Uruguay. In this sub-Section, we start by defining more precisely what we mean by performance and viability of a financial institution. Later, we describe briefly the balance sheet structure of AB, the profit and loss statement, and the computation of performance indicators. Finally, we discuss what are the projection rules for the model variables of the AB.

The first question we have to ask ourselves, before we start to examine the performance of a given financial institution, is what is the main purpose or objective of its existence. The main role of a bank, either public or private, is to attract funds from people with surpluses (depositors) and provide these funds to people (borrowers) who have productive projects. Ideally, the borrowers will earn enough money to repay the funds (principal) with an adequate increment (interest) to be able to pay back depositors, cover operating costs and in the case of private banks distribute dividends to shareholders. The bank should attract depositors' funds through a combination of value on interest return, ease of access and security. At the same time, the bank should identify borrowers with the highest probability of repaying the funds. Thus, banks should provide a social function acting as information brokers and earning profits, or for a public bank at least not making losses, in the process.

To compete effectively, a bank should be able to provide these quality services at a "low cost." If a bank cannot compete on cost control and service quality, it is unlikely to survive for long in a competitive environment. A public bank may not be subject to the same competitive pressures from shareholders as conmmercial banks. Nevertheless, the very nature of its social function requires that **it** performs efficiently. A public bank that is not behaving competitively has a negative impact for the society at large. Thus, it is important to understand the bank's relative performance with respect to other domestic,.and foreign, banks. As we show below, the most convenient way to assess the performance of a bank, is through the computation of standard indicators. Ideally, oiie may compute performance indicators for a bank and then compare them with those computed for peer banks. Because of the obvious difficulty of doing this, we may be able only to compare them against indicators computed for some "representative" banks. There are various publications that provide information indicative of what would be good performance for different kinds of banks in different environments.

Even if a bank is performing well, however, it does not necessarily means that it is viable. The best evidence that a bank is viable is if it is able to **sustain** consistent growth of high-quality earnings. For a commercial bank, it is important to sustain earnings growth at a pace compatible with a level of dividends satisfactory to shareholders, while at the same time reinforcing its capital so as to maintain an adequate capital to assets ratio. Similarly, a public bank should be able to maintain growth without making undue losses on its core operations. Clearly, to study the issue of viability it is essential to be able to project not only all the relevant internal variables of a bank, but also of its external environment. A bank may find it difficult to ma,ntain its viability in a changing regulatory, economic, or competitive environment. The model presented here should then be a helpful tool to address these issues.

# **The Balance** Sheet

The balance sheet has been the traditional analysis tool of a financial institution. The balance sheet provides a snapshot of the assets, liabilities, and equity of a bank at a point in time. This is the one statement that is usually available in some form at the end of the bank's fiscal year in its annual or quarterly report. Some international banks also prepare a monthly, or even a daily balance sheet for internal management purposes. A thorough analysis of a financial institution requires a balance sheet that exposes realistically its financial condition, and that reflects accurately the (net) income generation of its 14