Reported Profit Versus Supervisory Reality
Audited accounts of Suryodaya Commercial Bank show total assets of NPR 210 billion, gross loans of NPR 150 billion, deposits of NPR 175 billion and shareholders' equity of NPR 18 billion. Reported net profit is NPR 1.8 billion. Interest income is NPR 19.0 billion, interest expense NPR 11.5 billion, non-interest income NPR 3.0 billion and operating expenses NPR 7.0 billion. The bank booked loan-loss provisions of NPR 1.1 billion, but the central bank's classification exercise shows that NPR 4.0 billion of provisions are required. The auditor has issued a qualified opinion on loan classification. NPLs are 3.2% of loans and restructured loans are NPR 4.0 billion. The bank proposes a 30% cash dividend and cites a 10% return on equity. Tax is 25% and the bank has no deferred tax asset.
1. Reconstruct the income statement and compute adjusted net profit and equity after the additional provisioning. Then compute reported and adjusted ROA, ROE, net interest margin and credit-to-deposit ratio.
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Reported: net interest income = 19.0 - 11.5 = 7.5; operating income = 7.5 + 3.0 = 10.5; pre-provision operating profit = 10.5 - 7.0 = 3.5; profit before tax = 3.5 - 1.1 = 2.4; tax at 25% = 0.6; net profit = 1.8. Additional provision required = 4.0 - 1.1 = 2.9. Adjusted profit before tax = 2.4 - 2.9 = -0.5; with no deferred tax asset, tax is zero and adjusted net loss is NPR 0.5 billion. Adjusted equity = 18.0 - 2.9 = NPR 15.1 billion. Reported ROA = 1.8/210 = 0.86%; adjusted ROA = -0.5/210 = -0.24%. Reported ROE = 1.8/18 = 10.0%; adjusted ROE = -0.5/15.1 = -3.3%. Net interest margin = 7.5/210 = 3.57% on total assets. Credit-to-deposit ratio = 150/175 = 85.7%. Combined NPL plus restructured = (4.8 + 4.0)/150 = 5.87% of loans, a better stress indicator than the 3.2% NPL ratio alone.
2. Can the bank lawfully declare the proposed 30% cash dividend? Explain the accounting and regulatory reasoning, including the effect of the auditor's qualification.
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No. A dividend can only be paid from distributable profit, and after the required provisioning the bank has an adjusted loss of NPR 0.5 billion, not a profit. The reported NPR 1.8 billion profit depends on under-provisioning by NPR 2.9 billion. Paying 30% of paid-up capital would further reduce equity and capital adequacy, and would be a transfer of capital to shareholders at the expense of depositors. The auditor's qualification is a red flag: it means the accounts may not be reliable for distribution purposes. The supervisor should direct the bank to restate or adjust the accounts, prohibit the dividend until the provision shortfall is fully recognized and capital is restored, and require board accountability for the classification process. Any dividend decision must also satisfy the capital buffer rules.
3. What should the central bank do about the qualified audit opinion and the classification weakness? Outline supervisory, accounting and governance responses.
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The central bank should treat the qualification as evidence of a control failure, not merely a disclosure issue. Supervisory response: require a full loan-file review, independent classification of large exposures, and a time-bound provisioning plan; verify that restructured loans are not being used to hide NPLs; and impose restrictions on new lending to stressed sectors until classification is reliable. Accounting response: require adjustment of the financial statements, disclosure of the provision shortfall, and a reconciliation of audited profit to regulatory profit. Governance response: question whether the board and audit committee challenged management, require an independent review of the credit function, and consider fit-and-proper action if the board ignored repeated warnings. The aim is to restore reliable numbers and market discipline, not just to penalize the auditor.