A STUDY OF PERFORMANCE EVALUATION OF TOP 6 INDIAN BANKS

USING CAMELS ANALYSIS

Submitted By: Kinjal Gandhi Keval Patel PGDM-Finance NRIBM Ahmedabad

Submitted to:-

Prof. Neha Patel

Assistant Professor

NRIBM-MBA Ahmedabad

Submitted For:PARTIAL FULFILLMENT OF THE REQUIREMENTS OF TWO YEARS FULL TIME MASTER OF BUSINESS MANAGEMENT

INDEX

CHAPTER NO

TOPIC NO

TOPIC NAME List of tables List of figures Annexure Preface Acknowledgement Executive Summary Introduction Research problem & Literature review Research methodology Objective of the research Scope of the research Detailed project

PAGE NO.

I II III

1. 2. 2.1 2.2 2.3 3

LIST OF TABLES

LIST OF GRAPHS

Declaration
We undersigned hereby declare that the work incorporated in the grand project titled A study of comparative analysis of 6 top Indian Banks using camels analysis is original and has not been submitted to any university as part fulfillment of award of any degree or diploma. The material obtained and used from other sources has been duly acknowledged in the report.

Place: Ahmedabad

(Signature) (Kinjal Gandhi) (Keval Patel)

GENESIS The banking sector has been undergoing a complex, but comprehensive phase of restructuring since 1991, with a view to make it sound, efficient, and at the same time it is forging its links firmly with the real sector for promotion of savings, investment and growth. Although a complete turnaround in banking sector performance is not expected till the completion of reforms, signs of improvement are visible in some indicators under the CAMELS framework. Under this bank is required to enhance capital adequacy, strengthen asset quality, improve management, increase earnings and reduce sensitivity to various financial risks. The almost simultaneous nature of these developments makes it difficult to dissent angle the positive impact of reform measures. In 1994, the RBI established the Board of Financial Supervision, which operates as a unit of the RBI. The entire supervisory mechanism was realigned to suit the changing needs of a strong and stable financial system. The supervisory jurisdiction of the BFS was slowly extended to the entire financial system barring the capital market institutions and the insurance sector. Its mandate is to strengthen supervision of the financial system by integrating oversight of the activities of financial services firms. The BFS has also established a subcommittee to routinely examine auditing practices, quality, and coverage. In 1995, RBI had set up a working group under the chairmanship of Shri S. Padmanabhan to review the banking supervision system. The Committee gave certain recommendations and based on such suggestions a rating system for domestic and foreign banks based on the international CAMELS model combining financial management and sensitivity to market risks element was introduced for the inspection cycle commencing from July 1998. It recommended that the banks should be rated on a five point scale (A to E) based on the lines of international CAMELS rating model. CAMELS rating model measures the relative soundness of a bank. OBJECTIVE OF THE PROJECT STUDY: To analyze the top 10 banks according to the Market Capitalization under the BSE ratings to get the desired results by using CAMELS as a tool of measuring performance.

SCOPE OF THE RESEARCH:To study the Financial Performance of the banks To study the strength of using CAMELS framework as a tool of performance evaluation for Banks. To describe the CAMELS model of ranking banking institutions, so as to analyze the performance of various banks.

Rationale
In the recent years the financial system especially the banks have undergone numerous changes in the form of reforms, regulations and norms. The attempt here is too see various ratios have been used and interpreted to reveal a banks performance and how this particular model encompasses a wide range of parameters making it a widely used and accepted model in todays scenario.

Data Collection
Primary Data: Primary Data was collected from the Banks Balance sheets and profit and loss statements. Secondary Data: Secondary Data on the subject was collected from ICFAI journals, Banks annual reports and RBI website.

Methodology
As long as the methodology is concerned, we have made use of framework called CAMELS FRAMEWORK. There are so many models of evaluating the performance of the banks, but we have chosen the CAMELS model for this purpose. We have gone through several books, journals and websites and found out the best model because it measures the performance of the banks from each parameter i.e. Capital, Assets, Management, Earnings, Liquidity and Sensitivity to Market risks. CAMELS evaluate banks on the following six parameters:Capital Adequacy (CRAR) Asset Quality (GNPA) Management Soundness (MGNT) Earnings & Profitability (ROA) Liquidity (LQD)

Sensitivity to Market Risks

CAMELS FRAMEWORK
CAMELS is basically a ratio-based model for evaluating the performance of banks. Various ratios forming this model are explained below:-

CAPITAL ADEQUACY
Capital base of financial institution facilities depositors in forming their risk perception about the institutions. Also, it is the key parameter for financial managers to maintain adequate levels of capitalization. The most widely used indicator of capital adequacy is capital to risk-weighted asset ratio (CRWA). According to Bank Supervision Regulation Committee (The Basle Committee) of Bank for International Settlements, a minimum 9 % CRWA is required. Thus it is useful to track capital adequacy ratios that take into account the most important financial risksforeign exchange, credit and interest rate risks-by assigning risks weightings to the institutions assets. A sound capital base strengthens confidence of depositors. This rate is used to protect the depositors and promote the stability and efficiency of financial systems around the world.

CAPITAL RISK ADEQUACY RATIO:CRAR is a ratio of Capital Fund to Risk Weighted Assets. RBI prescribes Banks to maintain minimum Capital to Risk weighted assets ratio (CRAR) of 9% with regard to credit risk, market risk and operational risk on an ongoing basis, as against 8% prescribed in Basel documents. CRAR=Capital/Total Risk Weighted Credit Exposure

ASSET QUALITY:Asset quality determines the robustness of financial institutions against the loss of value in the assets. The deteriorating values of assets, being prime source of banking problems, directly pour into other areas, as losses are eventually written off against capital, which ultimately jeopardizes the earning capacity of the institution. With this backdrop, the asset quality is gauged in relation to the level and severity of non-performing assets, adequacy of provisions, recoveries and distribution of assets etc. Popular indicators include non-performing loans to advances, loan default to total advances and recoveries to loan default ratios. One of the indicators for asset quality is the ratio of non-performing loans to total loans (GNPA). The gross non-performing loans to gross advances ratio is more indicative of the quality of credit
decisions made by bankers. Higher GNPA is indicative of poor credit decision-making. NPA: Non-Performing Assets: Advances are classified into performing and non-performing advances (NPAs) as per RBI guidelines. NPAs are further classified into sub-standard, doubtful and loss assets based on the criteria stipulated by

RBI. An asset, including a leased asset, becomes non-performing when it ceases to generate income for

the Bank. An NPA is a loan or an advance where 1. Interest and/or installment of principal remains overdue for a period of more than 90days in respect of a term loan. 2. The account remains "out-of-order'' in respect of an Overdraft or Cash Credit (OD/CC). 3. The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted; 4. A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for two crop seasons; and 5. A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for one crop season.

MANAGEMENT SOUNDNESS:Management of the financial institution is generally evaluated in terms of capital adequacy, asset quality, earnings and profitability, liquidity and risk sensitivity ratings. In

addition, performance evaluation includes compliance with set norms, ability to plan and react to changing circumstances, technical competence, leadership and administrative ability. In effect, management rating is just an amalgam of performance in the above-mentioned areas. Sound management is one of the most important factors behind financial institutions performance. Indicators of quality of management, however, are primarily applicable to individual institutions, and cannot be easily aggregated across the sector. Furthermore, given the qualitative nature of management, it is difficult to judge its soundness just by looking at financial accounts of the banks. Nevertheless, total expenditure to total income and operating expense to total expense helps in gauging the management quality of the banking institutions. Sound management is a key to bank performance but is difficult to measure. It is primarily a qualitative factor applicable to individual institutions. Several indicators, however, can jointly serve as, for instance, efficiency measures do-as an indicator of management soundness.

The ratio of non-interest expenditures to total assets (MGNT) can be one of the measures to assess the working of the management. . This variable, which includes a variety of expenses, such as payroll, workers compensation and training investment, reflects the management policy stance. Efficiency Ratios demonstrate how efficiently the company uses its assets and how efficiently the company manages its operations. It indicates the relationship between assets and revenue.

Companies with low profit margins tend to have high asset turnover, those with high profit margins have low asset turnover - it indicates pricing strategy. This ratio is more useful for growth companies to check if in fact they are growing revenue in proportion to sales. Asset Turnover Analysis: This ratio is useful to determine the amount of sales that are generated from each rupee of assets. As noted above, companies with low profit margins tend to have high asset turnover, those with high profit margins have low asset turnover.

EARNINGS AND PROFITABILITY

Earnings and profitability, t he prime source of increase in capital base, is examined with regards to interest rate policies and adequacy of provisioning. In addition, it also helps to support present and future operations of the institutions. The single best indicator used to gauge earning is the Return on Assets (ROA), which is net income after taxes to total asset ratio. Strong earnings and profitability profile of banks reflects the ability to support present and future operations. More specifically, this determines the capacity to absorb losses, finance its expansion, pay dividends to its shareholders, and build up an adequate level of capital. Being front line of defense against erosion of capital base from losses, the need for high earnings and profitability can hardly be overemphasized. Although different indicators are used to serve the purpose, the best and most widely used indicator is Return on Assets (ROA). However, for in-depth analysis, another indicator Net Interest Margins (NIM) is also used. Chronically unprofitable financial institutions risk insolvency. Compared with most other indicators, trends in profitability can be more difficult to interpret-for instance, unusually high profitability can reflect excessive risk taking. ROA-Return on Assets: An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's annual earnings by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment". ROA tells what earnings were generated from invested capital (assets). ROA for public companies can vary substantially and will be highly dependent on the industry. This is why

LIQUIDITY
An adequate liquidity position refers to a situation, where institution can obtain sufficient funds, either by increasing liabilities or by converting its assets quickly at a reasonable cost. It is, therefore, generally assessed in terms of overall assets and liability management, as mismatching gives rise to liquidity risk. Efficient fund management refers to a situation where a spread between rate sensitive assets (RSA) and rate sensitive liabilities (RSL) is maintained. CAPITAL ASSET PRICING MODEL CAPM

The Capital Asset Pricing Model (CAPM) is the centre piece of modern financial economies. The model gives us a precise prediction of the relationship that one should observe between the risk of an asset and its expected return. This relationship serves two vital functions. First, it provides a benchmark rate of return for evaluating possible investments. Second, the model helps us to make an educated guess as to the expected return on assets that have not yet been traded in marketplace.

What does Capital Asset Pricing Model - CAPM mean?

CAPM is the model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. It implies that the risk premium on any asset or portfolio is the product of the risk premium on the market portfolio and the beta coefficient: E (Rs) Rf = i [E(Rm) Rf] Where: E (Rs) = Expected return from the security Rf = Risk free rate of return i = Beta of the security E (Rm) = Expected market return

The general idea behind CAPM is that investors need to be compensated in two ways: Time value of money and risk. The time value of money is represented by the risk-free Rf rate in the formula and compensates the investors for placing money in any investment over a period of

time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium [E (Rm) Rf]. The capital asset pricing model says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken or else it might result into a non profitable opportunity. The difference between the actual rates of return and the expected rates of return on the stock is called the stocks alpha, denoted . The higher the better is the return prospectus of the security.

BETA Beta is a measure of the volatility, or systematic risk of a security or a portfolio in comparison to the market as a whole. It is also known as "beta coefficient". The Beta coefficient is the covariance of the asset with the market portfolio as a fraction of the variance of the market portfolio i = CoV/2M A beta of 1 indicates that the security's price will move with the market. If beta is less than 1, it means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

Calculations:-

The SENSEX and the BSE Quote of the SIX companies stock under analysis for the last years are as under. SENSEX and BSE Quotes for the year 2010-2011. The risk free rate of return is assumed to be 5% as it the return assumed from the treasury bonds. The return from the company stock is taken as x and the return from the nifty is taken as y.