nonresident5001,5002,000
(iii)Other currency and deposits
25.Loans200300150650
26.Debt securities4003,0001,5004,900
27.Other liabilities250801501,101
28.Debt (= 24 + 25 + 26 + 27)11,05015,8016,85033,701
29.Financial derivatives700700
30.Capital and reserves1,4001,7006003,700
(i)Narrow capital1,1601,1605002,820
31.Balance sheet total (= 23 + 30 = 14)12,45018,2017,45038,101
Memorandum Series
Other series needed to calculate the agreed FSIs
Supervisory series
32.Tier 1 capital9001,2005002,600
33.Tier 2 capital3006043161,220
34.Tier 3 capital
35.Supervisory deductions
36.Total net capital resources (item 32 through item 34 minus item 35)1,2001,8048163,820
37.Risk-weighted assets8,50012,8004,22025,520
38.Number of large exposures3216
Series that provide a further analysis of the balance sheet
39.Liquid assets (core)1,0002,5005004,000
40.Liquid assets (broad measure)1,7502,7007005,150
41.Short-term liabilities6,00010,0502,00018,050
42.Nonperforming loans936603401,093
43.Residential real estate loans3501,0002,0003,350
44.Commercial real estate loans2,0002,000
45.Geographic distribution of loansSee addendumSee addendumSee addendumSee addendum
46.Foreign currency loans1,0003,0006004,600
47.Foreign currency liabilities1,2002,5001,5005,200
48.Net open position in equities100301200601
49.Net open position in foreign currency for on-balance-sheet items(200)500(900)(600)
Balance-sheet-related series
50.Total net open position in foreign currency(200)500(900)(600)
51.Exposures of largest deposit takers to largest entities in the economy7005001,200
52.Exposures to affiliated entities and other “connected” counterparties
Addendum
Geographic distribution of loans
Total loans to nonresidents1,0002,9001,1005,000
Advanced economies5002,0006003,100
Regions excluding advanced economies
Africa250200450
Of which: Sub-Sahara
Asia2507005001,450
Europe
Of which: Former Soviet Union, including Russia
Middle East
Western Hemisphere

4. All three deposit takers extend loans to residents of the local economy, but the sectoral allocation differs. Each deposit taker also extends some loans to nonresidents; a geographical distribution is reported as an addendum to the balance sheet. Deposits from (non-bank) residents in the local economy are the main form of funding, but deposit takers 2 and 3 have also raised some significant amounts through the issuance of debt securities. Financial derivative instruments are used by all three deposit takers but are limited to interest rate swaps. On the income and expense side, deposit taker 1’s performance is weaker than the other deposit takers’, reporting zero net income for the period.

Computation of a Base Data Set of FSIs

5. Using the guidance in Chapter 6 and the base data set of financial accounts, Table A5.3 presents the agreed FSIs at the sector level and, for illustrative purposes, for each bank individually. Moreover, where relevant, the value of the numerator and denominator for each FSI is shown. Because of the lack of financial relations among the three resident deposit takers, the sector-level FSIs can be calculated using the aggregated balance sheet and income statement data shown in Tables A5.1 and A5.2, without the need for sector-level consolidation adjustments discussed in Chapter 5. Furthermore, since the deposit takers have no foreign operations, the construction of FSIs on a domestic basis is sufficient for this economy.

Table A5.3.Financial Soundness Indicators: Deposit Takers—Aggregated Data1(FSIs are expressed in percentages; the underlying calculations are in millions of U.S. dollars, except as noted)
Deposit Taker 1Deposit Taker 2Deposit Taker 3Sector Level
Capital-based2 FSIs
Regulatory capital to risk-weighted assets*14%14%19%15%
Numerator [line 36]31,2001,8048163,820
Denominator [line 37]8,50012,8004,22025,520
Regulatory Tier 1 capital to risk-weighted assets*11%9%12%10%
Numerator [line 32]9001,2005002,600
Denominator [line 37]8,50012,8004,22025,520
Capital to assets7%11%7%9%7%8%7%10%
Numerator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Denominator [line 14]12,45012,45018,20118,2017,4507,45038,10138,101
Nonperforming loans net of provisions to capital*5%3%9%9%13%15%8%8%
Numerator [line 42 minus line 18(ii)]43431601609090293293
Denominator [line 36, line 30]1,2001,4001,8041,7008166003,8203,700
Return on equity*57%40%88%73%43%30%
Numerator4 [line 8]6806804404401,1201,120
Denominator5 [line 32, line 30]9001,4001,2001,7005006002,6003,700
Large exposures to capital Number [line 38]3216
–(to large resident entities)78%50%42%29%46%32%
Numerator [line 51]7007005005001,2001,200
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
–(to connected borrowers)
Numerator [line 52]
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Net open position in foreign exchange to capital*−22%−14%42%29%−180%−150%−23%−16%
Numerator [line 50](200)(200)500500(900)(900)(600)(600)
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Gross asset position in financial derivatives to capital22%14%17%12%40%33%23%16%
Numerator [line 21]200200200200200200600600
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Gross liability position in financial derivatives to capital58%41%27%19%
Numerator [line 29]700700700700
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Net open position in equities to capital11%7%25%18%40%33%23%16%
Numerator [line 48]100100301301200200601601
Denominator [line 32, line 30]9001,4001,2001,7005006002,6003,700
Asset-based FSIs
Liquid assets (core) to total assets*8%14%7%10%
Numerator [line 39]1,0002,5005004,000
Denominator [line 14]12,45018,2017,45038,101
Liquid assets (core) to short-term liabilities*17%25%25%22%
Numerator [line 39]1,0002,5005004,000
Denominator [line 41]6,00010,0502,00018,050
Customer deposits to total (noninterbank) loans124%83%73%94%
Numerator [line 24(i))]10,20011,2003,65025,050
Denominator [line 18(i.ii)]8,25013,5005,00026,750
Return on assets*4%6%3%
Numerator4 [line 8]6804401,120
Denominator6 [line 31]12,45018,2017,45038,101
Nonperforming loans to total gross loans*1%3%3%2%
Numerator [line 42]93360140593
Denominator [line 18(i)]9,25014,4005,60029,250
Sectoral distribution of loans to total loans (percentages of total)*
Deposit takers
[line 18(i.i.i) divided by line 18(i)]
Central bank
[line 18(i.ii.i) divided by line 18(i)]
Other financial corporations
[line 18(i.ii.iii) divided by line 18(i)]5%14%9%
Nonfinancial corporations
[line 18(i.ii.iv) divided by line 18(i)]76%14%31%
Other domestic sectors
[line 18(i.ii.v) divided by line 18(i)]4%17%45%18%
Government
[line 18(i.ii.ii) divided by line 18(i)]4%35%36%25%
Nonresident
[(line 18(i.i.ii) plus 18(i.ii.vi)) divided by 18(i)]11%20%20%17%
Residential real estate loans to total loans4%7%36%11%
Numerator [line 43]3501,0002,0003,350
Denominator [line 18(i)]9,25014,4005,60029,250
Commercial real estate loans to total loans14%7%
Numerator [line 44]2,0002,000
Denominator [line 18(i)]9,25014,4005,60029,250
Geographical distribution of loans to total loans (percentages of total)
[addendum items divided by line 18(i)]
Domestic economy89%80%80%83%
Advanced economies5%14%11%11%
Regions, excluding advanced economies
Africa3%1%0%2%
Of which: Sub-Sahara
Asia3%5%9%5%
Europe
Of which: Former Soviet Union, including Russia
Middle East
Western Hemisphere
Foreign-currency-denominated loans to total loans11%21%11%16%
Numerator [line 46]1,0003,0006004,600
Denominator [line 18(i)]9,25014,4005,60029,250
Foreign-currency-denominated liabilities to total liabilities11%15%23%15%
Numerator [line 47]1,2002,5001,5005,200
Denominator [line 23 minus line 21]10,85016,3016,65033,801
Income- and expense-based FSIs
Interest margin to gross income*55%49%33%46%
Numerator [line 3]3006602001,160
Denominator [line 5]5501,3606002,510
Trading income to total income9%7%17%10%
Numerator [line 4(ii)]50100100250
Denominator [line 5]5501,3606002,510
Noninterest expenses to gross income*91%44%25%50%
Numerator [line 6]5006001501,250
Denominator [line 5]5501,3606002,510
Personnel expenses to noninterest expenses60%50%67%56%
Numerator [line 6(i)]300300100700
Denominator [line 6]5006001501,250

Part 2. Accounting Rules

Treatment of Gains and Losses on Financial Instruments in the Income and Expense Statement

6. In the Guide, it is recommended that gains and losses on financial instruments that are valued at market or fair value in the balance sheet be included in the income and expense statement in the period in which they arise. Numerical examples are provided below to illustrate the application of the Guide’s recommendation and highlight the asymmetries that can arise at the sector level in the absence of consistent reporting of such gains and losses.

Example 1

7. This example, set out in Tables A5.4 and A5.5, illustrates the Guide’s approach to recording unrealized gains and losses on traded instruments and highlights the impact over time of adopting a different approach.

Table A5.4.Recording Gains and Losses on Traded Instruments: Case 1
Deposit Taker 1Deposit Taker 2
PriceΔ Net incomeCapital position (total)Δ Net incomeCapital position (total)
End period 11001,7001,700
End period 290–101,6901,690
End period 370–201,6701,670
End period 47551,675–251,675
Table A5.5.Recording Gains and Losses on Traded Instruments: Case 2
Level of FSI of Deposit Taker 2 Relative to Deposit Taker 1
FSIsPeriod 2Period 3Period 4
Return on equityHigherHigherLower
Return on assetsHigherHigherLower
Interest margin to gross incomeLowerLowerHigher
Trading gains (losses) to gross incomeHigherHigherLower
Noninterest expenses to gross incomeLowerLowerHigher

8. In this example, deposit takers 1 and 2 purchase a traded financial asset during period 1 at a purchase price of 100. Deposit taker 1 revalues the asset at its market price at the end of each period and records unrealized losses during periods 2 and 3 in the income statement. The asset is sold during period 4, and deposit taker 1 records a gain of 5 during this period. This approach is in line with the Guide’s recommendations. Therefore, as can be seen in Table A5.4, lower retained earnings are recorded in the periods 2 and 3 when unrealized losses arise, and a small gain is recorded in period 4, when the asset is sold.

9. In contrast, while deposit taker 2 also revalues the asset at market prices at the end of each period, it records only realized gains (losses) in the income statement. Unrealized gains (losses) are recorded in a valuation adjustment in the capital and reserves account—the counter-entry to the increase in the value of the instrument in the balance sheet. The asset is sold during period 4 at a (cumulative) loss of 25, which lowers retained earnings in that period. As can be seen in Table A5.4, the loss that accumulated over several periods is recognized only by deposit taker 2 in period 4, a period when the value of the instrument actually rose. The losses in the preceding periods were not reflected in income.

10. For deposit taker 2, Table A5.5 describes the impact on selected FSIs of not recording unrealized gains (losses) in the income statement compared with following the Guide’s recommendation, as is done by deposit taker 1. For example, in period 2 the return on assets for deposit taker 2 is higher because income is higher than it would have been if an unrealized loss had been recorded in its income.

Example 2

11. Table A5.6 illustrates how the exclusion of unrealized gains and losses on traded instruments from the income statement disguises the nature of a deposit taker’s activity.

Table A5.6.Recording Gains and Losses on Traded Instruments: Case 3
Deposit Taker 1
Δ Net incomeOf which: Trading gains (losses)Deposit Taker 2
Δ Net income
End period 1
End period 230255
End period 340355
End period 4−15−205

12. Deposit takers 1 and 2 both purchase a traded instrument. Both revalue the instrument at its market price; deposit taker 1 records unrealized gains and losses in the income statement as recommended by the Guide, but deposit taker 2 does not. As both deposit takers have other income of 5 each period, the result is that deposit taker 1 has net income that is both higher and more volatile than that of deposit taker 2. The relative importance of the business in traded instruments to the earnings of deposit taker 1 and the potential for greater volatility can be monitored each period. In contrast, the net income of deposit taker 2 disguises the extent to which that deposit taker has invested in a potentially volatile instrument, increasing the potential for surprises when the instrument is sold and the entire holding gain or loss on the instrument is realized at once.

Example 3

13. Table A5.7 illustrates the problems of intrasectoral consistency if deposit takers adopt different approaches to recording realized and unrealized gains and losses on traded instruments.

Table A5.7.Recording Gains and Losses on Traded Instruments: Case 4
Deposit Taker 1Deposit Taker 2Subsector Total (Deposit Takers 1 + 2)Deposit Taker 2*Subsector Total (Deposit Takers 1 + 2*)Deposit Taker 1*Subsector Total (Deposit Takers 1* + 2*)
Column 1Column 2Column 3Column 4Column 5Column 6Column 7
PriceΔ Net incomeΔ Net incomeΔ Net incomeΔ Net incomeΔ Net incomeΔ Net incomeΔ Net income
End period 1100
End period 290−10−10−20−10
End period 370−20−20−40−20
End period 4755510−25−20−25
End period 570−5−5−5

14. In the example, both deposit taker 1 and 2 purchase a traded financial asset during period 1 at a price of 100. In the first two columns of Table A5.7 the two deposit takers record gains (losses) on the asset in accordance with the recommendations of the Guide. Therefore, both deposit takers record the same entries in their respective income statements and balance sheets, regardless of whether the asset is sold (as deposit taker 2 does in period 4) or retained (as deposit taker 1 does), and regardless of whether the asset is held in the trading or investment book. At the sector level, changes in net income reflect unrealized losses (gains) of both deposit takers in the period in which they occur, as well as a weakening capital position for the sector.

15. Now, assume deposit taker 2 records only realized gains (losses) in the income statement (shown as 2* in the fourth column of Table A5.7). On selling the asset in period 4, deposit taker 2* records a loss of 25 in its income statement for that period. However, deposit taker 1 reflected such losses in earlier periods, when they arose, causing asymmetries to arise when aggregating data to produce sector-level data on net income and undermining the coherence of the sector-level data in the fifth column of Table A5.7.

16. Further, assume that deposit taker 1, like deposit taker 2*, also records only realized gains (losses) in the income statement but does not sell the asset (shown as 1* in the sixth column in Table A5.7). Even though both deposit taker 1* and 2* are using the same recording approach, there are asymmetries in the measurement of net income—one deposit taker reflects a loss, the other records nothing—between the two deposit takers, again undermining the coherence of the sector-level data (seventh column of Table A5.7).

17. The impact on the sector-level data, and thus on any analysis, of these different approaches is clear. For instance, when both deposit takers follow the Guide’s recommendations, losses cease in the fourth period, and a small recovery in income takes place as market prices rebound. In contrast, in the case where one deposit taker records only gains and losses when realized, the losses recorded in the fourth period remain of the same magnitude as in the third, despite the small rebound in market prices. When both deposit takers record gains and losses only when they are realized, there is no evidence of any worsening performance until the fourth quarter, increasing the possibility of a surprise when the losses are taken.

Example 4

18. Table A5.8 illustrates the problems that can arise for sector-level data if a deposit taker records gains and losses on its own traded debt differently from another deposit taker that owns the debt.

Table A5.8.Recording Gains and Losses on Traded Instruments: Case 5
Deposit Taker 1Deposit Taker 2Subsector Total (Deposit Takers 1 and 2)Deposit Taker 1*Subsector Total (Deposit Takers 1* and 2)
Column 1Column 2Column 3Column 4Column 5
PriceΔ Net incomeΔ Net incomeΔ Net incomeΔ Net incomeΔ Net income
End period 190
End period 2100−10100010
End period 3110−10100010
End period 4115−55005

19. Deposit taker 2 purchases a traded debt instrument issued by deposit taker 1 in period 1. Both deposit takers revalue the instrument at its market price and record unrealized gains and losses in the income statement each period, in line with the recommendations of the Guide. Consequently, both deposit takers record equal and opposite entries in their respective income statements, ensuring that net income (and capital) at the sector level is unaffected by the claims of one deposit taker in the reporting population on another.

20. Now, assume that deposit taker 1 does not record unrealized gains (losses) on its debt liability (deposit taker 1* in the fourth column of Table A5.8). Consequently, asymmetric recording approaches are followed, and the sector’s net income is boosted because the sector has recorded a gain in value arising from claims on itself, as shown in the fifth column of Table A5.8.

Treatment of Interest on Nonperforming Loans

21. The Guide recommends that interest accrue continuously on loans, unless the loan is nonperforming. Numerical examples are provided below that illustrate the application of the Guide’s recommendations on interest accrual on loans, particularly on those loans that are nonperforming.

Example 1: Loan performs through to maturity as envisaged by the contract (base case)

22. As a reference point, Table A5.9 sets out the entries under interest income in the income statement and loans in the balance sheet statement of a creditor deposit taker when a loan performs through to maturity as envisaged by the contract. Each month, the amount of interest that has accrued is recorded as interest income in the income statement, with the counter-entry increasing the outstanding value of the loan recorded in the balance sheet. As a payment of interest is made—quarterly in this example—the cash balances of the deposit taker increase by 3, and the outstanding loan amount decreases by 3 to 100. If the deposit taker compiles data on only a quarterly basis, the only entries would be the accrual of interest of 3 and an increase in cash balances of 3.

Table A5.9.Treatment of Interest on Nonperforming Loans: Case 1
JanFebMarAprMayJunJulAugSepOctNovDec
Income and expense
Interest income111111111111
(i) Gross interest income111111111111
(ii) Less provisions for accrued interest on nonperforming assets
Loan loss provisions
Balance sheet (assets)
Loans (after specific provisions)101102100101102100101102100101102100
(i) Gross loans101102100101102100101102100101102100
(ii) Specific provisions
Memorandum:
Cash interest payments by debtor3333

Example 2: Loan is classified as nonperforming, but interest is subsequently received

23. Table A5.10 sets out the entries under interest income and loan loss provisions in the income statement and under loans in the balance sheet statement when a deposit taker classifies a loan as nonperforming but subsequently receives payments on the loan. The contractual arrangements for the loan are the same as in example 1 above.

Table A5.10.Treatment of Interest on Nonperforming Loans: Case 2
JanFebMarAprMayJunJulAugSepOctNovDec
Income and expense
Interest income111111003111
(i) Gross interest income111111111111
(ii) Less provisions for accrued interest on nonperforming assets11−2
Loan loss provisions66−6
Balance sheet
Loans (after specific provisions)101102103104105106404040414240
(i) Gross loans101102103104105106106106100101102100
(ii) Specific provisions6660
Memorandum:
Cash interest payments by debtor0093

24. In this example, the first-quarter interest payment is missed by the debtor, so the end-first-quarter outstanding loan amount in the balance sheet is 103. The loan continues to accrue interest in the second quarter, but again the second-quarter interest payment is missed, resulting in an end-second-quarter loan amount outstanding of 106. At the start of the third quarter, with payment of interest more than 90 days overdue, the loan is classified as nonperforming. On reviewing the loan, the deposit taker considers that neither the amount of interest that has accrued in the first two quarters (6) nor all the amount originally advanced will be paid. Thus a loan loss (specific) provision of 66 is made in July, reducing the loan amount outstanding (after specific provisions).

25. As the loan is nonperforming, accrual of interest ceases, and the loan is placed on a cash basis—that is, no interest income is recorded until payment is made. Nevertheless, for consistency of recording between the debtor and the creditor, gross interest income continues to be recorded at the contractual rate of interest, although it is offset in the creditor’s income statement by a provision for accrued interest on nonperforming assets.

26. At the end of the third quarter, the overdue interest for the six months January–June is paid together with the interest of 3 for the third quarter. The payment increases the deposit taker’s cash balances by 9, with the following counter-entries: a negative loan loss provision of 6, partially reversing the provision made in July; a negative provision for accrued interest on nonperforming loans of 2 in the income statement, reversing the provision against interest accrued that was recorded in the first two months of the third quarter; and a recording of gross interest income in September of 1.

27. Once the interest payments are caught up, the expectation is that the debtor will continue to make interest payments according to the loan contract, so the accrual of interest resumes in the fourth quarter. Nonetheless, the deposit taker remains doubtful that all the amount advanced will be repaid, and so a specific provision of 60 remains.

Example 3: Loan is classified as nonperforming, but partial payment of interest is expected

28. Table A5.11 sets out the entries under interest income and loan loss provisions in the income statement and under loans in the balance sheet when a deposit taker identifies a loan as nonperforming but expects partial payment of interest on the loan.

Table A5.11.Treatment of Interest on Nonperforming Loans: Case 3
JanFebMarAprMayJunJulAugSepOctNovDec
Income and expense
Interest income1110.50.520.50.50.5004.5
(i) Gross interest income111111111111
(ii) Less provisions for accrued interest on nonperforming assets0.50.5−10.50.50.511−3.5
Loan loss provisions
Balance sheet
Loans (after specific provisions)101102100100.5101.0100100101100100100100
(i) Gross loans101102100100.5101.0100100101100100100100
(ii) Specific provisions
Memorandum:
Cash interest payments by debtor331.54.5

29. In the first quarter, interest accrues and is paid in accordance with the loan contract. At the end of that quarter, the outstanding loan value is 100. The deposit taker reviews the loan and determines that there is evidence that the loan will not fully perform in the future and expects that only partial payments of interest of 1.5 per quarter will be forthcoming. Therefore, 0.5 is recorded in provisions for accrued interest on nonperforming assets in both April and May. The balance sheet value of the loan at the end of each month includes the accrual of interest income less the provision for accrued interest on nonperforming assets. In this example, unexpectedly at the end of the second quarter interest is paid in accordance with the loan contract. Therefore, the entries in April and May for provisions for accrued interest income on nonperforming assets are reversed in June. At the end of the second quarter, the outstanding loan value is 100.

30. Despite the payment made at the end of the second quarter, the deposit taker continues to expect payment of 1.5 per quarter and so continues to include 0.5 every month in provisions for accrued interest on nonperforming assets. The deposit taker proves to be correct in its expectation, and at the end of the third quarter the debtor pays 1.5. The balance sheet value of the loan at the end of each month continues to include the accrual of interest income less the provision for accrued interest on nonperforming assets. During the third quarter, interest of 1.5 accrues and is actually paid, rendering the outstanding loan amount at the end of the quarter again 100.

31. In the fourth quarter, the deposit taker decides that the loan interest payments are expected to cease, and so accrual of interest ceases—the loan is placed on a cash basis in October. Entries are made in provisions for accrued interest on nonperforming loans to the full amount of the contracted rate of accrual per month. The balance sheet value of the loan at the end of each month is unchanged at 100 because no interest is accrued. However, full payment of interest, including past due interest, is made by the debtor in December. Therefore, the accumulated provisions of 3.5 for accrued interest on nonperforming loans are reversed, and 4.5 is recorded for interest income in the quarter. The outstanding loan amount at the end of the quarter remains at 100.

Part 3. Consolidation and Associated Sector-Level Issues

32. Unlike the base case, within a financial system deposit takers are likely to have interrelations. Therefore, the examples below illustrate the derivation of sector-level consolidated data when such interrelations exist.

Extended Base Data Set

Domestic consolidated data

33. The base case is extended to include interrelations among the three deposit takers. These transactions and positions are reflected in Tables A5.12 and A5.13, which follow the same format as Tables 11.2 and 11.3 of the Guide. Tables A5.14 and A5.15 present the income and expense statements and balance sheets for the three domestic deposit takers specified in the base case. The first three columns are similar to those in the base case,2 while the remaining columns illustrate the derivation of sector-level data when interrelations exist. The derivation is shown in two steps to demonstrate that, consistent with the Guide’s recommendations, all intragroup flows and positions are eliminated, but intergroup debt and financial derivatives positions are not eliminated (see Box 5.1). For clarity, an intermediate step that aggregates the group consolidated data for banks in the population is also shown in the table.

Table A5.12.Interbank Positions and Flows
Domestic Deposit Takers
Bank 1Bank 2
Bank 1’s positions with other deposit takersBank 2’s positions with its subsidiaryBank 2’s position with other deposit takers
1.Shares and other equity120301
2.Shares and other equity2
3.Noninterest income (excluding trading gains and losses)
Of which:Fees and commissions1515
Dividends receivable771.4
Prorated share of retained earnings63.2
Gains or losses on sale of fixed assets to other deposit takers
4.Gains and losses on equity investments in other deposit takers5
5.Nonperforming loans to deposit takers in the reporting population3
Current period
Provisions for accrued interest
Specific provisions8
Outstanding position
Provisions for accrued interest
Specific provisions8
6.Short-term claims on other deposit takers in the reporting economy (remaining maturity)
Table A5.13.Other Intragroup Positions and Flows
Domestic Deposit Taker Other Group Entities
Deposit taker 2Deposit taker 3
Balance Sheet
Liabilities to:
Deposits10
Loans100
Of which:Foreign-currency-denominated
Foreign-currency-linked
Debt securities1,000
Financial derivatives100
Other liabilities
Foreign-currency-denominated liabilities
Foreign-currency-linked liabilities
Income and Expense Statements
Interest income receivable
Memorandum Items Relating to Claims
Liquid assets claims (core)
Liquid assets claims (broad)
Nonperforming loans
Table A5.14.Income and Expense Statements: Deposit Takers—Sector-Level Consolidated Data (Domestic Consolidated Data)1
Deposit Taker 1 ADeposit Taker 2 BDeposit Taker 3 CStep 1: Group Consolidated Data D (= B + C +/− [Group Consolidated Adjustment])Aggregated Group Consolidated Data E (= D + A)Step 2: Sector Level Consolidated Data F (= E +/− [Sector Consolidated Adjustment])
1.Interest income4008003001,1001,5001,500
(i) Gross interest income4008003001,1001,5001,500
(ii) Less provisions for accrued interest on nonperforming assets
2.Interest expense100140100240340340
3.Net interest income (= 1 minus 2)3006602008601,1601,160
4.Noninterest income2507004009501,2001,173
(i) Fees and commissions receivable110300200485595580
(ii) Gains or losses on financial instruments50100100200250245
(iii) Prorated earnings5014020257575
(iv) Other income4016080240280273
5.Gross income (= 3 + 4)5501,3606001,8102,3602,333
6.Noninterest expenses5006001507351,2351,220
(i) Personnel costs300300100400700700
(ii) Other expenses20030050335535520
7.Provisions (net)50801090140132
(i) Loan loss provisions50801090140132
(ii) Other financial asset provisions
8.Net income (before extraordinary item and taxes) (= 5 minus (6 + 7))680440985985981
9.Extraordinary items
10.Income tax272176448448448
11.Net income after tax and extraordinary items (= 8 minus (9 + 10))408264537537533
12.Dividends payable300140369369362
13.Retained earnings (= 11 minus 12)108124169169172
Table A5.15.Balance Sheets: Deposit Takers—Sector-Level Consolidated Data (Domestic Consolidated Data)1
Deposit Taker 1 ADeposit Taker 2 BDeposit Taker 3 CStep 1: Group Consolidated Data D (= B + C +/− [Group Consolidated Adjustment])Aggregated Group Consolidated Data E (= D + A)Step 2: Sector Level Consolidated Data F (= E +/− [Sector Consolidated Adjustment])
14.Total assets (= 15 + 16 = 31)12,45018,2017,45024,14036,59036,578
15.Nonfinancial assets5005003008001,3001,300
16.Financial assets (= 17 through 22)11,95017,7017,15023,34035,29035,278
17.Currency and deposits200200100290490490
18.Loans (after specific provisions)9,20013,9005,35019,15028,35028,358
(i)Gross loans9,25014,4005,60019,90029,15029,150
(i.i)Interbank loans1,0009006001,4002,4002,400
(i.i.i)Resident30015050350350
(i.i.ii)Nonresident7007506001,3502,0502,050
(i.ii)Noninterbank loans8,25013,5005,00018,50026,75026,750
(i.ii.i)Central bank
(i.ii.ii)General government4005,0002,0007,0007,4007,400
(i.ii.iii)Other financial corporations5002,0002,0002,5002,500
(i.ii.iv)Nonfinancial corporations7,0002,0002,0009,0009,000
(i.ii.v)Other domestic sectors3502,5002,5005,0005,3505,350
(i.ii.vi)Nonresidents2,0005002,5002,5002,500
(ii)Specific provisions50500250750800792
19.Debt securities2,2503,0001,3003,3005,5505,550
20.Shares and other equity100301200200300280
21.Financial derivatives200200200300500500
22.Other assets100100100100
23.Liabilities (= 28 + 29)11,05016,5016,85022,14133,19133,191
24.Currency and deposits10,20011,7005,15016,84027,04027,040
(i)Customer deposits10,20011,2003,65014,85025,05025,050
(ii)Interbank deposits5001,5001,9901,9901,990
(ii.i)Resident10
(ii.ii)Nonresident4901,5001,9901,9901,990
(iii)Other currency and deposits
25.Loans200300150350550550
26.Debt securities4003,0001,5003,5003,9003,900
27.Other liabilities250801508511,1011,101
28.Debt (= 24 + 25 + 26 + 27)11,05015,8016,85021,54132,59132,591
29.Financial derivatives700600600600
30.Capital and reserves1,4001,7006001,9993,3993,387
(i)Narrow capital1,1601,1605001,3592,5192,507
31.Balance sheet total (= 23 + 30 = 14)12,45018,2017,45024,14036,59036,578

(i) Consolidated group data

34. The derivation of consolidated group data involves the elimination of all intragroup transactions and positions. The fourth column in Tables A5.14 and A5.15 shows the consolidated group data for deposit taker 2 and its subsidiary, deposit taker 3. The adjustments made to eliminate intragroup transactions and positions are described below. The data that have been adjusted are shaded.

  • Income and expense statement (Table A5.14)

    • Fees and commissions of 15 that are receivable/ payable between deposit taker 2 and deposit taker 3 are eliminated from the group’s income and expenses, as such fees and commissions are intragroup transactions.

    • – Deposit taker 2 recognizes 134.6 of noninterest income as its share of the net income of deposit taker 3. This amount is recorded as 71.4 of dividends payable and 63.2 of retained earnings by deposit taker 3. To eliminate double counting in the group data, the following amounts are eliminated: 134.6 from noninterest income, and 71.4 from dividends payable, and 63.2 from retained earnings.

  • Balance sheet (Table A5.15)

    • – Deposit taker 2 has deposit liabilities of 10 to deposit taker 3. These deposits are eliminated on consolidation from the group’s currency and deposit liabilities to resident banks and claims on resident banks.

    • – Deposit taker 3 has loan liabilities of 100 to deposit taker 2. These loans are eliminated on consolidation from the group’s loans to and from resident banks.

    • – Deposit taker 3 also has liabilities of 1,000 to deposit taker 2 in the form of debt securities issued. These are eliminated on consolidation from the group’s assets and liabilities.

    • – Deposit taker 2 has an equity investment of 301 in deposit taker 3, valued according to the prorated share in the capital and reserves of the associate. On consolidation, 301 is eliminated from shares and other equity on the asset side and from capital and reserves on the liability side of the group’s balance sheet. If the capital and reserves for deposit takers 2 and 3 were simply aggregated, there would be double counting of capital.

    • – Deposit takers 2 has liabilities of 100 to deposit taker 3 in the form of financial derivatives. These derivatives are eliminated on consolidation from the group’s assets and liabilities.

(ii) Sector-level consolidated data

35. The sixth column in Tables A5.14 and A5.15 presents the sector-level consolidated income and balance sheet data for the banking system. These data are derived by aggregating the data of deposit taker 1 with the group consolidated data (covering the activities of deposit takers 2 and 3) and eliminating certain transactions and positions between deposit taker 1 and the group; as noted earlier, positions in debt instruments and financial derivatives among unrelated deposit takers are not eliminated (see Chapter 5) in the sector-level data. The data eliminated at the sector level on consolidation are described below. The data that have been adjusted are shaded.

  • Income and expense statement (Table A5.14)

    • Fees and commissions of 15 receivable/payable between deposit taker 2 and deposit taker 1 are eliminated in the sector-level consolidated data. If this adjustment were not made, gross income of the sector would be overstated.

    • – Deposit taker 1 made a gain of 5 on holdings of equity investments in other resident deposit takers. Because of the asymmetric valuation of capital on the two sides of the balance sheet, these gains are not offset by counterpart losses for the issuing bank. Thus, to avoid overstating net income for the sector, these gains are eliminated from gains and losses on financial instruments and retained earnings at the sector level. Examples that illustrate the Guide’s recommendation for the measurement of sector-wide capital are provided below.

    • – Deposit taker 1 has dividends of 7 receivable from other resident deposit takers, which are eliminated from noninterest income (other income) and dividends payable in the sector-level consolidated data.

    • – Deposit taker 2 has expensed 8 in specific provisions against loans to deposit taker 1. This provision is eliminated from sector-level provisions and retained earnings data.

  • Balance sheet (Table A5.15)

    • – The group consolidated data of deposit takers 2 and 3 show loans to other resident deposit takers of 50. These and any other intergroup positions in debt instruments and financial derivatives are not eliminated in the sector-level data.

    • – Deposit taker 2 has a stock of 8 in specific provisions against loans to deposit taker 1. Following the elimination of such provisions in the income statement, these provisions are also eliminated from the stock of specific provisions in the sector-level balance sheet. The counteradjustment is higher retained earnings in capital and reserves.

    • – Deposit taker 1 has a portfolio equity investment of 20 in other resident deposit takers. To avoid double counting of capital, the market value of this equity investment is deducted from shares and other equity on the assets side and from capital and reserves in the sector-level consolidated data. This adjustment is illustrated in the examples below covering the Guide’s recommendation for the measurement of sector-wide capital.

Cross-border consolidated data

36. In addition to the interrelations among resident banks discussed above, it is further assumed that deposit taker 2 has a foreign deposit-taking subsidiary and that deposit taker 1 has a foreign branch. Moreover, the foreign subsidiary of deposit taker 2 has a portfolio equity investment in deposit taker 1.

37. The intergroup positions and flows are set out in Table A5.16, which follows the same format as Table 11.4. The cross-border group consolidated income and balance sheet statements for deposit takers 1 and 2 are shown in the first and second columns of Tables A5.17 and A5.18. The financial statements of deposit taker 3 are subsumed within the group-consolidated financial statement of deposit taker 2.

Table A5.16.Intergroup Positions and Flows (Cross-Border Consolidated Data)
Other Domestically Incorporated, Domestically Controlled Deposit Takers, Their Subsidiaries,1 and Branches
Deposit taker 1 groupDeposit taker 2 group
1.Shares and other equity22050
2.Shares and other equity as valued on balance sheet3
3.Noninterest income (excluding trading gains and losses):
Of which:
Fees and commissions15
Dividends receivable7
Prorated share of retained earnings
Gains or losses on sale of fixed assets to other deposit takers
4.Gains and losses on equity investments in other deposit takers5–10
5.Nonperforming loans to deposit takers in the reporting population4
Current period
Provisions for accrued interest
Specific provisions8
Outstanding position
Provisions for accrued interest
Specific provisions8
6.Short-term claims on other deposit takers in the reporting economy (remaining maturity)
Table A5.17.Income and Expense Statements: Deposit Takers—Sector-Level Consolidated Data (Cross-Border Consolidated Data)1
Sector-Level Consolidated Data C
Deposit Taker 1 Group Consolidated Data ADeposit Taker 2 Group Consolidated Data B(= A + B +/− [Intergroup Consolidated Adjustment])
1.Interest income5001,2001,700
(i)Gross interest income5001,2001,700
(ii)Less provisions for accrued interest on nonperforming assets
2.Interest expense100440540
3.Net interest income (= 1 minus 2)4007601,160
4.Noninterest income250700933
(i)Fees and commissions receivable110535630
(ii)Gains or losses on financial instruments50–100–45
(iii)Prorated earnings502575
(iv)Other income40240273
5.Gross income (= 3 + 4)6501,4602,093
6.Noninterest expenses5259351,445
(i)Personnel costs320600920
(ii)Other expenses205335525
7.Provisions (net)12590207
(i)Loan loss provisions12590207
(ii)Other financial asset provisions
8.Net income (before extraordinary items and taxes) (= 5 minus (6 + 7))435441
9.Extraordinary items
10.Income tax448448
11.Net income after tax (= 8 minus (9 + 10))−13−7
12.Dividends payable377370
13.Retained earnings (= 11 minus 12)−389−376
Table A5.18.Balance Sheets: Deposit Takers—Sector-Level Consolidated Data (Cross-Border Consolidated Data)1
Sector-Level Cross-Border Consolidated Data C
Deposit Taker 1 Group Cross-Border Consolidated Data ADeposit Taker 2 Group C Cross-Border Consolidated Data B(= A + B +/− [Intergroup Consolidated Adjustment])
14.Total assets (= 15 + 16 + 31)13,30035,46948,707
15.Nonfinancial assets5001,3001,800
16.Financial assets (= 17 through 22)12,80034,16946,907
17.Currency and deposits200540740
18.Loans (after specific provisions)10,05027,67037,728
(i)Gross loans10,25028,07038,320
(i.i)Interbank loans1,0001,5502,550
(i.i.i)Resident30050350
(i.i.ii)Nonresident7001,5002,200
(i.ii)Noninterbank loans9,25026,52035,770
(i.ii.i)Central bank2020
(i.ii.ii)General government40011,00011,400
(i.ii.iii)Other financial corporations5005,0005,500
(i.ii.iv)Nonfinancial corporations7,0002,0009,000
(i.ii.v)Other domestic sectors1,3506,0007,350
(i.ii.vi)Nonresidents2,5002,500
(ii)Specific provisions200400592
19.Debt securities2,2505,3007,550
20.Shares and other equity100259289
21.Financial derivatives200300500
22.Other assets100100
23.Liabilities (= 28 + 29)11,90032,70044,600
24.Currency and deposits11,20026,94038,140
(i)Customer deposits11,20024,85036,050
(ii)Interbank deposits2,0002,000
(ii.i)Resident
(ii.ii)Nonresident2,0002,000
(iii)Other currency and deposits9090
25.Loans200350550
26.Debt securities4003,5003,900
27.Other liabilities1001,3101,410
28.Debt (= 24 + 25 + 26 + 27)11,90032,10044,000
29.Financial derivatives600600
30.Capital and reserves1,4002,7694,107
(i)Narrow capital1,1601,8902,988
31.Balance sheet total (= 23 + 30 = 14)13,30035,46948,707

38. The adjustments made to eliminate intergroup transactions and positions to derive sector-level cross-border consolidated data are described below. The data that have been adjusted are shaded.

  • Income and expense statement (Table A5.17)

    • – Deposit taker 2’s group receives 15 in fees and commissions from deposit taker 1’s group. These intergroup fees and commissions receivable/ payable are eliminated from the sector-level data.

    • – Deposit taker 1 made gains of 5 on equity investments in deposit taker 2’s group, while deposit taker 2’s group made losses of 10 on equity investments in deposit taker 1’s group. These intergroup gains and losses are eliminated from gains and losses on financial instruments and retained earnings in the sector-level consolidated data.

    • – Deposit taker 1’s group received 7 in dividends from deposit taker 2’s group. These intergroup payments are eliminated from other income, as well as from dividends payable, in the sector-level data.

    • – Deposit taker 2’s group has expensed 8 in specific provisions on loans to deposit taker 1’s group. These expenses are eliminated from loan loss provisions and retained earnings in the sector-level data.

  • Balance sheet (Table A5.18)

    • – The group of deposit taker 2 has accumulated a stock of specific provisions of 8 against loans to the group of deposit taker 1. Following the elimination of such provisions in the income statement, this stock of specific provisions is eliminated from the sector-level balance sheet data, resulting in a higher level of loans after specific provisions. The counteradjustment is higher sector-level retained earnings in capital and reserves.

    • – The group of deposit taker 1 has portfolio equity investments of 20 in the group of deposit taker 2, and, conversely, the group of deposit taker 2 has portfolio equity investments of 50 in the group of deposit taker 1. To avoid double counting of capital, the market value of these equity investments is deducted from shares and other equity on the asset side and from capital and reserves in the sector-level consolidated data. This adjustment is shown in the examples below, which illustrate the Guide’s recommendation for the measurement of sector-wide capital.

Deriving Sector-Wide Capital

39. Accurately measuring sector-wide capital is central to monitoring the soundness of deposit-taking institutions. Therefore, it is important not to overestimate or underestimate the actual amount of capital resources available to the deposit-taking sector. In particular, the Guide recommends that any double counting of capital arising from intra-deposit-taking sector equity investments be eliminated. The numerical examples below illustrate how such elimination is undertaken for equity investments other than in subsidiaries and associates under different scenarios.

40. As in the other examples, it is assumed that there are three deposit takers. Moreover, in the first period (1) deposit taker 1 owns 5 of 60 outstanding shares of deposit taker 2, and (2) the shares of deposit taker 2 have a stated or par value of 2 per share, which is also their market value. So, at end period 1, the equity holdings of deposit taker 1 are valued at 10, and the capital of deposit taker 2 is valued at 120, all “funds contributed by owners” (FC). To facilitate exposition, in the examples below, the holdings of deposit taker 1 are explicitly shown in the accounts of deposit taker 2 as “Funds Contributed by Deposit taker 1,” (FC(DT 1)), while funds contributed by owners outside the sector are shown as FC(Other).

Example 1: Consolidation of sector-wide capital (base case)

41. Following the guidance in the Guide, Table A5.19 illustrates that sector-wide capital is not the aggregation of the capital of each of the three deposit takers, because some of their respective capital is obtained from within the sector: deposit taker 1 owns 5 shares of the capital of deposit taker 2 with a value of 10. This capital contribution by deposit taker 1 to deposit taker 2 must be eliminated by subtracting its market value from aggregated total capital (with the counter-entry being the elimination from sector-wide assets of the equity investment of deposit taker 1 in deposit taker 2). Therefore in this instance for period 1, where DT equals the deposit taker’s capital,

Table A5.19.Consolidation of Sector-Wide Capital: Base Case
Period 1
Deposit Taker 1Deposit Taker 2
Cash40Deposits20Loans220Deposits100
Loans10Capital40Capital120
DT 2 Equity10Of which: FC(Other)140Of which: FC(Other)1110
Purchase Value10Of which: FC(DT 1)110
Deposit Taker 3Consolidated Sector-Wide Balance Sheet
Cash40Deposits20Cash80Deposits140
Loans20Capital40Loans250Capital190
Of which: FC(Other)140Of which: FC(Other)1190
FC(Other) = Funds contributed by non-deposit-takers.FC(DT 1) = Funds contributed by deposit taker 1.

42. Note that the equity of deposit taker 1 in deposit taker 2 is eliminated from funds contributed by deposit taker 1, FC(DT 1), and the consolidated sector-wide balance sheet reflects only capital resources from outside the sector.

Example 2: Consolidation of equity among deposit takers: unrealized valuation gains—case 1

43. In period 2, the net income and retained earnings of deposit taker 2 are 120. The capital resources (net assets) of deposit taker 2 thus double, and the market bids up the share price to 4 per share, doubling the market price of period 1 and reflecting retained earnings. On its equity investment, deposit taker 1 experiences an unrealized valuation gain of 10, increasing net income and retained earnings; deposit taker 1 also marks up the value of its equity investment in the balance sheet to 20. In the example, neither deposit taker 1 nor deposit taker 3 generates any other net income.

44. Sector-wide capital in period 2 is calculated excluding the market value of the equity investment of deposit taker 1 in deposit taker 2. From the perspective of deposit taker 1, the market value is composed of 10 in purchase value and 10 in valuation gain (and is deducted from narrow capital).3 By component, 10 is deducted from funds contributed, and 10 is subtracted from retained earnings of deposit taker 1 (RE(DT 1)):

45. Similar to sector-wide capital, an adjustment is required to sector-wide income. Aggregating the net income of the three deposit takers results in net income in period 2 of 70 (consisting of 10 as unrealized gains of deposit taker 1 and 60 as net income of deposit taker 2). However, 10 of the net income represents a valuation gain of the sector on itself. The Guide recommends that all unrealized gains/losses on intrasectoral equity investments be excluded from the income account (which constitutes an exception to the Guide’s general guidelines on the treatment of valuation changes on financial instruments).

46. Compared with end period 1, sector-wide capital has increased by 120, reflecting the retained earnings of deposit taker 2. The valuation gain experienced by deposit taker 1 adds to its retained earnings and capital but does not contribute any additional capital resources to the sector as a whole, because it represents a valuation gain of the sector on itself. Table A5.20 sets out the entries in the sector accounts.

Table A5.20.Consolidation of Sector-Wide Income and Capital: Unrealized Valuation Gains—Case 1
Period 2
Deposit Taker 1Deposit Taker 2
Cash40Deposits20Cash120Deposits100
Loans10Capital50Loans220Capital240
DT 2 Equity20Of which:FC(Other)140Of which:FC(Other)1110
Purchase Value10RE210FC(DT 1)10
Unrealized Gain10RE2120
Deposit Taker 3Consolidated Sector-Wide Position
Cash40Deposits20Cash200Deposits140
Loans20Capital40Loans250Capital310
Of which: FC(Other)40Of which: FC(Other)1190
RE2120
FC(Other) = Funds contributed by non-deposit takers.FC(DT 1) = Funds contributed by deposit taker 1.

Example 3: Consolidation of equity among deposit takers: unrealized valuation gains—case 2

47. In Table A5.20, the increase in price of the shares of deposit taker 2 reflected higher retained earnings. In contrast, Table A5.21 covers the treatment of a rise in the value of the share price due to market movements unconnected with an increase in retained earnings. In Table A5.21, as in Table A5.20, the retained earnings of deposit taker 2 are 120 in period 2, but in this example the price of the shares of deposit taker 2 rises to 20 per share. This increase in share price results in a valuation gain and higher retained earnings of 90 for deposit taker 1 (see Table A5.21). However, as the unrealized gain arises from the sector’s claim on itself, there are no new capital resources for the sector as a whole. Thus, the sector-wide adjustments are the same as in the previous example: the market value of the equity investment of deposit taker 1 in deposit taker 2 is deducted from sector-wide capital, and the associated valuation gains are subtracted from sector-wide net income.

Table A5.21.Consolidation of Sector-Wide Income and Capital: Unrealized Valuation Gains—Case 2
Period 2
Deposit Taker 1Deposit Taker 2
Cash40Deposits20Cash120Deposits100
Loans10Capital130Loans220Capital240
DT 2 Equity100Of which:FC(Other)40Of which:FC(Other)110
Purchase Value10RE90FC(DT 1)10
Unrealized Gain90RE120
Deposit Taker 3Consolidated Sector-Wide Position
Cash40Deposits20Cash200Deposits140
Loans20Capital40Loans250Capital310
Of which: FC(Other)40Of which:FC(Other)190
RE120

Example 4: Consolidation of equity among deposit takers: realized valuation gains—case 1

48. In this example, in period 2, deposit taker 1 realizes the valuation gains on its equity investment in deposit taker 2 through a sale to another sector (Table A5.22). Otherwise, the assumptions are the same as in the first valuation example above (Table A5.20). At end period 2, the cash position of deposit taker 1 has increased by 20, while its retained earnings have increased by 10. Because of the sale of the shares of deposit taker 1 in deposit taker 2 to an entity outside the sector, the capital resources of all the deposit takers now come from outside the sector. Therefore,

Table A5.22.Consolidation of Sector-Wide Income and Capital: Realized Valuation Gains—Case 1
Period 2A
Deposit Taker 1Deposit Taker 2
Cash60Deposits20Cash120Deposits100
Loans10Capital50Loans220Capital240
Of which:FC(Other)40Of which:FC(Other)110
RE10FC(DT 1)10
RE120
Deposit Taker 3Consolidated Sector-Wide Position
Cash40Deposits20Cash220Deposits140
Loans20Capital40Loans250Capital330
Of which:FC(Other)40Of which:FC(Other)210
RE120

49. In other words, sector-wide capital in period 2 is now simply an aggregation of the capital of the three deposit takers, since there are no intrasectoral equity investments.

50. However, with respect to income, an adjustment is required for sector-level data. If the income data for the three deposit takers were aggregated, sector-wide net income would be 130 (net income of 120 of deposit taker 2 plus realized gain of 10 of deposit taker 1). At the same time, sector-wide capital has increased by 140, consisting of the net income of 120 of deposit taker 2 plus 20 arising from the sale of the equity investment of deposit taker 1 to another sector. Because the Guide treats all such transactions in deposit takers’ equity as equity financing transactions—transactions that can increase/decrease capital without having to go through the income account—the realized gains/losses of deposit taker 1 on the equity it owns in deposit taker 2 must be excluded from the income account. Consequently, sector-wide net income and retained earnings is 120, equal to the net income of deposit taker 2, while sector-wide capital increases by 140, reflecting 20 in financing from outside the sector, achieving consistency in the relationship between net income and capital.

51. Why does the Guide treat transactions in deposit takers’ equity as financing transactions? It is because from a sector-wide perspective, it is immaterial whether the deposit taker transacting in a deposit taker’s equity is the original issuer of the equity operating in the primary market (in which case, the transaction would clearly be classified as financing) or is a deposit taker buying or selling in the secondary market. All sales/purchases of deposit takers’ equity vis-à-vis other sectors are exchanges of sector equity for capital resources with another sector. It follows that, if the transaction has occurred at a price higher than that initially recorded in the deposit taker’s books (for example, a sale price of 4 per share as opposed to 2 per share in the books of deposit taker 2), the gain to deposit taker 1 has the nature of additional paid-in capital, which should be classified under funds contributed by owners.

52. In Table A5.22, the realized gain is recorded as an increase of 10 in the retained earnings of deposit taker 1, because that is the accounting treatment from the individual deposit taker’s perspective. But from a sector-wide perspective, there is a deduction of 10 from sector-wide retained earnings for the reasons explained above.

Example 5: Consolidation of equity among deposit takers: realized valuation gains—case 2

53. In this example, in period 2, deposit taker 1 realizes the valuation gains on its equity investment in deposit taker 2 through a sale to deposit taker 3 (Table A5.23). The remaining assumptions are the same as in the first valuation example above (Table A5.20). At end period 2, the cash position of deposit taker 1 has increased by 20, while its retained earnings have increased by 10. In contrast to the previous example, the sale has not resulted in ownership of deposit takers’ equity leaving the sector; ownership of the shares of deposit taker 2 remains within the deposit-taking sector, with the shares now owned by deposit taker 3 rather than deposit taker 1.4 Deposit taker 3 records the share value at 20:5 shares at 4 per share.

Table A5.23.Consolidation of Sector-Wide Income and Capital: Realized Valuation Gains—Case 2
Period 2
Deposit Taker 1Deposit Taker 2
Cash60Deposits20Cash120Deposits100
Loans10Capital50Loans220Capital240
Of which:FC(Other)40Of which:FC(Other)110
RE10FC(DT 3)10
RE120
Deposit Taker 3Consolidated Sector-Wide Position
Cash20Deposits20Cash200Deposits140
Loans20Capital40Loans250Capital310
DT 2 Equity20Of which:FC(Other)40Of which:FC(Other)190
Purchase Value20RE120

54. Sector-wide capital in period 2 is calculated excluding the market value of the equity investment of deposit taker 3 in deposit taker 2. From the point of view of the sector, in period 2, 10 is deducted from funds contributed and 10 is subtracted from retained earnings, as shown below. However, as funds contributed and retained earnings are not presented separately in the Guide, only 20 should be deducted from sector-wide total (and narrow) capital and reserves.

55. Sector-wide capital is the same as in period 2 in the unrealized valuation gain examples above. The realization of the valuation gain by a sale to another deposit taker has not changed total sector-wide capital, because no additional capital has been obtained from outside sectors. In essence, the deposit-taking sector has “gained” from selling its equity at a price higher than purchased (deposit taker 1 has a realized gain of 10) but has similarly “lost,” because as a sector it has bought equity at a price higher than originally recorded in its books (deposit taker 3 has purchased the equity at 4 per share rather than the initial sale price of 2 per share).

56. An adjustment is required for sector-level income data. If the income data for the three deposit takers were aggregated, sector-wide net income would be 130 (net income of 120 of deposit taker 2 plus a realized gain of 10 of deposit taker 1), but sector-wide capital has increased by only 120 (the net income of deposit taker 2). Because the Guide treats all transactions in deposit takers’ equity as equity financing transactions—transactions that can increase/decrease capital without having to go through the income account—the realized gains/losses of deposit taker 1 from holding the equity of deposit taker 2 must be excluded from the income account. Consistency is achieved in the relationship between net income and capital: sector-wide net income is 120, which is reflected in an increase of 120 in sector-wide capital as compared with period 1 (see example in Table A5.19).

57. In summary, from the four valuation examples above, it can be seen that:

  • The market value of equity investments among deposit takers should be eliminated from the asset side of the deposit-taking sector’s balance sheet and from total (and narrow) capital and reserves.

  • All realized and unrealized gains/losses from deposit takers’ ownership of and transactions in equity of other deposit takers must be excluded from sector-wide income.

Accounting for Goodwill in Sector-Wide Capital

Example 1: Purchase with cash

58. In this example, there are three deposit takers in the economy. Deposit taker 1 has 1,000 shares outstanding at a market value of 10 per share, deposit taker 2 has 400 shares outstanding at 5 per share, and deposit taker 3 has 500 shares outstanding at 5 per share, Deposit taker 1 then buys all of the shares of deposit taker 2 with cash at a market price of 5 per share (total cost 2,000), becoming a 100 percent owner of deposit taker 2. The net asset value of deposit taker 2 is 1,500. The difference between the net asset value and the price paid is goodwill (500). This amount is not recorded as an asset by deposit taker 1.

59. Table A5.24 presents the balance sheets of deposit takers 1 and 2 prior to the purchase, the balance sheet of deposit taker 1 after the purchase, the balance sheet of deposit taker 3, and the sector-wide balance sheet. In line with Guide recommendations, the balance sheets are all assumed to be marked-to-market, including for fixed assets.

Table A5.24.Goodwill and Sector-Wide Capital: Purchase with Cash
Positions Prior to Purchase (at market value)Sector-Wide Position
Deposit taker 1Deposit taker 2Deposit Taker 1 (after purchase)Deposit Taker 3Amounts Eliminated in ConsolidationDT 1 (after purchase) + DT 2 + DT 3
Balance sheet
Assets
Cash4,0005002,0004002,900
Other assets8,0001,5008,0003,20012,700
Prorated claim on subsidiaryn.a.n.a.1,500n.a.−1,5000
Total assets12,0002,00011,5003,60015,600
Liabilities and capital
Liabilities2,0005002,0006003,100
Capital10,0001,5009,5003,000−1,50012,500
Total liabilities and capital12,0002,00011,5003,60015,600

60. After the purchase, cash declines by 2,000 in the balance sheet of deposit taker 1, offset by a prorated claim on a subsidiary (1,500) and 500 of goodwill, which is deducted from assets and from capital and reserves. On consolidation at the sector level, the prorated claim of deposit taker 1 on the subsidiary is eliminated from assets, with the counteradjustment made in the capital of the subsidiary (deposit taker 2).

Example 2: Purchase by issuing new shares

61. In this example, the assumptions are the same as in example 1 above, except that deposit taker 1 purchases the 400 of shares of deposit taker 2 by issuing 200 of its own shares to the owners of deposit taker 1 at the market price of 10 per share.

62. In this example (Table A5.25), the cash on the balance sheet of deposit taker 1 does not decrease following purchase, and the prorated claim of deposit taker 1 on deposit taker 2 (1,500) increases assets. There is a corresponding increase in capital, reflected in the 2,000 of equity issued less the 500 of goodwill deducted. The rationale is that while deposit taker 1 has issued 2,000 of equity, it has purchased “only” 1,500 in assets (net). On consolidation at the sector level, the prorated claim on the subsidiary is eliminated from assets. On the debit side of the sector-level balance sheet, there is a counteradjustment in the capital of the subsidiary (DT 2). Goodwill is eliminated from the debit side of the balance sheet of deposit taker 1, with the counteradjustment made in capital. However, because equity rather than cash was used for the purchase, the overall balance sheet (and capital) is 2,000 greater than in the example in Table A5.24.

Table A5.25.Goodwill and Sector-Wide Capital: Purchase by Issuing Shares
Positions Prior to Purchase (at market value)Sector-Wide Position
Deposit taker 1Deposit taker 2Deposit Taker 1 (after purchase)Deposit Taker 3Amounts Eliminated in ConsolidationDT 1 (after purchase) + DT 2 + DT 3
Balance sheet
Assets
Cash4,0005004,0004004,900
Other assets8,0001,5008,0003,20012,700
Prorated claim on subsidiaryn.a.n.a.1,500n.a.−1,5000
Total assets12,0002,00013,5003,60017,600
Liabilities and capital
Liabilities2,0005002,0006003,100
Capital10,0001,50011,5003,000−1,50014,500
Total liabilities and capital12,0002,00013,5003,60017,600

Part 4. Calculating FSIs for Nonfinancial Corporations

63. The following examples illustrate the application of the principles involved in deriving sector-level data and FSIs for nonfinancial corporations.

The Data Set

64. A set of data for income and expense, balance sheet, and associated memorandum items is provided below and is used to calculate FSIs. The data set provided is consistent with the guidelines in Chapters 4 and 7.

65. In this example, the economy has three resident nonfinancial corporations.5 There are financial relations among them in the form of cross-holdings of debt and equity securities, but none of the equity holdings qualify as an associate investment. End-period financial statements (income and balance sheet accounts) for the three resident corporations are presented in Tables A5.26 and A5.27, together with aggregated and sector-level income and balance sheet statements.

Table A5.26.Income and Expense Statements: Nonfinancial Corporations—Sector-Level Consolidated Data1
Nonfinancial Corporation 1 ANonfinancial Corporation 2 BNonfinancial Corporation 3 CAggregation A + B + CSector-Level Consolidated Data A + B + C +/− (Sector Consolidation Adjustment)
1.Revenue from sales of goods and services (excluding indirect sales taxes)80.0400.01,700.02,180.02,180.0
2.Cost of sales90.0200.01,500.01,790.01,790.0
3.Operating income (= 1 minus 2)−10.0200.0200.0390.0390.0
4.Interest income0.42.29.311.911.9
5.Interest expense12.614.020.046.646.6
6.Other income (net)1.010.05.016.09.0
7.Net income (before extraordinary items and taxes) (= 3 + 4 minus 5 + 6)−21.2198.2194.3371.3364.3
8.Extraordinary items
9.Corporate income taxes40.038.978.978.9
10.Net income after taxes (= 7 minus (8 + 9))−21.2158.2155.4292.4285.4
11.Dividends payable108.0105.0213.0211.0
12.Retained earnings (= 10 minus 11)−21.250.250.479.474.4
Table 5A.27.Balance Sheets: Nonfinancial Corporations—Sector-Level Consolidated Data1
Nonfinancial Corporation 1 ANonfinancial Corporation 2 BNonfinancial Corporation 3 CAggregation A + B + CSector-Level Consolidated Data A + B + C +/− (Sector Consolidation Adjustment)
13.Total assets (= 14 + 17)126.0761.0837.01,724.01,709.0
14.Nonfinancial assets125.0650.0560.01,335.01,335.0
15.Produced95.0570.0470.01,135.01,135.0
Of which:(i) Fixed assets90.0500.0410.01,000.01,000.0
(ii) Inventories5.070.060.0135.0135.0
16.Nonproduced30.080.090.0200.0200.0
17.Financial assets1.0111.0277.0389.0374.0
18.Currency and deposits0.640.0150.0190.6190.6
19.Debt securities0.240.070.0110.2110.2
Of which:Issued by other nonfinancial corporations in reporting population20.040.060.060.0
20.Shares and other equity25.050.075.060.0
21.Trade credit2.03.05.05.0
22.Financial derivatives0.13.02.05.15.1
23.Other assets0.11.02.03.13.1
24.Total liabilities (= 29 + 30)104.0201.0400.0705.0705.0
25.Loans20.020.020.0
26.Debt securities84.0200.0400.0684.0684.0
27.Trade credit
28.Other liabilities
29.Debt (= 25 through 28)104.0200.0400.0704.0704.0
30.Financial derivatives1.01.01.0
31.Capital and reserves22.0560.0437.01,019.01,004.0
(i) Narrow capital220.0300.0110.0430.0415.0
32.Balance sheet total = (24 + 31 = 13)126.0761.0837.01,724.01,709.0
Memorandum series2
Other series required to calculate the agreed FSIs
33.Interest income receivable from other nonfinancial corporations2.04.06.0
34.Earnings before interest and tax (items 3 + 4 + 6 minus 33)−8.6210.2210.3411.9
35.Debt service payments16.624.048.088.6
36.Corporate net foreign exchange exposure for on-balance-sheet items−4.040.036.0
37.Total corporate net foreign exchange exposure−2.022.020.0
Intrasector positions and flows
Dividends receivable from other nonfinancial corporations21.01.02.0
Gains/losses on equity investments in other nonfinancial corporations22.03.05.0

66. Among the corporations, it can be seen that corporation 3 is the largest in terms of total assets, followed by corporation 2. All three corporations have substantial holdings of nonfinancial produced assets (fixed assets and inventories) and nonproduced assets (for example, land) employed in the production of nonfinancial goods and services. Corporations 2 and 3 also have large holdings of financial assets and strong capital positions. By contrast, corporation 1 has minimal holdings of financial assets and a modest capital position. On the income and expense side, corporation 1 had a loss in the current period. Corporations 2 and 3 had profits for the period that exceeded dividends payable.

Computation of Sector-Level Data and FSIs

67. Using the guidance in Chapter 7 and the financial statements of the three nonfinancial corporations, Table A5.28 presents the agreed FSIs at the sector level and, for illustrative purposes, for each corporation individually. Moreover, where relevant, the numerator and denominator for each FSI are shown. The last columns in Tables A5.26 and A5.27 show the sector-level consolidated data that are used to calculate FSIs and incorporate the sector-level consolidation adjustments discussed in Chapter 5. The data series that have been adjusted are highlighted. The adjustments are described below.

Table A5.28.Financial Soundness Indicators: Nonfinancial Corporations—Sector-Level Consolidated Data1,2
Nonfinancial Corporation 1Nonfinancial Corporation 2Nonfinancial Corporation 3Sector Level
Total debt to equity473%520%36%67%92%364%70%170%
Numerator (line 29)104.0104.0200.0200.0400.0400.0704.0704.0
Denominator (line 31 and 31(i))22.020.0560.0300.0437.0110.01,004.0415.0
Return on equity−39%−43%38%70%48%191%41%99%
Numerator (line 34)−8.60−8.60210.20210.20210.30210.30411.90411.90
Denominator (line 31 and 31(i))22.0020.00560.00300.00437.00110.001,004.00415.00
Debt-service coverage−52%884%446%472%
Numerator (line 34 plus line 33)−8.6212.2214.3417.9
Denominator (line 35)16.624.048.088.6
Net foreign exchange exposure to equity (on balance sheet)−1%−1%9%36%4%9%
Numerator (line 36)–4.0–4.040.040.036.036.0
Denominator (line 31 and 31(i))22.020.0560.0300.0437.0110.01,004.0415.0
Total net foreign exchange exposure to equity0%−1%5%20%2%5%
Numerator (line 37)−2.0−2.022.022.020.020.0
Denominator (line 31 and 31(i))22.020.0560.0300.0437.0110.01,004.0415.0
Number of applications for protection from creditors10
  • Income and expense statement (Table A5.26)

    • – Corporation 2 and corporation 3 have valuation gains of 5 on their holdings of equity investments in other nonfinancial corporations in the reporting population (see the second item under intrasector positions and flows in Table A5.27), which are eliminated from other income (net) and from retained earnings in the sector-level consolidated data.

    • – Corporation 2 and corporation 3 have dividends receivable of 2 from corporations in the reporting population (see the first item under intrasector positions and flows in Table A5.27), which are eliminated from other income (net) and dividends payable in the sector-level consolidated data.

    • – Corporation 2 and corporation 3 also receive interest income from corporations in the reporting population (see memorandum item 33), but these intrasector payments net out in the net income line and are therefore not eliminated from the gross interest income and interest expense lines (lines 4 and 5) in the sector-level consolidated income and expense statement.

  • Balance sheet (Table A5.27)

    • – Corporation 2 and corporation 3 have portfolio equity investments of 15 in corporations in the reporting population. To avoid double counting of capital, the market value of these equity investments is deducted from shares and other equity on the asset side and from capital and reserves in the sector-level data.

    • – Corporation 2 and corporation 3 also hold debt instruments issued by corporations in the reporting population (see item 19 in the balance sheet statements), but these intrasector holdings are not eliminated in the sector-level data, thus enabling the monitoring of risk exposure and potential contagion.

As noted earlier, these assumptions are unlikely to hold in practice as deposit takers are expected to have financial relations with other deposit takers in the reporting population.

This example differs somewhat from the base case because the balance sheets of deposit takers 1 and 2 incorporate interbank loans and deposits with resident deposit takers (see shaded cells in Table A5.15).

When Tier 1 data are not available, funds contributed by owners together with retained earnings (including those earnings appropriated to reserves) could be identified as a narrow measure.

Strictly speaking, the sale means that deposit taker 3, rather than deposit taker 1, has the claim on the 10 of funds contributed to deposit taker 2 by its owners.

As noted in Chapter 5, data might be compiled on both domestically controlled cross-border consolidated and domestic consolidated bases. The extended data set for deposit takers illustrates the issues involved in compiling domestically controlled cross-border consolidated data.

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