Views on improving the integrity of global capital markets
24 March 2015

OCI Study: Understanding Bank Performance, Risk Through “Forgotten” Income Statement

A Fuller View

With banks’ earnings season in full swing and the looming threat of rising interest rates, a pertinent question remains: How effectively are investors monitoring the performance and risk profile of banks?

At the same time, a source of continued debate among financial reporting stakeholders and accounting standard setters is the relevance of information reported through the “other comprehensive income” (OCI) statement. During valuation, most investors typically monitor and are familiar with income statement line items (e.g., net interest income, fee income, loan impairments for the bank business model). In contrast, the OCI statement — where valuation changes of interest rate risk-sensitive debt instruments are reported — is not monitored as closely by investors.

CFA Institute recently released a report to help inform the debate. Analyzing Bank Performance: Role of Comprehensive Income, an extension of our earlier studies on bank performance reporting during the financial crisis, is based on analysis of bank data from 44 banks (US, EU, and Canada) over an eight-year period (2006 to 2013), including many systemically important financial institutions. Drawing on the bank data, we make the case for drawing increased investor attention towards key business activities that are reported through the OCI statement. The relevance of OCI information for valuation purposes is also evident in current academic literature, including a 2011 Columbia University working paper on valuation of US insurance companies. The relevance has also been highlighted in a previous blog post, as well as in media coverage. Two articles by Bloomberg writer Matt Levine lucidly outline the need to vigilantly monitor what is reported through OCI:

What Is Comprehensive Income?

There are two portions to the comprehensive income statement, namely the income statement and OCI statement. Taken together, these two statements reflect the wealth created during a reporting period including: the value added from operating and investing activities as well as gains or losses from re-measurements of assets and liabilities. The OCI statement is comprised of the following line items:

  • Debt and equity securities re-measurements
  • Derivatives used to hedge anticipated transactions (capital acquisition commitments, future interest rate payment/receipt fluctuations)
  • Pension obligation re-measurements
  • Foreign currency translation gains or losses

As shown here, net OCI during any reporting period has an impact on the change in and aggregate book value of equity reflected on the balance sheet: Net OCI + (Net Income – Dividends) + Net Capital Contribution = Change in Book Value of Equity Monitoring the dynamics of the balance sheet is a vital part of comprehending the performance and risk profile of reporting entities — which is especially true for financial institutions.

Why Comprehensive Income Reporting Is Important for Banks

A focus on OCI reporting for banks is appropriate because these institutions have large categories of assets and liabilities whose gains or losses are recorded in OCI. For example, “available for sale” securities (AFS) are part of the liquidity buffers used to structurally hedge fixed-rate liabilities. These securities are held by most banks, and a recent academic study showed that AFS assets are, on average, 11% of total assets. In addition, banks often use derivatives designated as cash-flow hedges for the purposes of hedging variable interest rate and foreign currency anticipated transactions. As seen in the table below, AFS re-measurements can be material. For example, in 2008 Belgian bank Dexia’s book value of equity was decimated in large part due to the significant AFS unrealized losses (11.1 billion euros) that occurred that year. Even so, despite massive losses and the need for a state bailout in 2008, Dexia’s regulatory capital (which filters out AFS unrealized gains or losses) actually portrayed the picture of a healthy bank from 2007 to 2010. This underscores why investors should not ignore the unrealized losses that are reported in the OCI statement, but not through net income, when assessing bank solvency and risk.

Illustrative Cases Where AFS Unrealized Losses > Return on Equity

CompanyCountryYearROEAF Sugle
DexiaBelgium2008-57.8%-209.9%
Deutsche BankGermany2008-12.2%-14.1%
Banco SabadellSpain20106.7%-10.6%
HSBCUK2008-12.2%-23.7%
Wells FargoUS20082.7%-6.7%
Bank of New York MellonUS20082.4%-8.1%
AFSUGLE (Available for sale unrealized gains or losses a percentage of equity)
Source: Annual Reports


Another important analytical consideration is how the likely reversal of low interest rates will affect the profitability and net asset values of banks. As noted, valuation changes of interest rate risk-sensitive financial instruments (e.g., debt instruments) are reported through the OCI statement, and monitoring these valuation changes can help investors anticipate how bank net asset value and price-to-book ratios are vulnerable to interest rate changes. As illustrated through the sensitivity analysis from Barclays’ 2014 annual report, the OCI statement may reveal a more significant impact of interest rate changes than on the net interest income reported on income statement. If there is a 100 basis points (1%) increase in interest rates, AFS and cash flow hedge reserve would contribute a 5.7% reduction in equity while net interest income would increase equity by only 0.2%. Tellingly, as illustrated in a recent blog post on unwinding low interest rates, many reporting banks’ interest sensitivity analysis only focus on net interest income effects of rate changes; it omits the often more significant OCI effects, potentially leaving readers of financial statements blindsided by the overall balance sheet effects of interest rate changes.

Barclays Bank: Analyzing Interest Rate Sensitivity of Equity

Analysis at 31 December2014 2013 
100 basis points(100) basis points100 basis points(100) basis points
Net interest income170(384)110(243)
Taxation effects on the above(41) 92(27)61
Effect on profit for the year129(292) 83(182)
As percentage of net profit after tax15.3%-34.6%6.4%-14.0%
Changes in Equity
Effect of profit for the year1.29(292) 83(182)
Available for sale reserve(698)845(861)861
Cash flow hedge reserve(3058)2048(2831)2808
Taxation effects on the above901(694)923(917)
Effects on equity(2726)1907(2686)2570
As percentage of equity-4.1%2.9%-4.2%4.0%
Source: Barclays 2014 Annual Report


Basel III: Regulatory Effects on Capital Adequacy

One other reason investors should pay greater attention to debt and equity securities classified as AFS is because they could impact the regulatory capital of banks to a greater extent than in the past. Prudential regulators, under Basel II, allowed banks to strip out AFS re-measurements when determining regulatory capital. However, Basel III eliminates the prudential filter and therefore AFS re-measurements will influence regulatory capital in certain countries (e.g., UK, Greece) where Basel III is fully adopted without opt-outs. The newly issued International Financial Report Standards (IFRS) financial instruments accounting requirements (IFRS 9) will no longer classify securities as AFS, but this is unlikely to neuter the impact of securities valuation changes on regulatory capital. Under IFRS 9, equity and debt securities re-measurements will likely be classified as fair value through OCI and still have an impact on regulatory capital for banks in countries that strictly follow Basel III requirements. This article provides further analysis and bank-specific examples of regulatory capital sensitivity due to potential interest rate changes.

In conclusion, it is worth emphasizing that while the worst economic ravages from the global financial crisis — including increased credit risk and the resulting erosion in asset quality — may be in the past, there remains the need for a sustained focus by preparers, regulators, and standard setters on enhancing the transparency of banks. Assessing the full comprehensive income reporting (i.e., both income and OCI statements) is a necessary component of understanding bank performance. Along similar lines, we will discuss the relevance of OCI information for insurance companies and nonfinancial institutions in future blog coverage. Stay tuned.

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Image credit: Stephen Campbell, 2014

About the Author(s)
Vincent Papa, PhD, CPA, FSA, CFA

Vincent Papa, PhD, CPA, FSA Credential, CFA, is director of financial reporting policy at CFA Institute. He is responsible for representing the interests of CFA Institute on financial reporting and on wider corporate reporting developments to major accounting standard setting bodies, enhanced reporting initiatives, and key stakeholders. He is a member of ESMA’s consultative working group for the Corporate Reporting Standing Committee, EFRAG user panel, and a former member of the IFRS Advisory Council, Capital Markets Advisory Committee, and Financial Stability Board Enhanced Disclosure Task Force. Prior to joining CFA Institute, he served in investment analysis, management consulting, and auditing roles.

2 thoughts on “OCI Study: Understanding Bank Performance, Risk Through “Forgotten” Income Statement”

  1. Muhammad Ali says:

    Mr. Vincent,

    I totally agree that OCI should not be excluded from analysis. IASB as part of its conceptual framework project is attempting to address the gap currently exist in how and what items be reported in OCI. In my view, one statement titled performance statement be presented and the column presentation be followed where earnings and other recognized gains / losses be reported. As I consider that OCI matter could better be addressed by increasing its visibility and could be achieved through putting all movements in net assets in one statement and to maintain traditional earnings it may still possible without affecting traditional earning a column presentation where picture be presented so that investors can not ignore the other bit in their analysis. Interested in hearing your views how the presentation aspect is dealt with,provided IASB get consensus on defining or pin down what is OCI and when to report items on OCI.

    1. Vincent Papa, PhD, CFA says:

      Thanks Muhammad- Agreed and what you propose aligns with what was proposed in the CFA Institute comprehensive business reporting model.
      http://www.cfapubs.org/toc/ccb/2007/2007/6

      That said, a few years ago there was pushback against a single comprehensive income statement and the financial statement presentation project which was looking at what you are proposing (i.e., multiple column income statement) was suspended. It may be revived under the performance reporting project. Thus the pursuit, as you point out, remains on how to meaningfully draw the P&L versus OCI line. FYI — A few weeks ago, the IASB issued its conceptual framework ED (http://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Documents/May%202015/ED_CF_MAY%202015.pdf)

      The ED mainly asserts the primacy of the P&L and has some thoughts on P&L versus OCI divide. Worth a read.

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