Finance Report: Capital Adequacy, Liquidity, and Leverage of Banks

This report provides an in-depth analysis of key financial metrics for banks, with a specific focus on HSBC UK. It begins by defining and explaining the significance of capital adequacy, liquidity, leverage, duration, and profitability. The report then delves into the financial measures used to evaluate banks, including the Capital Adequacy Ratio, Liquidity, Leverage Ratio, and Duration, illustrating their importance for both bank management and investors. The report also uses the balance sheet of HSBC UK to illustrate how the bank manages its finances, including its statutory liquidity reserve, cash reserve, and leverage ratio. The report concludes by emphasizing the importance of these financial measures in assessing a bank's stability and profitability, and how it can make decisions regarding their investment.

Finance Assessment

Table of Contents
INTRODUCTION...........................................................................................................................3
TASK 1............................................................................................................................................3
TASK 2............................................................................................................................................5
CONCLUSION................................................................................................................................7

INTRODUCTION
In this report the author will cover the significance and importance of the capital
adequacy, liquidity, leverage, duration and profitability of the bank. The report will further
enhance the use of financial reports of banks to make certain decisions. To illustrate these factors
HSBC Bank UK has been chosen. HSBC Holdings plc is a British Global Investment Bank and a
financial service holding organisation which was founded in 1865 with its origin from The
Hongkong and Shanghai Banking Corporation. It has its headquarters in London, England, UK.
It has its operations in more than 65 countries with more than 38 million customers. It is also the
largest bank in the entire Europe.
TASK 1
There are various measures which helps the directors, managers and investors to
understand the financial information in an easy and effective way. Various measure used to
evaluate banks are:
Capital Adequacy: Capital adequacy is a ratio which depicts the capacity of the bank to
payback its leverage. This ratio determines the capital adequacy of the bank. It is generally set by
the central bank or the banking regulatory authorities of the specified country where the bank is
carrying out its business. This ratio further prevents the banks from getting insolvent as it limits
their ability to generate more credit than their capacity to pay. This is the ratio of bank capital in
relation to its risk-weighted assets and current liabilities. This prevents the depositors and
maintains discipline in the financial system by promoting stability and efficiency.
The formula used to measure Capital Adequacy Ratio is = (Tier I + Tier II + Tier III
(Capital funds)) /Risk weighted assets). Tier 1 capital consists of the bank's core capital which is
equity and retained earning reserves. Tier 2 includes reserves like revaluation reserves with
mixed capital instruments and short term debts. HSBC UK maintains its capital adequacy ratio
which is set by The Prudential Regulation Authority (PRA) and Bank of England.
Liquidity: A bank's liquidity refers to its ability to pay short term debt, day to day
business obligations and the due bills. This measures the cash and other current assets that the
bank has to maintain to carry out these obligations. Liquid assets are the assets that can be easily
converted into cash and can be used to pay financial obligations. Some examples of liquid assets

are; central bank reserves and government bonds. To maintain stability the banks have to
maintain enough liquid assets to meet short-term obligations and withdrawals by the depositors.
The central banks and the banking regulatory authorities mandate the banks to maintain
certain reserves which prevents them from getting unstable and insolvent. These reserves are
different in every country, some of these reserves are statutory liquidity reserve and cash reserve.
Statutory Liquidity Reserve and Cash Reserve of a bank is determined by statutory liquidity ratio
and cash reserve ratio which is set by the central bank or the banking regulatory authority of that
particular country. Statutory Liquidity Reserve is deposited to the central bank by the
commercial banks and cash reserve is maintained by the banks itself. HSBC UK maintains all
these reserve to enhance its liquidity and effectiveness.
Leverage Ratio: This ratio determines the financial health of a bank. As banking sector
deals in leverage more than any other sector it has to maintain discipline in the financial market.
The leverage ratio is an instrument which measure how easily can the assets be liquidated in the
event of financial crises. This ratio is further used by central banks and the banking regulatory
authorities to ensure the capital adequacy of commercial banks and to limit the degree to which a
bank can leverage its capital.
The leverage ratio is calculated by comparing or dividing Tier 1 capital with Tier 1
assets. Tier 1 capital is the core capital which is equity and retained earning reserves. Tier 1
assets are the assets which can be liquidated quickly. HSBC UK maintains a certain leverage
ratio which is expressed in percentage and depicts the soundness of the bank in carrying out its
operations.
Duration: Duration refers to the time period which measure the change in market value
of a security due to 1% change in interest rates. This is relevant to commercial banks as they
hold multiple securities and also deal in these securities. Any variation in the values of these
securities affects the business and financial position of banks greatly. Security value is volatile
and is inversely affected by the change in interest rates. For example if the interest rate increases
it will reduce the price of certain securities and if it falls it will increase the price of these
securities. The more the duration of a security, the greater the risk that its price will drop as a
result of increase in rate of interest.
Banks analyse this information and purchase or sell the securities by predicting rise or
fall in the interest rates. It also helps in choosing the right time duration security. If the prediction

says that interest rates will fall in the future the banks can buy long term securities, on the other
hand if it says that the interest rates will rise then the banks will opt for short term securities.
HSBC UK carefully analyses this and keeps securities with low time duration as there is a high
chance that the interest rates will increase in the future.
Profitability of the Bank: Any bank earn profits by generating more revenue that the
expenses. A bank's profit majorly comes from the fees that it charges for the services it provides
and from the interest that it earns on its assets (loans, securities etc.). Majorly the assets include
the loans that the bank provides to individuals, businesses and other organisations and the
securities that it has purchased or acquired. Major liabilities of banks are the deposits and the
borrowed funds either from other financial institutions or by the people.
Banks earn profit by using leverage, that is by initiating deposits from public and using
the same to generate credit and lend loans to the public and other institutions. HSBC UK has a
global market image of a successful bank which maintains its profitability and has a good
market capture all around the globe.
TASK 2
HSBC UK follows and considers various financial measures which helps the bank to run
its operations effectively and efficiently. The capital adequacy of the bank has increased
significantly from the past years which is clearly depicted by the significant decrease in the
Capital Adequacy Ratio. Capital Adequacy Ratio can be understood by the following Balance
sheet of HSBC UK as on 31st December 2019. It shows increase in assets of the company and
stability in capital of the Bank which signifies that the company can easily pay its debts when an
unforeseen situation of crises arise.
HSBC maintains its statutory liquidity reserve and its cash reserve as per the required
ratio set by the concerned authority of banks. The statutory liquidity reserve is deposited to the
central bank as per the set ratio which can be withdrawn when needed. Cash reserve is kept by
the bank itself so that it can meet any unforeseen situation and carry out its day to day financial
obligations and liabilities. The cash and balances with central bank kept by HSBC UK has
increased over the past year, clearly stating the increase in deposits initiated by people and
institutions. Cash reserve of the bank has also increased over the past year which will help the
bank to meet the situation of short term crises.

Leverage is the most important part for every bank. HSBC UK has a sound leverage ratio
that means the bank will be easily able to cover up all its liabilities and debts in a situation where
the bank is needed to pay its long term debts immediately and also the money deposited by the
the general public, financial institutions, government and other financial institutions. The
liabilities of the bank has increased over time which can be maintained and met with as the bank
is equally profitable.

Assets Liabilities Equity Customer Accounts
0
50000
100000
150000
200000
250000
300000
231251
211485
19766
196858
249556
230111
19445
207830
2018
2019
HSBC UK is predicted to expand and earn higher profits in the next 5 years as there is a
sudden hike in the disposable income of general public. The bank will have more funds through
which it can generate more credit and increase its chances to earn more profit in the future.
CONCLUSION
The above reports conclude that the financial measures have an important role to play in
depicting the profitability and stability of any bank. These instruments provide investors with the
data which helps them in making decisions regarding their investment. Banking regulatory
authorities and central banks of a country plays a significant role in managing the financial
system of that country. HSBC UK has an efficient financial system which help the bank in
maintaining all the said ratios which depicts its profitability and stability. The bank has further
extended its roots globally, covering all the major markets which has increased its sales as well.