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CAMELS MODEL Analysis on Banking Sector.

CAMELS MODEL Analysis on Banking Sector.

  1. 1. A Camel Model Analysis on BOB, CUB, South Indian Bank and Dhanlaxmi bank Sub Name: Banking Slot: G1 Faculty Name: Prof.S.S.Shanthakumari Submitted by: S. Ranganathan-14MBA0129 C.Nirmalraj-14MBA0111 P.Yuvaraj-14MBA0041 D.Hariharan-14MBA0003
  2. 2. Introduction to CAMELS models During an on-site bank exam, supervisors gather private information, such as details on problem loans, with which to evaluate a bank's financial condition and to monitor its compliance with laws and regulatory policies. A key product of such an exam is a supervisory rating of the bank's overall condition, commonly referred to as a CAMELS rating. This rating system is used by the three federal banking supervisors (the Federal Reserve, the FDIC, and the OCC) and other financial supervisory agencies to provide a convenient summary of bank conditions at the time of an exam. The acronym "CAMEL" refers to the five components of a bank's condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. A sixth component, a bank's Sensitivity to market risk was added in 1997; hence the acronym was changed to CAMELS .Ratings are assigned for each component in addition to the overall rating of a bank's financial condition. The ratings are assigned on a scale from 1 to 5. Banks with ratings of 1 or 2 are considered to present few, if any, supervisory concerns, while banks with ratings of 3, 4, or 5 present moderate to extreme degrees of supervisory concern. In 1994, the RBI established the Board of Financial Supervision (BFS), 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 sub-committee to routinely examine auditing practices, quality, and coverage. In addition to the normal on-site inspections, Reserve Bank of India also conducts off-site surveillance which particularly focuses on the risk profile of the supervised entity. The Off-site Monitoring and Surveillance System (OSMOS) were introduced in 1995 as an additional tool for supervision of commercial banks. It was introduced with the aim to supplement the on-site inspections. Under off-site system, 12 returns (called DSB returns) are called from the financial institutions, which focus on supervisory concerns such as capital adequacy, asset
  3. 3. quality, large credits and concentrations, connected lending, earnings and risk exposures (viz. currency, liquidity and interest rate risks). In 1995, RBI had set up a working group under the chairmanship of Shri S. Padmanabhanto review the banking supervision system. The Committee 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 systems and control elements 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. All exam materials are highly confidential, including the CAMELS. A bank's CAMELS rating is directly known only by the bank's senior management and the appropriate supervisory staff. CAMELS ratings are never released by supervisory agencies, even on a lagged basis. While exam results are confidential, the public may infer such supervisory information on bank conditions based on subsequent bank actions or specific disclosures. Overall, the private supervisory information gathered during a bank exam is not disclosed to the public by supervisors, although studies show that it does filter into the financial markets. S – Sensitivity to Market Risk: It refers to the risk that changes in market conditions could adversely impact earnings and/or capital. Market Risk encompasses exposures associated with changes in interest rates, foreign exchange rates, commodity prices, equity prices, etc. While all of these items are important, the primary risk in most banks is interest rate risk (IRR), which will be the focus of this module. The diversified nature of bank operations makes them vulnerable to various kinds of financial risks. Sensitivity analysis reflects institution’s exposure to interest rate risk, foreign exchange volatility and equity price risks (these risks are summed in market risk). Risk sensitivity is mostly evaluated in terms of management’s ability to monitor and control market risk. Banks are increasingly involved in diversified operations, all of which are subject to market risk, particularly in the setting of interest rates and the carrying out of foreign exchange transactions. In countries that allow banks to make trades in stock markets or
  4. 4. commodity exchanges, there is also a need to monitor indicators of equity and commodity price risk. Interest Rate Risk: In the most simplistic terms, interest rate risk is a balancing act. Banks are trying to balance the quantity of reprising assets with the quantity of reprising liabilities. For example, when a bank has more liabilities reprising in a rising rate environment than assets reprising, the net interest margin (NIM) shrinks. Conversely, if your bank is asset sensitive in a rising interest rate environment, your NIM will improve because you have more assets reprising at higher rates. Liquidity risk: Liquidity risk is financial risk due to uncertain liquidity. An institution might lose liquidity if its credit rating falls, it experiences sudden unexpected cash outflows, or some other event causes counterparties to avoid trading with or lending to the institution. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. Business risk: Business risk is managed with a long-term focus. Techniques include the careful development of business plans and appropriate management oversight. Book-value accounting is generally used, so the issue of day-to-day performance is not material. The focus is on achieving a good return on investment over an extended horizon. Market risk is managed with a short-term focus. Long-term losses are avoided by avoiding losses from one day to the next. On a tactical level, traders and portfolio managers employ a variety of risk metrics —duration and convexity, the Greeks, beta, etc.—to assess their exposures. These allow them to identify and reduce any exposures they might consider excessive. On a more strategic level, organizations manage market risk by applying risk limits to traders' or portfolio managers' activities. Increasingly, value-at-risk is being used to define and monitor these limits. Some organizations also apply stress testing to their portfolios
  5. 5. CAPITAL ADEQUACY It is important for a bank to maintain depositors’ confidence and preventing the bank from going bankrupt. It reflects the overall financial condition of banks and also the ability of management to meet the need of additional capital. The following ratios measure capital adequacy:  Capital Adequacy Ratio (CAR): The capital adequacy ratio is developed to ensure that banks can absorb a reasonable level of losses occurred due to operational losses and determine the capacity of the bank in meeting the losses. As per the latest RBI norms, the banks should have a CAR of 9 per cent.  Debt-Equity Ratio (D/E): This ratio indicates the degree of leverage of a bank. It indicates how much of the bank business is financed through debt and how much through equity.  Advance to Assets Ratio (Adv/Ast): This is the ratio indicates a bank’s aggressiveness in lending which ultimately results in better profitability.  Government Securities to Total Investments (G-sec/Inv): It is an important indicator showing the risk-taking ability of the bank. It is a bank’s strategy to have high profits, high risk or low profits, low risk.
  6. 6. Table 1: Composite Ranking of Banks in Capital Adequacy: BANK Capital Adequacy Ratio Advance To Assets Debt-Equity Ratio (D/E) Government Securities To Total Investment Group Rank AVG RANK AVG RANK AVG RANK AVG RANK AVG RANK BOB 14.05 2 63.78 3 15.9 3 77.88 2 2.5 2 South Indian Bank 12.01 3 63.25 4 6.2 1 73.88 4 3 3.5 Dhanlaxmi bank 9.59 4 76.99 1 17.11 4 76.02 3 3 3.5 CUB 16.52 1 64.45 2 8.93 2 86.2 1 1.5 1 From table 1, on the basis of group averages of four sub-parameters of Capital Adequacy, CUB Bank is at the top position with group average of 1.5, followed by BOB is second position and South Indian bank, Dhanlaxmi bank stood at the last position due to its poor performance in CAR, Advances to assets and also due to less investment in Govt. Securities.
  7. 7. ASSETS QUALITY: The quality of assets is an important parameter to gauge the strength of bank. The prime motto behind measuring the assets quality is to ascertain the component of non-performing assets as a percentage of the total assets. The ratios necessary to assess the assets quality are:  Net NPAs to Total Assets (NNPAs/TA): This ratio discloses the efficiency of bank in assessing the credit risk and, to an extent, recovering the debts. Net NPA to Total Asset = Net NPA/ Total Asset  Net NPAs to Net Advances (NNPAs/NA): It is the most standard measure of assets quality measuring the net non-performing assets as a percentage to net advances. Net NPA to Total Advances = Net NPA/ Total Loan  Total Investments to Total Assets (TI/TA): It indicates the extent of deployment of assets in investment as against advances. Total investment to Total Asset=Total Inv/Total Assets  Gross NPA to Total Advances: This ratio is used to check whether the bank's gross NPAs are increasing quarter on quarter or year on year. If it is, indicating that the bank is adding a fresh stock of bad loans. It would mean the bank is either not exercising enough caution when offering loans in terms of following up with borrowers on timely repayments. Gross NPA to Total Advances = Gross NPA/ Total Loan  Advances Yield Ratio: Yield on advances, is another important ratio, which helps us to measure the quality of advances. Here yield means interest income received on the advances of the bank. Increases in advance yield ratio is an indicator of sound asset quality. Advances Yield Ratio = Interest income on advances / Total advances
  8. 8. Table 2: Composite Ranking of Banks in Asset Quality: BANK NAME Net NPA to Total Advances Net NPA to Total Asset Gross NPA to Total Advances Advance d Yield Ratio Total investment to Total Asset Group Rank AVG RANK AVG RANK AVG RANK AVG RANK AVG RANK AVG RANK BOB .41 1 1.45 3 1.27 9 1 .75 4 27 2 2.2 2..5 South Indian Bank .96 2 .60 1 1.71 2 0.11 1 28 3 1.8 1 Dhanlaxmi bank 3.29 4 1.76 4 7.00 4 0.59 3 33 4 3,8 4 CUB 1.30 3 1.23 2 1.86 3 .45 2 22.83 1 2.2 2.5 From table 2, on the basis of group averages of sub-parameters of assets quality, South Indian Bank had the highest rank, followed by CUB and BOB .Dhanlaxmi bank was positioned last in terms of Assets Quality.
  9. 9. Management Efficiency Management efficiency is another important element of the CAMEL Model. The ratio in this segment involves subjective analysis to measure the efficiency and effectiveness of management. The ratios used to evaluate management efficiency are described as  Total Advance to Total Deposits: This ratio measures the efficiency and ability of the banks management in converting the deposits available with the banks (excluding other funds like equity capital, etc.) into high earning advances. Total deposits include demand deposits, saving deposits, term deposit and deposit of other bank. Total advances also include the receivables. Total Advance to Total Deposits=Total Advance/ Total Deposit  Profit per Employee: This ratio shows the surplus earned per employee. It is arrived at by dividing profit after tax earned by the bank by the total number of employee. The higher the ratio shows better management efficiency. Profit per Employee =Profit after Tax/ No. of Employees  Business per Employee: Revenue per employee is a measure of how efficiently a particular bank is utilizing its employees. Ideally, a bank wants the highest business per employee possible, as it denotes higher productivity. In general, rising revenue per employee is a positive sign that suggests the bank is finding ways to squeeze more sales/revenues out of each of its employee. Business per Employee =Total Income/ No. of Employees
  10. 10. Table 3: Composite Ranking of Banks in Management Efficiency: BANK NAME Total Advances to Total Deposits Profit per Employee Business per Employee Group Rank AVG RANK AVG RANK AVG RANK AVG RANK BOB 74.83 1 6.04 1 23.98 1 1 1 South Indian Bank 72% 3 0.04 3 11.54 2 2.6 3 Dhanlaxmi bank 61% 4 -10.6 4 8.99 4 4 4 CUB 74% 2 0.09 2 9.65 3 2.3 2 From table 3, on the basis of group averages of three sub-parameters of Management Efficiency BOB is at the top position with group average of 1, followed by CUB and South Indian Bank. Dhanlaxmi bank bank stood at the last position due to its poor performance in Business per Employee and Profit per Employee respectively.
  11. 11. Earning Quality The quality of earnings is a very important criterion that determines the ability of a bank to earn consistently. It basically determines the profitability of bank and explains its sustainability and growth in earnings in future. The following ratios explain the quality of income generation.  Spread to Total Asset: It is the difference between the interest income and interest expended as percentage of total assets. Interest expended includes interest paid on deposits. Spread indicates a bank`s ability to with stand pressure on margins and higher the spread, the better. Total asset = (interest income – interest Expended / total asset)*100  % Growth in Net profit: Net profits are obtained after deducting income tax and if net profit is not sufficient, the firm shall not be able to achieve a satisfactory return on investment. Growth in net profit helps the bank to face adverse economic conditions. Percentage growth in net profit can be found out by using the following formula . % Growth in Net profit =  Dividend payout ratio: Dividend payout ratio shows the percentage of profit shared with the shareholders. The more the ratio will increase the goodwill of the bank in the share market. Dividend pay out ratio = Dividend/ Net profit  Interest income to Total Income: Interest income is a basic source of revenue for banks. The interest income total income indicates the ability of the bank in generating income from its lending. In other words, this ratio measures the income from lending operations as a percentage of the total income generated by the bank in a year. Interest income includes income on advances, interest on deposits with the RBI, and dividend income. Interest income to Total Income = Interest Income/ Total Income
  12. 12. Table 4: Composite Ranking of Banks in Earning Quality BANK NAME Interest Spread % Growth in Net profit Dividend Per Share Interest income to Total income Group Rank AVG RANK AVG RANK AVG RANK AVG RANK AVG RANK BOB 5.47% 4 25.16 2 3.20 1 .9070 3 2.5 2.5 South Indian Bank 6.90% 3 39.4 1 .60 3 .9145 2 2.25 1 Dhanlaxmi bank 9.34% 1 -4.14 4 0 4 0.9379 1 2.5 2.5 CUB 7.22 2 13.8 3 1.10 2 0.8697 4 2.75 4 From table 4, on the basis of group averages of 4 sub-parameters of Earnings Quality, South Indian Bank is at the top followed by Dhanlaxmi Bank and BOB. CUB was at the last position due to poor performance in Interest income to Total income.
  13. 13. Liquidity: Risk of liquidity is curse to the image of bank. Bank has to take a proper care to hedge the liquidity risk; at the same time ensuring good percentage of funds are invested in high return generating securities, so that it is in a position to generate profit with provision liquidity to the depositors. The following ratios are used to measure the liquidity:  Liquidity Asset to Total Asset: Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions. Liquid assets include cash in hand, balance with the RBI, balance with other banks (both in India and abroad), and money at call and short notice. Total asset include the revaluations of all the assets. The proportion of liquid asset to total asset indicates the overall liquidity position of the bank. Liquidity Asset to Total Asset = Liquidity Asset/ Total Asset  Liquidity Assets to Total Deposits: This ratio measures the liquidity available to the deposits of a bank. Total deposits include demand deposits, savings deposits, term deposits and deposits of other financial institutions .Liquid assets include cash in hand, balance with the RBI, balance with other banks (both in India and abroad), and money at call and short notice. Liquidity Asset to Total Deposits = Liquidity Asset/ Total Deposit  Government securities Total Asset Government Securities are the most liquid and safe investments. This ratio measures the government securities as a proportion of total assets. Banks invest in government securities primarily to meet their SLR requirements, which are around 25% of net demand and time liabilities. This ratio measures the risk involved in the assets hand by a bank. Government security Total Asset = Government Securities/ Total Asset
  14. 14. Table 5: Composite Ranking of Banks in Liquidity: BANK NAME Liquidity Asset to Total Asset Liquidity Asset to Total Deposits Government security Total Asset Group Rank AVG RANK AVG RANK AVG RANK AVG RANK BOB .2074 2 .2467 2 0.4250 1 1.7 1.5 South Indian Bank .6081 1 .6925 1 .2089 3 1.7 1.5 Dhanlaxmi bank .0898 3 .1059 3 0.2569 2 2.7 3 CUB 0.091 4 .1053 4 0.1968 4 4 4 From table 5, on the basis of group averages of 3 sub-parameters of Liquidity, South Indian Bank and BOB was at the top followed by Dhanlaxmi bank. CUB was at the last position.
  15. 15. OVERALL RANKING As stated in initial part of this paper, CAMEL model is used to rating the banks according to their performance. Table-6: Composite ranking: Overall Performance Name Of Bank C A M E L Avg Rank BOB 2 2.5 1 2.5 1.5 1.9 1 South Indian Bank 3.5 1 3 1 1.5 2 2 Dhanlaxmi bank 3.5 4 4 2.5 3 3.4 4 CUB 1 2.5 2 4 4 2.7 3 Conclusion: CAMEL approach is significant tool to assess the relative financial strength of a bank and to suggest necessary measures to improve weaknesses of a bank. In India, RBI adopted this approach in 1996 followed on the recommendations of Padmanabham Working Group (1995) committee. It is clear from table no 6 that BOB is ranked at top position with composite average 1.9, followed by South Indian Bank (2), Punjab CUB (2.7). Dhanlaxmi bank was at the bottom most position. A good bank is not only the financial heart of the community, but also one
  16. 16. with an obligation of helping in every possible manner to improve the economic conditions of the common people. References:  BOB Annual Report-15  CUB annual Report-15  South Indian Bank Annual Report-15  Dhanlaxmi bank Annual Report-15  Moneycontrol.com  Dr. K. Sriharsha Reddy, Relative Performance of Commercial Banks in India using Camel Approach, The Research Journal of Economics and Business Studies,ISSN:2251-1555  K.V.N. Prasad, G. Ravinder, A Camel Model Analysis of Nationalized Banks in India, ( 2012), International Journal of Trade and Commerce, Volume 1, No. 1, pp. 23-33 ISSN- 2277-5811

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