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Performance Measurement System in Indian Banking Sector in Camel Framework

CHAPTER SIX

PERFORMANCE MEASUREMENT SYSTEM IN INDIAN BANKING SECTOR IN CAMEL FRAMEWORK

A sound financial system is indispensable for a healthy and vibrant economy. The banking sector constitutes a predominant component of the financial services industry. The performance of any economy to a large extent is dependent on the performance of the banking sector. The banking sectors performance is seen as the replica of economic activities of the nation as a healthy banking system acts as the bedrock of social, economic and industrial growth of a nation. Banking institutions in our country have been assigned a significant role in financing the process of planned economic growth. During the past six decades since independence, the banking sector has witnessed significant changes and has surely come a long way from the days of nationalisation during early 1970s to the advent of liberalization, privatization and globalization, in the post-991 era. The flurry of reforms witnessed over the last one and half decade has brought about significant changes in the banking arena in the country. Leveraging on their new found tech-savvy and increased thrust on product/service innovation, the banks in the country witnessed a phenomenal growth in the last few years as the economic growth moved up into top gear to be amongst top in the world. The Asian crisis of 1997 and the recent events like the US sub prime crisis have once again underlined the significance of a strong and robust financial sector for smooth and efficient allocation of resources. Indian banks, which initially were in a denial mode about the impact of crisis (on them), but soon admitted to vulnerability to global shocks, have shown remarkable resilience, thanks to the Reserve Bank of Indias timely and prudent measures which saved the domestic banks from the blushes of the worst financial crisis. Life seems to be returning to normal in the global banking sector after it was hard hit by the financial catastrophe, which unravelled in September, 2008, as better than expected results from banks across the globe lend credence to the claims that stimulus efforts are finally yielding results. Against this background, it is important to measure the performance of the banking sector through a performance measurement system that provides an opportunity to assess the performance of Indian banks

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.. Performance Measurement System in Indian Banking Sector in Camel Framework

The present supervisory system in banking sector is a substantial improvement over the earlier system in terms of frequency, coverage and focus as also the tool employed. Majority of the Basel Core Principles for effective banking supervision have already been adhered to and rest is at the stage of implementation. Two supervisory rating models based on CAMELS (Capital Adequacy, Assets Quality, Management, Earning, Liquidity, Systems and Controls) and CACS (Capital Adequacy, Assets Quality, Compliance, Systems and Controls) factors for rating of Indian commercial Banks and Foreign Banks operating in India respectively, have been worked out on the lines recommended by Padmanabhan Working Group (1995). These ratings would enable the RBI to identify the banks whose condition warrants special supervisory attention (Bodla and Verma, 2006). Two decades have elapsed since the initiation of banking sector reforms in India. Over this period, the banking sector has experienced a paradigm shift. Hence, it is high time to make performance appraisal of this sector. Accordingly, a framework for the evaluation of the current strength of the system, and of operations and the performance of the banks has been provided by Reserve Banks measuring rod of CAMELS which stands for capital adequacy, assets quality, management efficiency, earning quality, liquidity and internal control systems. The main endeavour of CAMEL system is to detect problems before they manifest themselves. The RBI has instituted this mechanism for critical analysis of the balance- sheet of banks by themselves and presentation of such analysis to provide for internal assessment of the health of banks. The analysis, which is made available to the RBI, forms a supplement to the system of off-site monitoring of banks. The prime objective of the CAMEL model of rating banking institutions is to catch up the comparative performance of various banks (Bodla and Verma, 2006). CAMEL is, basically, a ratio-based model for evaluating the performance of banks. It is a model for ranking/rating of the banks. The prime objective of this chapter is to measure the performance of banking sector by dividing banks into public and private sectors as explained earlier. Various ratios forming the model are explained as follows (Joshi and Joshi, 2002):

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