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Camels and Performance Evaluation of Banks in Malaysia: Conventional

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 Journal of Islamic Finance and Business Research
Vol. 2. No. 1. September 2013 Issue. Pp. 36 – 45

Camels and Performance Evaluation of Banks in Malaysia:

Conventional Versus Islamic
Nabilah Rozzani* and Rashidah Abdul Rahman**
This study had explored the area of bank performance using CAMELS
rating, where its main objective was to examine the performance of both
Islamic and conventional banks that are currently operating in Malaysia. 19
conventional banks and 16 Islamic banks were chosen to be samples of the
study, where year-end financial data from the years 2008 until 2011 were
gathered from these banks’ annual reports. From analysis, it could be seen
from an overall view that the levels of performance for both conventional and
Islamic banks in Malaysia were highly similar. By displaying the potential
interaction between both Islamic and conventional banks in Malaysian
banking system, this study is hoped to provide useful information for
stakeholders to make better investment decisions and to help both
conventional and Islamic banks to mark and re-evaluate their performance
based on the performance measurement used in the study.

JEL Codes: C510, G210 and M410.

1. Introduction and Research Objectives

In simple accounting terms, performance to banks refers to the capacity in

generating sustainable profitability (Wild, Shaw & Chiappetta 2009). Traditional
method of applying financial ratios to evaluate bank’s state of performance has been
long practiced, with practitioners using CAMELS rating to measure their banks’
performance. According to Barron’s Dictionary of Banking Terms (Fitch 1990),
CAMELS bank rating is used by bank’s management to evaluate financial health and
performance. Each components of this rating are calculated on a 1 to 5 scale, being
accumulated into a composite evaluation, also defined by the 1 to 5 scale. Recently,
another factor has been added to the rating as a measurement for Islamic banks,
which is Shariah compliance (Sarker 2006). To banking regulators, a precise and on-
going measuring of bank’s performance would allow allocation of resources to be
more effective, assist in audits targeting, leading to a better understanding of the
operation of banks (Barr, Seiford & Siems 1994). The Central Bank of Malaysia had
concluded in 2001 that the performance of Islamic banks’ operation is still relatively
insignificant in comparison to conventional banking, even though their performance
has been encouraging these years.

In todays’ globalized industry, it is important for all companies to stay in the

business. This does not exclude financial institutions, in particular, banks. In
Malaysia especially, we have heard of banks being merged and business being shut
down by insolvency and financial distress, due to the 1997-1998 Asian Economic
Crisis (Mat-Nor, Mohd Said & Hisham 2006).

* Nabilah Rozzani, Accounting Research Institute, Universiti Teknologi MARA Shah Alam, Selangor,
Malaysia. Email: nabilah.rozzani@gmail.com
** Prof. Dr. Rashidah Abdul Rahman, Accounting Research Institute, Universiti Teknologi MARA Shah
Alam, Selangor, Malaysia. Email: shidah@salam.uitm.edu.my
 Rozzani & Rahman
For example, Bank Bumiputera Malaysia Berhad had merged with Bank of
Commerce Berhad in 1999 to form Bumiputera Commerce, that later changed its
name to CIMB Bank Berhad (CIMB Group 2011). This shows how close bank
operation relates to a country’s economic condition. Further, according to the study
by Mat-Nor, Mohd Said and Hisham (2006), efficiency and performance are one of
the many factors that had made the economic changes unavoidable. Therefore, it is
important of banks to remain competitive to survive in the long run. Banks should
also be able to perform effectively to ensure it contributes to the nation’s overall
economic growth. As such, there is a need on the review of how performance level
can be measured in the context of financial institutions, in this case, banks.

With challenges being faced due to the difference of operation, how well have both
Islamic and conventional banks perform in the Malaysian environment during the
years of 2008 until 2011? Hence, the objective of this study is to examine the
current performance of Malaysian banks, where it is hoped to provide useful
information for stakeholders to make better investment decisions and to help both
conventional and Islamic banks to mark and re-evaluate their performance based on
the rating. By displaying the potential interaction between both Islamic and
conventional banks in Malaysian banking system, this study is hoped to provide
useful information for stakeholders to make better investment decisions and to help
both conventional and Islamic banks to mark and re-evaluate their performance
based on the performance measurement used in the study. Unlike other researches,
this study has placed emphasize on Malaysian Conventional and Islamic banks,
aiming to make comparison between these different types of banks, as Islamic
banks is making significant development ever since its establishment in Malaysia.
Using financial data from 2008 until 2011, this study provides the latest outcome of
these banks, hence providing more recent performance and efficiency estimates of
this banks that could be reviewed by both regulators and management.

This paper is further structured to be as follows. Section 2 develops the literature

review that structures the overall study. The research method is defined in Section 3
with results reported in Section 4. The discussion of the findings and the conclusions
drawn are in Section 5.

2. Literature Review
Malaysian financial institution are being regulated by the Central Bank of Malaysia,
aiming to empower its official supervision, reducing private monitoring regulations,
and imposing greater restrictions on the non-lending activities of banks after its
financial crisis (Barth, Caprio & Levine 2008). According to Barth, Caprio and Levine
(2008), private monitoring is associated with greater bank performance. However,
Dr. Zeti Akhtar Aziz, the Governor for the Central Bank of Malaysia (2011), believe
that enhancement of performance of financial institutions rely heavily on the
development of supporting infrastructure. Either way, regulators of financial
institutions in Malaysia would benefit from a better monitor for risk-sensitive activities
of the banks, since restrictions on risky activities of banks would tend to produce
banks with good performance (Thangavelu & Findlay 2010).

According to Mazzillo (1993), CAMELS ratings are highly useful in identifying banks
which need a large amount of supervisory attention. However, they also had
limitations. First, they would not necessarily capture the seriousness of the situation
when looking at banks that has potentials to fail. Second, the information for the

37
 Rozzani & Rahman
calculation of these ratings is based on the internal operations of the bank.
Therefore, local economic developments that might give for future problems are not
taken into account, since they do not reflect to the condition of the banks. The next
weakness is that they are generally a measurement of the condition of the bank at
the present time, when the bank is being examined. They do not effectively track risk
factors that may provide for future losses.

Therefore, it could be seen that in practice, CAMELS rating of banks are highly
confidential, since it includes the sensitive insider information that has been gathered
during the private investigation of respective banks, other than regulatory information
on the bank’s financial health that is available to the public (Hirtle & Lopez 1999).
Barron’s Dictionary of Banking Terms (Fitch 1990) had mentioned that individual
CAMELS ratings are only for the discretion of bank management. That is why
CAMELS ratings were never made public, and only made known strictly to the
bank’s senior management and appropriate supervisory staffs at relevant regulatory
agencies.

According to Muljawan (2005), there is a high expectation on banking institution to

be able to operate for the long run so that they would make a contribution to the
economy through the process of intermediation. This means that through public
funds mobilization by banks, investment activities could be further promoted. Hence,
the financial institution regulators should care about any systemic costs that could
lead to bank failures as this could give extreme losses to all stakeholders of the
financial institutions.

From the review of previous literature, it could be seen that there is a scarcity of past
study that is related to the lack of CAMELS rating disclosure among financial
institutions. However, it is able to measure and develop these ratings separately by
relying to the accounting ratio that would measure for bank’s financial health,
according to the measurements of capital adequacy, asset quality, management
quality or efficiency, earnings, liquidity, and sensitivity to market risk (Christopoulos,
Mylonakis & Diktapanidis 2011). Hence, emphasize of this study is placed to the
environment of Malaysian financial institution system.

3. Methodology
A sample of banks in Malaysia was selected for this study. This population is further
subdivided into conventional and Islamic banks. By the Central Bank of Malaysia’s
List of Licensed Banking Institutions in Malaysia, there were 27 conventional banks
(Central Bank of Malaysia 2012a) as well as 16 Islamic banks (Central Bank of
Malaysia 2012b) in Malaysia, as at 31st December 2011. However, the study
excludes 8 conventional banks because their annual reports were not published for
some of the years chosen for analysis. The final sample collected of Malaysian
banks comprise of 19 conventional banks and 16 Islamic banks. This is to meet the
objective of this study, which is to exploring the level of performance among
conventional and Islamic banks in Malaysia. Finally, after taking into consideration
the four years of observation, a total of 140 items of data were derived. Panel data is
used over the range of four years to provide accuracy to measurement, as was
suggested by Nuryartono, Anggraenie and Firdaus (2012). The data collected for the
four year period is deemed to be sufficient in order to prevent the sample size from
being smaller due to incomplete data.

38
 Rozzani & Rahman
3.1 CAMELS Rating

The United States’ CAMELS rating system is adapted by Malaysian financial

institution regulators to all banking institutions, in order to oversee overall strength,
safety and soundness of each individual bank (Suzuki & Sastrosuwito 2011). This
would then help the regulatory body to identify weak banks that would require
greater supervisory attention (Central Bank of Malaysia 2001).

The Islamic banking industry could adopt similar CAMELS framework that is used in
conventional banks when designing an appropriate rating system for Islamic banking
(Muljawan 2005). However, it would be effective with some improvements and
modifications in order to adopt the typical differences in the Islamic operations of
banks. As was mentioned by Sarker (2006), also Khatkhatay and Nisar (2007) and
Masngut and Abdul Rahman (2012), the factor of implementation of Shariah
compliance for Islamic banks should be taken into consideration in analysing the
soundness of the banks’ financial health through the application of CAMELS rating.

After the ratios for all six indicator components have been calculated, they would be
put on average weightage and with that, banks would be compared by the ranking of
1 to 5. Consequently, rankings given to individual components would be combined to
obtain a single rank to determine the overall performance of the banks being
investigated, where banks rated 1 and 2 are considered strong, while those rated 3,
4 or 5 are considered weak (Kambhamettu 2012). The ranking is explained and
simplified in Table 1, in accordance to studies by Wirnkar and Tanko (2008), and
Sarker (2006).

Table 1: Interpretation of CAMELS Composite Rating

Rating Rating Range Rating Analysis Interpretation
1 1.0 - 1.4 Strong Bank is basically good in every aspect.
Bank is primarily good but has several identified
2 1.6 - 2.4 Satisfactory
weaknesses.
Fair, with some Bank have financial, operational, or compliance
3 2.5 – 3.4 categories to be weaknesses would that give reasons for
watched supervisory concern.
Bank has serious financial weaknesses that could
Marginal, with some
4 3.5 – 4.4 damage future capability to ensure normal growth
risk of failure
and development.
Unsatisfactory with Bank has critical financial weaknesses that give a
5 4.5 – 5.0 a high degree of probability of failure to be extremely high in the
failure near future.
Source: Wrinkar & Tanko (2008); Sarker (2006)

3.1.1 Model Specification

The current study examined the performance levels of conventional and Islamic
banks in Malaysia. Collection of previous literatures (Majithiya & Pattani 2010; Babar
& Zeb 2011; Sarwar & Asif 2011; Masngut & Abdul Rahman 2012) had classified the
classes of ratio for these components to be as in Table 2.

39
 Rozzani & Rahman
Table 2: Ratio Classification for Components of CAMELS Rating
Rank
Component Ratio
1 2 3 4 5
Capital Above Below
8%-11% 4%-8% 1%-4%
Adequacy 11% 1%

Below Above
Asset Quality 1.5%-3.5% 3.5%-7% 7%-9.5%
1.5% 9.5%

Management Below 45%- Above

30%-26% 38%-31%
Quality 25% 39% 46%
Above 1.25%- 1.01%- 0.75%- Below
Return on Assets
Earnings 1.50% 1.50% 1.25% 1.00% 0.75%
Quality Above 17%- 7%- Below
Return on Equity 10%-16.99%
22% 21.99% 9.99% 6.99%
Below 70%- Above
60%-65% 65%-70%
60% 80% 80%
Liquidity
Below 70%- Above
60%-65% 65%-70%
60% 80% 80%

Shariah Shariah Compliance Score Above 60%- Below

70%-80% 65%-70%
Compliance Sheet 80% 65% 60%
Source: Majithiya & Pattani (2010); Babar & Zeb (2011); Sarwar & Asif (2011); Masngut & Abdul Rahman (2012)

4. Data Analysis and Results

Overall, it could be seen in Table 3 that the rating distribution had varied among the
banks, where there were banks reaching the best rating of 1 and also banks
achieving the worst rating of 5. It could also be seen that the mean for all
components and also the composite CAMELS rating was in between the ratings of 2
and 3. This showed that all banks being investigated were equally distributed for all
rates of 1 until 5. Looking at the mean value of the composite CAMELS rating (2.81),
it was evident that the 35 banks being examined have a fair rating of 3, with some
components to be watched for, as the bank could have financial, operational or
compliance weakness that should be a reason for supervisory concern. Focusing
more into each component of CAMELS ratings, it could be seen that Management
Quality (1.00) was the component that had achieved an overall best rating. This was
closely followed by the components of Asset Quality (1.91), Shariah Compliance
(2.05), Capital Adequacy (2.10), Earnings Quality (2.93 and 3.51) and Liquidity (3.59
and 4.37). This was different from Babar and Zeb (2011), also Sarwar and Asif
(2011), where the component of Capital Adequacy achieved the best rating in
Pakistan. With this, it shows that the different economic environment in both
Pakistan and Malaysia had shown differences to the outcome of the CAMELS
performance analysis, where the environment of Malaysia had strongly emphasized
on the management quality of an organisation, while Pakistan stressed on the
strength of capital in their organisation.

A high rating of Management Quality displayed the strong growth of these banks as
well as the high competency of its employees, which would help the bank to grow in
the future (Majithiya & Pattani 2010). The high rating of Asset Quality showed that
banks are good in detecting, measuring, monitoring and regulating credit risk
(Christopulous, Mylonakis & Diktapanidis 2011). Strong rating of Shariah
Compliance was a result of enforcement and supervisions with respect to Shariah

40
 Rozzani & Rahman
regulations as being the main support to the Islamic banks’ operations (Sarker
2006). The strong rating of Capital Adequacy displayed a strong sign of bank
survival in times of crisis and also opportunities to expand in the future, where the
rating reflects the inner strength of the banks (Sangmi & Nazir 2010). However, the
weak rating to the component of Earnings Quality could be caused by banks’ rigid
lending policies and strict lending criteria (Sarwar & Asif 2011). Being added with
lack of proper management, Islamic banks would find it more difficult to earn their
part of earnings in a large conventional environment. For the component of Liquidity,
the weak rating displayed unbalanced mixture of liquid and non-liquid assets. By
that, the management should design better strategies of liabilities and asset
management, as banks should be able to meet its liability obligations in times when
demand arises (Sangmi & Nazir 2010).

Table 3: Descriptive Analysis for Overall CAMELS Rating (2008-2011)

Mean Standard Minimum Maximum Sig.
Deviation
Composite 2.81 0.489 2 4 0.000**
Capital Adequacy 2.10 0.892 1 4 0.000**
Asset Quality 1.91 1.199 1 5 0.000**
Management Quality 1.00 0.000 1 1 N/A*
Earnings Quality (Return on Assets) 2.93 1.544 1 5 0.000**
Earnings Quality (Return on Equity) 3.51 1.214 1 5 0.000**
Liquidity (Net Loans/Deposits and 4.37 1.416 1 5 0.000**
Short Term Funding)
Liquidity (Liquid Assets/ Deposits 3.59 1.604 1 5 0.000**
and Long Term Funding)
Shariah Compliance 2.05 0.744 1 4 0.000**
* T-value for Management Quality cannot be computed because the standard deviation is 0
** Value is significant to 1% level

From Table 4, it could be seen that for composite rating of CAMELS, there was a
very small difference found between the ratings of conventional (2.78) and Islamic
(2.86) banks, where the result of two sample t-test indicated that there was no
significant difference between the two groups. Hence, it showed that the levels of
composite performance achieved by both conventional and Islamic banks in
Malaysia were highly similar. The same observation could be seen in the analysis for
the component of Asset Quality and also the ratio of Net Loans over Deposits and
Short Term Funding for the component of Liquidity. This showed that these qualities
were not the components that provided differences to the overall ratings for
conventional and Islamic banks.

Going further the six components, it was evident that Islamic banks were efficient in
maintaining its Liquidity rating, in the form of its Liquid Assets over Deposits and
Long Term Funding ratio (2.88), as compared to conventional banks (4.20). This
supported the findings of Haron and Abdul Rahman (2012) while being in contrary to
the study of Jaffar and Manarvi (2011), who found that Islamic banks were better in
maintaining Capital Adequacy and Asset Quality. This high rating of Liquid Assets
over Deposits and Long Term Funding ratio showed that even though Islamic
banking practices high confidence and beliefs without prejudice to discreet principles
in evaluating the feasibility of customers who need financing, the management has
high confidence that the bank’s own equity is able to cover bank deposit withdrawals
made by customers (Hasbi & Haruman 2011). By that, Islamic banks were shown to
have better liquidity positions and are better in managing one of the most critical
tasks in its operation (Haron & Abdul Rahman 2012).

41
 Rozzani & Rahman
In comparison to Islamic banks, conventional banks were significantly efficient in the
components of Capital Adequacy (1.92) and also Earnings Quality (1.92 and 3.25).
This showed that with respect of Capital Adequacy, conventional banks were
stronger in responding to balance sheet shocks such as liabilities payment,
operational and credit risks or any other loss. Meanwhile, with respect to Earnings
Quality, conventional banks had better investment decision in attracting more profit
for these banks and shareholders, hence showed lack of management ability
towards Islamic banks, where they were more focused on growth and expansion
strategies rather than profit-oriented strategies (Jaffar & Manarvi 2011). With the
significant values reached in the descriptive analysis between conventional and
Islamic banks, it is evident that both types of banks in Malaysia have interacted well
and provided steady competition in achieving their respective goals of establishment.

Table 4: Descriptive Analysis for Conventional and Islamic Banks’ CAMELS

Rating (2008-2011)
Conventional Islamic
Mean Standard Mean Standard Sig.
Deviation Deviation
Composite 2.78 0.479 2.86 0.500 0.318
Capital Adequacy 1.92 0.829 2.31 0.924 0.009***
Asset Quality 1.93 1.258 1.88 1.134 0.772
Management Quality 1.00 0.000 1.00 0.000 N/A*
Earnings Quality (Return on Assets) 1.92 0.829 4.13 1.327 0.000***
Earnings Quality (Return on Equity) 3.25 1.190 3.81 1.180 0.006***
Liquidity (Net Loans/Deposits and 4.36 1.467 4.39 1.364 0.884
Short Term Funding)
Liquidity (Liquid Assets/ Deposits 4.20 1.233 2.88 1.704 0.000***
and Long Term Funding)
Shariah Compliance N/A** N/A** 2.05 0.744 N/A**
* T-value cannot be computed because the standard deviations for both groups are 0
** T-value cannot be computed because at least one of the groups is empty
*** Value is significant to 1% value

As reported in Table 5, the statistical results indicated that all banks were rated as
being at Rate 2 until Rate 4. From that, most banks in the four years had achieved a
fair rate of 3, where only four banks had reached the lower ranking of 4 in the years
of analysis, which are AmBank (M) Berhad, Malayan Banking Berhad, Bank
Muamalat Malaysia Berhad, and also Kuwait Finance House (M) Berhad. Other than
that, it could also be seen that only Deustche Bank (M) Berhad achieved a
satisfactory composite rank of 2 for all years 2008 to 2011. On the surface, these
banks were rated fairly as intermediates, indicating that the banks were fairly good in
terms of their overall operations, although with major weaknesses in several aspects
that should be considered by the bank’s management for improvement in
subsequent years. These weaknesses that oversee the six components of Capital
Adequacy, Asset Quality, Management Quality, Earnings Quality, Liquidity and
Shariah Compliance, that were concerned to damage future capability to ensure
normal growth and development, hence requiring supervisory concern by the top
management of the banks. This is because these weaknesses, being added to the
presently high competition, deregulation of interest rates, reforms in priority sector
lending, and improvement of banking services, could pull the banks towards
bankruptcy if they are not being well managed (Kambhamettu 2012).

42
 Rozzani & Rahman
Table 5: Distribution of CAMELS Composite Rating (2008-2011)
Rate Frequency Percentage
1 0 0.0%
2 32 22.9%
3 102 72.9%
4 6 4.3%
5 0 0.0%

5. Summary and Conclusions

From the analysis of CAMELS rating, the component of Management Quality (1.00)
was found to be the component that had achieved an overall best rating in the
study’s data samples. This was closely followed by the components of Asset Quality
(1.91), Shariah Compliance (2.05), Capital Adequacy (2.10), Earnings Quality (2.93
and 3.51) and Liquidity (3.59 and 4.37). This was found to be different from the
findings of Babar and Zeb (2011), also Sarwar and Asif (2011) in Pakistan, where
the component of Capital Adequacy achieved the best rating. The contradiction in
the outcome of the studies between these two countries show that the economic
environment in both Pakistan and Malaysia is indeed influencing CAMELS
performance analysis, where the environment of Malaysia had strongly emphasized
on the management quality of an organisation, while Pakistan stressed on the
strength of capital in their organisation.

It could also be seen that the aspects of Earnings Quality and Liquidity needed to be
put to emphasize by bank regulators since these two elements had pictured these
banks into having poor management of earnings and liquidity. The weak rating to the
component of Earnings Quality could be caused by banks’ rigid lending policies and
strict lending criteria (Sarwar & Asif 2011). That being added with the lack of proper
management due to staff experience, Islamic banks would find it more difficult to
earn their part of earnings in a large conventional environment. For the component
of Liquidity, the weak rating displays unbalanced mixture of liquid and non-liquid
assets. By that, the management should design better strategies of liabilities and
asset management, as banks should be able to meet its liability obligations in times
when demand arises (Sangmi & Nazir 2010).

Confidentiality of data had been found to be a setback to this study. There are many
other ratios that could be used in assessing the CAMELS rating, but is restricted
from being utilized in the study due to its confidentiality issue, where it was an
obstacle to obtain certain types of material. Hence, the study could only rely on ratios
that make use of data that are publicly available in the banks’ websites.

Nevertheless, this study had contributed to the literature in the sense that this study
has made use of CAMELS rating. By that, it could be seen that this methodology had
been closely related in evaluating a bank’s financial health, in terms of performance.
The results of analysis could also increase public trust, influence an increase in
savings through the bank’s excess funds, and also encourage an increment of new
customer numbers which influence on increasing depositor funds in Islamic banks.
Hence, future researches could place focus on other types of financial institutions
such as investment banks, mutual funds and insurance companies. By that, the
difference of how these industry gain effectiveness could be evaluated and the
management could improve by taking notes of lessons learned by these different
industries. Other than that, results obtained from the analysis of CAMELS ratings

43
 Rozzani & Rahman
could be put into comparison with other international regulatory rating systems to
investigate the suitability of the adaption of the rating to the local banking industry.

Acknowledgement

The authors would like to express their gratitude to Accounting Research Institute
(ARI), Universiti Teknologi MARA (UiTM) for providing the financial means and
facilities. This article would not have been possible without the support of the grant
provider, family members, and friends.

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