A CAMELS ANALYSIS OF THE INDIAN BANKING INDUSTRY

MIHIR DASH1 ANNYESHA DAS

INTRODUCTION The banking sector occupies a very important place in the countrys economy, acting as an intermediary to all industries, ranging from agriculture, construction, textile, manufacturing, and so on. The banking sector thus contributes directly to national income and its overall growth. As the banking sector has a major impact on the economy as a whole, evaluation, analysis, and monitoring of its performance is very important. Many methods are employed to analyse banking performance. One of the popular methods is the CAMELS framework, developed in the early 1970s by federal regulators in the USA. The CAMELS rating system is based upon an evaluation of six critical elements of a financial institutions operations: Capital adequacy, Asset quality, Management soundness, Earnings and profitability, Liquidity, and Sensitivity to market risk. Under this bank is required to enhance capital adequacy, strengthen asset quality, improve management, increase earnings, maintain liquidity, and reduce sensitivity to various financial risks.

LITERATURE REVIEW The analysis of banking performance has received a great deal of attention in the banking literature. A popular framework used by regulators is the CAMELS framework, which uses some financial ratios to help evaluate a banks performance (Yue, 1992). Several studies involve the use of ratios for banks performance appraisal, including Beaver (1966), Altman (1968), Maishanu (2004), and Mous (2005). Beaver (1966) initiated the use of financial ratios for predicting bankruptcy, considering only one ratio at a time. Altman (1968) went further, using a multiple discriminant analysis (MDA) for the same purpose, combining several financial ratios in a single prediction model called the Altmans z-score model. However, Altmans model ignored the industry-specificity of healthy indications by the financial ratios. Maishanu (2004) studied financial health of banks, and suggested eight financial ratios to diagnose the financial state of a bank. Mous (2005) studied bankruptcy prediction models of banks using financial ratios of profitability, liquidity, leverage, turnover and total assets in decision tree models and multiple discriminant models, and found that the decision tree approach performed better. The CAMEL framework was originally intended to determine when to schedule onsite examination of a bank (Thomson, 1991; Whalen and Thomson, 1988). The five CAMEL factors, viz. Capital adequacy, Asset quality, Management soundness, Earnings and profitability, and Liquidity, indicate the increased likelihood of bank

The first author is a senior faculty at Alliance Business School, No. 2 & 3, 2nd Cross, 36th Main, BTM Layout, I Stage, Bangalore-560068, and can be contacted by phone on +91-9945182465, or by email at mihirda@rediffmail.com. The other author is a research scholar at the same institution.

Electronic copy available at: http://ssrn.com/abstract=1666900

failure when any of these five factors prove inadequate. The choice of the five CAMEL factors is based on the idea that each represents a major element in a banks financial statements. Several studies provide explanations for choice of CAMEL measures: Lane et al. (1986), Looney et al. (1989), Elliott et al (1991), Eccher et al. (1996), and Thomson (1991). For example, Waldron et al (2006) suggested that one of these threats represented in CAMEL exists in the loss of assets (A); similarly, short-term liquid assets (L) aid in covering loan payment defaults and offset the threat of losses or large withdrawals that might occur. The CAMELS framework extends the CAMEL framework, considering six major aspects of banking: Capital adequacy, Asset quality, Management soundness, Earnings and profitability, Liquidity, and Sensitivity to market risk. The usage of the CAMEL(S) framework in banking studies in emerging economies is limited. Wirnkar and Tanko (2008) studied banking performance of major Nigerian banks using the CAMEL framework. Very recently, Sangmi and Nazir (2010) have studied banking performance of two Indian banks using the CAMEL framework. Also, Agarwal and Sinha (2010) have studied the performance of microfinance institutions in India using the CAMEL framework. The present study analyses and compares the performance of public and private/foreign banks in India using the CAMELS framework.

DATA AND METHODOLOGY The analysis was performed for a sample of fifty-eight banks operating in India, of which twenty-nine were public sector banks, and twenty-nine were private sector/foreign banks. The study covered the financial years 2003-04, 2004-05, 200506, 2006-07, and 2007-08 (i.e. prior to the global financial crisis). The data for the study consisted of financial variables and financial ratios based on the CAMELS framework, obtained from the Capitaline database. The variables used in the analysis were: Tier-I Capital, Tier-II Capital, and Capital Adequacy Ratio (for Capital Adequacy); Gross Non-performing Assets, Net Non-performing Assets, and Net Nonperforming Assets to Total Advances Ratio (for Asset Quality); Total Investments to Total Assets Ratio, Total Advances to Total Deposits Ratio, Sales per Employee, and Profit After Tax per Employee (for Management Soundness); Return on Net Worth, Operating Profit to Average Working Fund Ratio, Profit After Tax to Total Assets Ratio (for Earnings and profitability); Government Securities to Total Investments Ratio and Government Securities to Total Assets Ratio (for Liquidity); and Beta (for Sensitivity to Market Risk). In order to calculate the CAMELS ratings for the banks, the ratios corresponding to each CAMELS factor were considered: viz. Capital Adequacy Ratio, Net Nonperforming Assets to Total Advances Ratio, Total Investments to Total Assets Ratio, Total Advances to Total Deposits Ratio, Sales per Employee, Profit After Tax per Employee, Return on Net Worth, Operating Profit to Average Working Fund Ratio, Government Securities to Total Investments Ratio, and Beta (two ratios, viz. Profit After Tax to Total Assets Ratio and Government Securities to Total Investments Ratio were removed). The variables were normalized using the formula: , where u represents the upper bound, and l the lower bound; the ratings were assigned as follows: 1 = 0.0 - 0.2, 2 = 0.2 - 0.4, 3 = 0.4 - 0.6, 4 = 0.6 - 0.8, and 5 = 0.8 - 1.0 (except for non-performing assets and beta, for which the ratings were reversed). The CAMELS rating was obtained as the total of the individual variable ratings.
2

Electronic copy available at: http://ssrn.com/abstract=1666900

ANALYSIS AND INTERPRETATION CAPITAL ADEQUACY: Table 1 shows the Tier-I Capital, Tier-II Capital, and Capital Adequacy Ratio of public and private/foreign banks. It was found that private/foreign banks had higher Tier-I Capital than public sector banks, while public sector banks had higher Tier-II Capital than private/foreign banks. It was also found that private/foreign banks had higher Capital Adequacy Ratio than public sector banks. In particular, these differences were statistically significant in 2008. ASSET QUALITY: Table 2 shows the Gross Non-performing Assets, Net Nonperforming Assets, and Net Non-performing Assets to Total Advances Ratio of public and private/foreign banks. It was found that public sector banks had higher Gross Non-performing Assets and Net Non-performing Assets than private/foreign banks, and that these differences were statistically significant. On the other hand, there was no significant difference in the Net Non-performing Assets to Total Advances Ratio of public and private/foreign banks. MANAGEMENT SOUNDNESS: Table 3 shows the Total Investments to Total Assets Ratio, Total Advances to Total Deposits Ratio, Sales per Employee, and Profit After Tax per Employee of public and private/foreign banks. It was found that private/foreign banks had higher Total Investments to Total Assets Ratio than public sector banks, while public sector banks had higher Total Advances to Total Deposits Ratio than private/foreign banks; however, these differences were not statistically significant. It was found that private/foreign banks had higher Sales per Employee than public sector banks, and that these differences were statistically significant. It was also found that private/foreign banks had higher Profit After Tax per Employee than public sector banks, but that these differences were not statistically significant. EARNINGS AND PROFITABILITY: Table 4 shows the Return on Net Worth, Operating Profit to Average Working Fund Ratio, Profit After Tax to Total Assets Ratio of public and private/foreign banks. It was found that public sector banks had higher Return on Net Worth than private/foreign banks, and that these differences were statistically significant. On the other hand, it was found that private/foreign banks had higher Operating Profit to Average Working Fund Ratio and Profit After Tax to Total Assets Ratio than public sector banks, though the differences were not statistically significant. LIQUIDITY: Table 5 shows the Government Securities to Total Investments Ratio and Government Securities to Total Assets Ratio of public and private/foreign banks. It was found that public sector banks had higher Government Securities to Total Investments Ratio and Government Securities to Total Assets Ratio than private/foreign banks (except in 2008), but the differences were not statistically significant. SENSITIVITY TO MARKET RISK: Table 6 shows the Beta of public and private/foreign banks. It was found that public sector banks had higher Beta than private/foreign banks, and the difference was statistically significant. OVERALL CAMELS RATINGS: Table 7 shows the overall CAMELS ratings for all the sample banks in the study period. It was found that Barclays Bank was the best performing bank in the years 2003-04, 2004-05, and 2005-06, while Bank of America was the best performing bank in the years 2006-07 and 2007-08. Table 8 shows the overall CAMELS ratings of public and private/foreign banks. There was found to be no significant difference in the overall CAMELS ratings of
3

public and private/foreign banks. Moreover, there was a trend improvement in the overall CAMELS ratings of private/foreign banks over that of public sector banks.

DISCUSSION The results of the study show that private/foreign banks fared better than public sector banks on most of the CAMELS factors in the study period. The two contributing factors for the better performance of private/foreign banks were Management Soundness and Earnings and Profitability. The results of the study suggest that public sector banks have to adapt quickly to changing market conditions, in order to compete with private/foreign banks. This is particularly due to the wide difference in their credit policy, customer service, ease of access and adoption of IT services in their banking system. Public sector banks must improve their credit lending policies so as to improve asset quality and profitability. They need to continuously monitor the health and profitability of bank borrowers, so that the risk of non-performing assets decreases. They also must improve their marketing and distribution strategies in order to attract customers and provide better customer service. They also must take steps to improve employee motivation and productivity. There are some limitations inherent in the present study. The sample size used for the study is limited. Further, the study period was limited due to the limited availability of data. Another limitation was in the nature of the overall CAMELS rating used: the rating gives undue importance to the factors of management soundness and earnings. Further, the CAMELS framework is not a comprehensive framework; for example, it does not take into consideration other forms of risk (such as credit risk). Further studies can incorporate other risk factors into the framework to provide a more comprehensive measure of banking performance.

BIBLIOGRAPHY Agarwal, P.K. and Sinha, S.K. (2010), Financial Performance of Microfinance Institutions of India, Delhi Business Review, 11(2). Altman, I.E. (1968), Financial Ratios, Discriminant Analysis and Prediction of Corporate Bankruptcy, Journal of Finance, September 1968, New York University. Eccher, E. A., Ramesh K., and Thiagarajan S. R. (1996), Fair value disclosures by bank holding companies, Journal of Accounting and Economics, 22(1). Elliott, J. A., Douglas, H. L. J., and Shaw, W. H. (1991), The Evaluation by the Financial Markets of Changes in Bank Loan Loss Reserve Levels, The Accounting Review, 66(4). Lane, W. R., Looney, S. W., and Wansley J. W. (1986), An Application of the Cox Proportional Hazards Model to Bank Failure, Journal of Banking and Finance, 10(4). Looney, S. W., Wansley, J. W., and Lane, W. R. (1989), An Examination of Misclassifications with Bank Failure Prediction Models, Journal of Economics and Business, 41(4). Maishanu, M.M. (2004), A Univariate Approach to Predicting failure in the Commercial Banking Sub-Sector, Nigerian Journal of Accounting Research, Vol. 1, No. 1.

Mous, L. (2005), Predicting bankruptcy with discriminant analysis and decision tree using financial ratios, Working Paper Series, University of Rotterdam. Sangmi, M. and Nazir, T. (2010), Analyzing Financial Performance of Commercial Banks in India: Application of CAMEL Model, Pak. J. Commer. Soc. Sci., 4(1) Thomson, J. B. (1991), Predicting Bank Failures in the 1980s, Federal Reserve Bank of Cleveland Economic Review, 27. Waldron, M., Jordan, C., and MacGregor, A. (2006), the Information Content of Loan Default Disclosure in the Prediction of Bank Failure, Journal of Business & Economic Research, 4(9). Whalen, G. and Thomson, J. B. (1988), Using Financial Data to Identify Changes in Bank Conditioning. Federal Reserve Bank of Cleveland, Economic Review, 24(1), 17-26. Wirnkar, A.D. and Tanko, M. (2008), CAMELS and Banks Performance Evaluation: The Way Forward, Working Paper Series, SSRN: http://ssrn.com/abstract=1150968 Yue, P. (1992), Data Envelopment Analysis and Commercial Bank Performance: A Primer with Applications to Missouri Banks, Working Papers, IC2 Institute, University of Texas at Austin.

Table 1: Capital Adequacy

mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value 2004 private/foreign 13.5043 8.1287 3.4700 0.0678 3.9157 2.3999 2.1903 0.1446 16.4231 8.0232 1.0960 0.3000 public 9.8710 6.5372 2005 private/foreign 12.9090 10.8474 2.7100 0.1050 3.1341 1.4922 11.6720 0.0010 16.0431 10.7070 1.1810 0.2820 public 9.0603 6.3911 2006 private/foreign 13.2128 11.8815 1.7730 0.1880 2.7790 1.9754 0.8400 0.3630 15.7955 11.2442 1.3520 0.2500 public 10.0245 5.0085 2007 private/foreign 11.9670 7.6960 3.7490 0.0580 2.4824 1.8280 12.4560 0.0010 14.4490 6.7998 1.2650 0.2650 public 8.8720 3.8540 2008 private/foreign 12.9999 8.6535 11.3160 0.0010 2.2703 1.7239 23.7420 0.0000 15.2693 7.9247 5.2690 0.0250 public 7.4134 2.2510

Tier I Capital

Tier II Capital

4.6717 1.3222

4.5121 1.5782

3.1648 1.1115

4.0307 1.4965

4.3148 1.4608

Capital Adequacy Ratio

14.5241 5.5702

13.5724 5.9343

13.1893 4.3927

12.9028 2.9257

11.7283 2.4937

Table 2: Asset Quality

mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value 2004 private/foreign 287.3079 553.9922 10.2250 0.0020 69.4252 70.3939 8.5950 0.0050 2.3745 2.3914 0.1650 0.6860 public 1770.2390 2435.2389 2005 private/foreign 281.9297 507.3847 9.9130 0.0030 129.7760 276.3352 5.6950 0.0200 2.4066 4.4495 0.3850 0.5380 public 1663.5238 2307.9851 2006 private/foreign 243.1379 421.4886 11.9840 0.0010 104.1886 202.7454 5.4730 0.0230 1.0200 1.0940 0.5440 0.4640 public 1420.7266 1782.7094 2007 private/foreign 326.7738 760.6410 7.7810 0.0070 145.8483 371.3168 4.0910 0.0480 0.7521 0.7459 0.6450 0.4250 public 1356.8621 1837.4099 2008 private/foreign 470.4955 1389.6714 3.4770 0.0670 206.8386 641.0819 2.1510 0.1480 0.6414 0.5918 0.3570 0.5520 public 1409.5845 2328.8894

Gross Nonperforming Assets Net Nonperforming Assets Net Nonperforming Assets: Total Advances

642.1021 1049.5997

585.7270 991.0549

502.4679 894.0809

530.5334 954.5044

614.0869 1350.9161

2.6279 2.3650

1.8617 1.6081

1.2028 0.7646

0.8879 0.5230

0.7259 0.4786

Table 3: Management Soundness

2004 private/foreign 33.9520 13.8621 3.5430 0.0650 63.2424 42.5020 1.4080 0.2400 5.7541 4.0709 20.5840 0.0000 0.1752 0.3995 1.2520 0.2680 public 39.9900 10.3075 2005 private/foreign 34.0070 8.9716 0.7490 0.3910 73.2493 49.6188 1.1410 0.2900 6.2979 4.1143 13.3210 0.0010 0.1466 0.3342 0.8500 0.3600 public 36.0970 9.4176 2006 private/foreign 30.0930 8.0381 0.0140 0.9070 77.0934 43.2790 1.0040 0.3210 6.8490 4.3031 9.5630 0.0030 0.1862 0.5104 1.0910 0.3010 public 29.8450 8.1042 2007 private/foreign 29.7030 7.7604 2.9240 0.0930 84.7807 63.4981 0.9940 0.3230 7.3938 4.4179 8.5470 0.0050 0.1286 0.1929 0.5480 0.4620 public 26.3860 6.9939 2008 private/foreign 28.4069 13.3129 2.3100 0.1340 77.8710 46.3586 1.0080 0.3200 8.9931 5.9585 6.1570 0.0160 0.1548 0.2529 0.8940 0.3490 public 24.0517 7.8020

Total Investments: Total Assets Total Advances: Total Deposits Sales per Employee

Profit After Tax per Employee

mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value

105.0652 185.0132

117.5234 217.6143

2040.2352 10549.0729

1285.3172 6484.2471

580.3107 2694.3073

2.2328 0.9473

3.1010 2.3069

3.8903 2.8337

4.6790 2.3429

5.9145 3.0223

0.0800 0.2241

0.0755 0.2459

0.0762 0.2474

0.0845 0.2566

0.0897 0.2718

Table 4: Earnings and Profitability

mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value 2004 private/foreign 15.8445 11.1593 11.1680 0.0010 3.2338 2.9614 0.0760 0.7830 1.3676 1.1553 0.0200 0.8880 public 25.3186 10.4188 2005 private/foreign 9.6024 7.8660 14.7310 0.0000 2.0593 1.4878 1.1750 0.2830 0.6969 1.2869 1.3140 0.2570 public 18.2507 9.2394 2006 private/foreign 11.0345 6.4684 5.5830 0.0220 2.8607 3.0354 2.1950 0.1440 1.3597 1.9140 1.5230 0.2220 public 15.2852 7.2117 2007 private/foreign 12.7783 7.3289 8.0940 0.0060 2.9145 1.7458 8.1210 0.0060 1.4172 1.0914 4.2360 0.0440 public 17.6931 5.7299 2008 private/foreign 12.8828 6.9565 13.8410 0.0000 3.0662 1.8654 12.6360 0.0010 1.4214 0.9207 6.1050 0.0170 public 19.2259 5.9922

Return on Net Worth

Operating Profit: Average Working Fund Profit After Tax: Total Assets

3.0772 0.7279

2.3969 0.7739

2.0186 0.3934

1.9734 0.3383

1.7824 0.5503

1.3348 0.4765

0.9907 0.4988

0.9110 0.4114

0.9879 0.2657

0.9731 0.3269

Table 5: Liquidity
2004 private/foreign 72.2450 23.0563 1.5740 0.2150 26.0970 11.6054 4.3020 0.0430 public 78.7110 15.4482 2005 private/foreign 74.4170 13.4782 11.6720 0.0010 25.4720 9.2848 1.7000 0.1980 public 79.3930 20.0318 2006 private/foreign 75.8070 10.3587 4.3570 0.0410 22.4520 4.1967 2.2780 0.1370 public 81.6790 11.0560 2007 private/foreign 71.9720 17.9599 5.7340 0.0200 21.0030 3.3962 0.4000 0.5300 public 81.2340 10.5502 2008 private/foreign 72.4690 22.8196 1.3000 0.2590 22.0862 9.2968 0.7750 0.3830 public 78.7034 18.6039

Government Securities: Total Investments Government Securities: Total Assets

mean std. dev. F-statistic p-value mean std. dev. F-statistic p-value

32.0450 10.1892

28.8790 10.5742

24.8280 7.3647

21.8340 6.2052

20.2034 6.8011

Table 6: Sensitivity to Market Risk

2004 private/foreign 0.4148 0.5262 7.8430 0.0070 public 0.8921 0.7518 2005 private/foreign 0.4207 0.5107 7.1660 0.0100 public 0.8645 0.7322 2006 private/foreign 0.4490 0.5807 2.7530 0.1030 public 0.6862 0.5056 2007 private/foreign 0.4331 0.4751 4.7310 0.0340 public 0.7224 0.5360 2008 private/foreign 0.4897 0.5338 1.357 0.249 public 0.6397 0.4428

Beta

mean std. dev. F-statistic p-value

Table7: Overall CAMELS Ratings

CAMELS 2008 29 32 29 33 29 30 25 32 30 34 27 34 32 21 28 31 33 29 33 30 30 31 23 25 30 26 24 34 27 34 20 31 46 29 32 39 44 28 39 28 34 CAMELS 2007 30 31 27 27 27 29 26 29 25 31 26 34 34 23 29 27 31 28 31 29 30 32 32 26 31 29 25 29 30 36 30 30 39 29 36 35 38 27 31 25 32 CAMELS 2006 32 29 25 25 27 29 26 29 26 27 27 31 33 22 29 27 27 27 32 30 28 33 29 29 32 29 26 25 28 31 30 29 31 22 40 28 35 22 27 24 30 CAMELS 2005 36 34 32 26 32 33 32 33 30 34 31 33 35 31 36 30 26 33 38 34 36 34 36 35 35 36 32 33 36 35 32 32 35 29 42 30 33 25 32 27 33 CAMELS 2004 34 34 31 29 33 31 30 33 29 26 31 31 32 32 34 32 25 36 34 36 34 35 35 32 33 33 32 31 36 32 25 32 33 32 45 30 31 28 39 29 31

Bank Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharastra Canara Bank Central Bank Corporation Bank Dena Bank EXIM Bank IDBI Bank Indian Bank Indian Overseas Bank NABARD Oriental Bank Punjab National Bank Punjad Sind Bank State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Bikaner and Jaipur State Bank of Hyderabad State Bank of Travancore State Bank of India Syndicate Bank United Bank of India UCO Bank Union Bank Vijaya Bank ABN Amro Bank American Express Bank AXIS Bank Bank of America Bank of Rajasthan Barclays Bank BNP Paribas Celyon Bank Development Credit Bank Deutshe Bank Dhanalakshmi Bank HDFC Bank

HSBC Bank ICICI Bank IndusInd Bank ING Vysya Bank Jammu & Kashmir Bank Karnataka Bank Karur Vysya Bank Kotak Mahindra Bank Lakshmi Vilas Bank Mizuho Corporate Bank Nainital Bank Ratanakar Bank Standard Chartered Bank Societe Generale Bank South Indian Bank TamilNad Merchantile Bank Yes Bank

32 29 23 27 28 30 33 30 25 35 20 31 36 38 28 32 34

33 28 26 27 26 25 33 28 25 31 27 25 36 33 29 32 29

29 29 27 24 26 28 28 29 26 25 27 22 31 34 26 27 27

33 32 35 27 28 33 31 30 29 38 30 23 34 41 30 33 26

34 32 34 28 31 30 33 33 28 31 18 28 34 35 33 30 17

Table 8: Overall CAMELS ratings

CAMELS mean std. dev. F-statistic p-value 2004 private/foreign 30.8966 5.2328 1.4411 0.2350 public 32.2069 2.6777 2005 private/foreign 31.6552 4.2951 2.5305 0.1173 public 33.17241 2.8166 2006 private/foreign 28.0690 3.9364 0.0382 0.8457 public 28.2414 2.6546 2007 private/foreign 30.3793 4.1440 2.6118 0.1117 public 28.8966 2.6905 2008 private/foreign 31.5517 6.0979 2.8747 0.0955 public 29.3448 3.4566

10