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Submitted by
SUMIT TAMRAKAR
Prof. SATHYANARAYANA
(MPBIM)
BANGALORE-01
Bangalore-560001
DECLARATION
original work carried out by me as a partial fulfillment for the requirement of MBA
Degree of Bangalore University. This project has not been previously submitted
University.
Place:
Bangalore-560001
PRINCIPAL’S CERTIFICATE
Bangalore.
Date: (Dr.N.S.Malavalli)
Bangalore-560001
GUIDE’S CERTIFICATE
work done carried under my guidance during the academic year 2007-09 in a
partial fulfillment of the requirement for the award of MBA degree by Bangalore
University. To the best of my knowledge this report has not formed the basis for
guide & Faculty of Finance, M. P. Birla Institute of Management., for his valuable
for his significant advice and suggestions for the project I would also like to thank
And further I would like to thank all the faculty members of MPBIM who
I would like to sincerely thank my Parents and all my Friends who have
academic support.
Place:
This is an attempt to provide quick and handy access to data on scheduled commercial banks from
1999-00 to 2007-08, excluding regional rural banks, Foreign bank and bank with special nature of
operations and to understand the supervision process of Banks .
The purpose behind this study is to determine the health of banks on International Standards by
the analysis of publicly available information and check their readiness as a global player. A study
such as CAMEL rating is vital as enhancing the performance of banks has been the key goal of
financial sector reforms in many countries, and India is not an exception.
> How the top banks (i.e., Six, each three from public and private sector) have fared in the last ten
years?
> Is there any significant variation between the performances of these banks?
> Whether the performance of these banks in terms of various parameters such as Capital Adequacy,
Assets Quality, Management Efficiency and Liquidity, etc., has improved in the recent past?
For this I have collected the publicly available information from the financial statement and
calculated various ratio under five major categories viz capital adequacy , asset quality
,management effectiveness , earning quality and liquidity concerns. Then analysis of each under
different parameters to quantify the soundness of individual system and comparision with peer
set ie. Competitor companies performance . Finally on the basis of their performance , I rank and
rate them as per CAMEL 5 point scale .
.
Here , my intention is to understand the complex nature of business of Privte and Public sector
Banks which works under the purview of Indian Legal Environment.
Apart from this , assessment of Banks’ performance in continuously changing environment and
identification of most important factors responsible for the overall performance of a bank.
I also did the literature survey of the previously conducted studies, it is clear that they used
CAMEL Model for ranking/rating under different purposes like loan assessment , to check
regulatory toughness etc.. In the light of the above, the present study, “A study of CAMEL
Model: Evaluating Performance of Banks through CAMEL Study”, has been
conducted.
1. Introduction 1-8
Introduction
Literature Survey
Operational Definitions
Hypothesis
Research Methodology
Plan Of Analysis
Chapter scheme
A sound financial system is indispensable for a healthy and vibrant economy. The banking sector
constitutes a predominant component of the financial services industry and the performance of any
economy, to a large extent, is dependent on the performance of the banks. Banking institutions in our
country have been assigned a significant role in financing Ihe process of planned economic growth. In
1969, 14 banks were nationalized with the objective of extending credit facilities to all segments of the
economy and also to mitigate seasonal imbalances in their availability. Since nationalization, the
banking system in India has witnessed structural and dimensional changes. A number of steps were
taken in close succession, enabling the nationalized banks to play an active role in economic
development. The second step in the process of nationalizing the banks was taken in 1980. when six
other major banks were nationalized. Directed interest rates on deposits and lending, exchange
controls, directed credit became the hallmark of this tightly regulated new structure.
whenever the crisis occurs , why the banks start making changes in their policis with immediate effects
unlike other industries which takes time , because the financial system is the backbone of any economy
The industrialist have their own goals irrespective of governing party of the country , and for their
Projects/Business models it is very necessary that the economic environment should be stable , sothat
their estimated time and forecasted result should not be changed. Hence the financial system follows
the NEWTON”S THIRD LAW ie it reacts very quickly with the global changes , to provide the
inertia/shelter to the Domestic Environment.
The banking sector in India has once again come out with another fiscal of robust performances. This
is commendable given the fact that the banking environment has suddenly become quite challenging
post the US subprime crisis that surfaced last year and which has resulted in an unprecedented global
liquidity crunch. While the domestic banking sector did not remain totally unscathed, the ex-tent of the
hit or damage was negligible as compared to the banks in the US, which were hit maximum, as well as
those in Europe and even China. The fiscal year also confirmed the end of the era of benign interest
rates as the country's apex bank embarked on belt-tightening. Interest rates further headed north as
headline inflation hit double-digits led by unprecedented rise in food and oil prices, thus prompting the
banking sector regulator, the Reserve Bank of India, to come out with a series of tougher measures.
Bank supervisors need timely and reliable information about the financial condition and risk profile of
banks in order to conduct effective supervision. Although such information can be obtained in part
from regulatory reports and public disclosures, a key source is the on-site bank examination.
Bank examinations enable supervisors to confirm the accuracy of information in regulatory reports.
More important, perhaps, the examinations allow supervisors to gather confidential information
about banks’ financial conditions and to assess qualitative attributes, such as internal controls and risk
management procedures, that affect bank risk profiles.
In an attempt to keep pace with the international best practices, India has decided to implement Basel II
norms. Foreign banks having presence in India and Indian banks with operational presence outside the
country have already adopted Basel II with effect from March 31. 2008. All other commercial banks,
excluding local area banks and regional rural banks, are expected to adopt Basel II with effect from
March 31, 2009. Nevertheless, the shift from Basel I regime to Basel II regime of capital adequacy
norms is undeniably going to be a daunting task for the Indian banks. Thus, to meet the growing capital
needs under Basel II regime, Indian banks are more likely to access the capital markets sooner than
later. However, the present policy holds back PSBs from raising capital freely in equity markets as
government’s holding in the banks cannot fall below 51%. This implies that out of the total capital
requirement of Rs 3,69,115 cr (64.9%] of the state-owned banks, only a small portion can come
through capital markets. No wonder it is also equally costly for the government to keep infusing such
huge capital to meet the norms. Hence, many industry experts opine that the time is ripe for the
government to slash down its stake in state-owned banks to 33%, which will give them enough room
to raise additional capital from the capital market.
Allocation of ranks banks on the basis of the famous CAMEL (Capital, Assets Quality,
Management, Earnings, and Liquidity) rating. Banks have been classified into three categories
based on their ownership group, viz., Public Sector Banks (PSBs), Private Sector and Foreign
Banks.
It is widely accepted that bank regulation and prudential supervision exists to promote an
efficient and competitive banking system; to prevent the occurrence of unnecessary
financial disruptions caused by banking panics and failures; and to reduce depositor’s risk
exposure to episodes of financial distress. While these objectives serve to ensure the stability
and growth of the macroeconomy, it is important to recognize that they may not be costless to the
banking sector. Indeed, many studies of bank regulation focus on the identification and
estimation of these costs. The concern stems from the possibility that regulatory oversight
can unintentionally impose costs that may be unduly burdensome, thereby becoming financial
straightjackets for bank lending operations.
The acronym CAMEL refers to the five componentsof a bank’s condition assessed by examiners:
Capital adequacy, Asset quality, Management, Earnings, and Liquidity.
All of this examination material, including the CAMEL rating, is highly confidential. A
bank’s CAMEL rating is known only by the bank’s senior management and appropriate
supervisory staff at the relevant supervisory agencies. CAMEL ratings are never made
publicly avail- able, even on a lagged basis. Thus, to a considerable degree, the CAMEL
rating reflects the private supervisory information gathered during a bank examination as well as
whatever public and regulatory information is available about the bank’s condition. For this
reason, we use the ratings as our indicator of the private supervisory information arising from
bank examinations.
The purpose of this dissertation is to study in greater detail how bank supervision, through its
evaluation process, impacts bank-lending operations. Regulatory oversight requires that all
federally insured commercial banks be periodically evaluated through on-site examinations as
well as off-site monitoring. The evaluation results in the assignment of a “CAMEL” safety and
soundness rating based on the overall financial health of the institution. A downgrade in this
rating conveys the message that the bank’s financial health has deteriorated, and that its
management must take corrective action to improve its supervisory rating.
It is, therefore, not far-fetched to think that “CAMEL” ratings downgrades, especially those tothe
3, 4 or 5 level, would be associated with more conservative or restricted lending practices and
potentially higher capital requirements at least in the short run. Thus, a poor rating has real
consequences for how the bank operates.
Following the balance of payments crisis in 1991-92, wide-ranging reforms were initiated in almost all
the spheres of the economy including real sector, external sector, agricultural and industrial sectors,
A decade and a half has elapsed since the initiation of banking sector reforms in India. Over this
period, the Indian banking sector has experienced a paradigm shift. Hence, it is high time to make
performance appraisal of this sector. It is against the above background that the present study has been
conducted.
Banking Industry in India - After India's independence in 1947, the Reserve Bank was nationalized
and given broader powers. In 1969 the government nationalized the 14 largest commercial banks; the
government nationalized the six next largest in 1980.
Currently, India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the
Government of India holding a stake), 31 private banks (these do not have government stake; they may
be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined
network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating
agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the
private and foreign banks holding 18.2% and 6.5% respectively.
The sustainable bank: Where eco-friendly meets business-friendly. Many banks have
announced environmental initiatives, but few have adopted a strategic approach.
Payments consolidation: Time to act Although vital for most banks, payment is in-
creasingly a commodity business subject to price and margin pressures.
SOA: Moving beyond IT. At a time when banks often struggle to keep aging, disparate
systems in step with business needs, Service-Oriented Architectures (SOA] are a way to
integrate and streamline the-IT landscape.
Padmanabhan Working Group (1995), in its report on On-Site Supervision, recommended for
supervisory interventions and introduction of a rating methodology for banks on the lines of CAMEL
model with appropriate modification to suit Indian conditions. The Working Group has recommended
six rating factors—Capital Adequacy, Assets Quality, Management, Earnings, Liquidity, Systems and
Controls (i.s., CAMELS), and for Foreign Banks four rating factors, namely—Capital Adequacy,
Assets Quality, Compliance, Systems and Controls (i.e., CACS). Narasimham Committee (1998)
made several important recommendations like introduction of internationally accepted prudential
norms relating to income recognition, ‘assets classification, provisioning and capital adequacy.
Accordingly, a framework for the evaluation of the current strength of the system and of the operations
and performance of banks has been provided by Reserve Bank's measuring rod of "CAMELS", which
stands for Capital Adequacy, Assets Quality, Management, Earnings, Liquidity and Internal Control
Systems.
The main endeavor of CAMEL system is to detect problems before they manifest themselves. The
RBJ has instituted this mechanism for critical analysis of (he balance sheet of banks by themselves and
presentation of such analysis before their boards to provide an internal assessment of the health of the
bank. The analysis, which is made available to the RBI, forms a supplement lo the system of off-site
monitoring of banks. An efficient resuJt-oriented on-site inspection system requires an efficient
follow-up. The entire cycle of inspection and follow-up action are now completed within a maximum
period of 12 months. Monitorable action plan for rectification of irregularities/deficiencies noticed
during the inspection within a time frame is drawn up and progress in implementation pursued with
Thus, 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 tools employed. Nearly one-half
of the Basle Core Principles for Effective Banking Supervision has already been adhered to and the
remaining is at a stage of implementation. Two Supervisory Rating Models, based on CAMELS and
CACS factors for rating of Indian commercial banks and foreign banks operating in India respectively,
have been worked out on the lines recommended by the Padmanabhan Working Group (1995).
These ratings would enable the Reserve Bank to identify the banks whose condition warrants special
supervisory attention.
The purpose behind this study is to determine the health of banks on International Standards by
the analysis of publicly available information and check their readiness as a global player. A study
such as CAMEL rating is vital as enhancing the performance of banks has been the key goal of
financial sector reforms in many countries, and India is not an exception.
> How the top banks (i.e., Six, each three from public and private sector) have fared in the last ten
years?
> Is there any significant variation between the performances of these banks?
> Whether the performance of these banks in terms of various parameters such as Capital Adequacy,
Assets Quality, Management Efficiency and Liquidity, etc., has improved in the recent past?
To build the conceptual framework for the application of CAMEL Model, we may draw on the
following literature-
Abstract : The paper has examined financial indicators and their prudential implications for
banking system soundness in Nigeria. The paper has given more focus on loan related activities
and shown a very narrow approach using CAMEL model parameters.
Barrand Siems (1996) tried to predict bank failures in the US, using the data from December 1984
to June 1987 using CAMEL Model. They used technical efficiency measure, using DEA in their
prediction model. Along with their DEA results, which represent Management Quality "M" in the
CAMEL rating, they used financial ratios representing soundness of Capital, Asset Quality,
Earnings and Liquidity. They found that the use of the DEA Efficiency Score in the regression
increased the accuracy of (he classification results from 89% to 92,4% and Ihe new model was
superior to the earlier early-warning models.
Godse (1996) examined the application of newmodel CAMEL, i.e., "Capital Adequacy, Assets
Quality, Management, Earning Quality, Liquidity, Systems and Control", for evaluating the
performance of banks.
RaoandDatta (199SJ made an attempt to derive rating based on CAMEL. In their study, based on
these five groups (C-A-M-E-L, 21 parameters in all were developed. After deriving separate
rating for each parameter, a combined rating w/as derived for all nationalized banks (19) for the
year 1998. The study found that Corporation Bank has the best rating followed by Oriental Bank
Veni (2004) studied the capital adequacy requirement of banks and the measures adopted by them
to strengthen their capital ratios. The author highlighted that the rating agencies give prominence
to Capital Adequacy Ratios of banks while rating the bank's certificate of deposits, fixed deposits
and bonds. They normally adopt CAMEL Model for rating banks. Thus, Capital Adequacy is
considered as the key element of bank rating.
Satish, Jutur Sharath and Surender (2005) adopted CAMEL model to assess the performance of
Indian banks. The authors analyzed the performance of 55 banks for the year 2004-05, using
CAMEL Model. They concluded that the Indian banking system looks sound and Information
Technology will help the banking system grow in strength while going into future. Banks' Initial
Public Offer will be hitting the market to increase their capital and gearing up for the Basel I]
norms.
Other researchers have examined the role of CAMEL ratings in providing information about the
financial condition of banks. For instance, Berger and Davies (1994) examine the information
content of CAMEL ratings by testing for stock price reactions when new ratings are assigned.
Despite the fact that CAMEL ratings are confidential, the authors find that rating downgrades
seem to lead to negative excess stock returns. They interpret this result as evidence that
examinations generate valuable private information and that rating downgrades reveal
unfavorable private information about bank conditions. Similarly, DeYoung, Flannery, Lang, and
Sorescu (1998) find that CAMEL ratings contain information useful to the market for
subordinated, bank holding company debt.
These papers suggest that newly assigned CAMEL ratings contain relevant information. Some
researchers have also studied how that relevance changes over time. For example, Gilbert
(1993) addresses the issue to some extent by finding that more frequent examinations reduced
losses to the Bank Insurance Fund, which covers government
losses when a bank fails. Cole and Gunther (1995, 1998) find that the information contained in
CAMEL ratings decays quickly with respect to predicting bank failure from 1986 to 1992. In
particular, they find that a model using publicly available financial data is a better indicator of the
likelihood of bank failure than the previous CAMEL
rating is once the rating is more than one or two quarters old. These two studies address the
issue of information decay directly; however, the primary purpose of CAMEL ratings is
not to identify future bank failures, but to provide an assessment of banks’ overall
conditions at the time of the examinations.
Focusing on this aspect of supervisory ratings, Berger, Davies, and Flannery (1998) examine
BOPEC ratings in relation to market-based data and find that only very recent examinations
provide useful information. The information appears to become much less useful, or “stale,” over
time. In our analysis, we focus directly on the time decay of the supervisory information
in CAMEL ratings and the decay’s impact on assessing the current condition of a bank. Thus, we
view our article as complementary to,and an extension of, this general line of research.
Houston and James (1993) document regulatory effectiveness in terms of one enforcement
activity, namely, to discipline poorly performing managers. Houston and James find that the
To further explore the influence of regulatory activity, Houston and James compared the
frequency of turnover among firms that w ere not subject to oversight (22 percent) to the turnover
rate in firms subject to regulatory oversight (70 percent). Additionally, the cost of these actions to
the subject managers, in terms of lost income and future opportunities, is substantial, suggesting
that bank managers bear the consequences of financial distress.
An Approach to the Regulation of Bank Holding Companies. , Journal of Business Black, F.,
M. H. Miller and R.A. Posner. 1978 ,51(3): 379-412.
Regulatory Costs - Increased regulatory attention is costly to the bank and its management.
Banks incur two costs related to more frequent or more detailed examinations.
First, the insurance premium paid to the Deposit Insurance Corporation (DIC) is a risk-related
charge. The charge is based on qualified deposits at the bank and adjusted for risk using the
CAMEL rating. Typically, national banks pay about $1.25 of insurance premium for every $100
of deposits. An example of the impact of CAMEL ratings on insurance premiums is provided in
Cocheo (1995). Cocheo (1995) reports that in 1993 examiners issued higher (i.e., poorer)
CAMEL ratings for the National Bank of Rising Sun, Rising Sun, Md., a small bank with about
$83 million in assets. During the next six months, insurance premiums increased by $13,500 due
to the poorer CAMEL ratings.
A second cost, from increased regulatory attention is the fact that bank staff and management are
distracted from their normal responsibilities to prepare reports, gather documents and respond to
questions.
Additionally, receiving poor CAMEL ratings from bank examiners restricts the
bank managers' ability to raise capital, reduces the managers' compensation, limits the
accumulation of human capital, and decreases the managers' credibility (Gargill, 1989). Williams
and Jacobsen (1995) report that banks spend up to 14 percent of their noninterest expenses on
costs directly associated with complying with regulatory requirements. Thus, increased regulatory
effort during the review process and the receipt of poor CAMEL ratings are costly to the bank and
Evaluating the Productive Efficiency and Performance of U.S. Commercial Banks , Richard
S. Barr , December 1999
Abstract: In this study, Barr has use a constrained multiplier, input-oriented, data envelopment
analysis (DEA) model to evaluate the productive efficiency and performance of U.S. commercial
banks from 1984 to 1998. We find strong and consistent relationships between efficiency and our
inputs and outputs, as well as independent measures of bank performance. Further, our results
suggest that the impact of varying economic conditions is mediated to some extent by the relative
efficiencies of the banks that operate in these conditions. Finally, we find a close relationship
exists between efficiency and soundness as determined by bank examiner ratings.
In reality, however, changes in CAMEL ratings reflect two types of variations: (a) “financial-
driven” changes, stemming from changes in banks’ financial ratios, and (b) changes in the
examiner’s private information set, which reflect variations in “soft” information
(DeYoung, Flannery, Lang, and Sorescu, 2001). To capture the effects of “soft” information
(changes in private information), it is necessary to include a comprehensive set of variables that
control for existing banking conditions. Although previous research attempts to deal with
this problem in various ways (mostly by including a different set of controls and different
lag structures), none has used what we consider to be the most superior one, the SCOR index.
The rapid and incremental changes in world economy has affected the Financial system of every
country. In such a complex business environment , Banks and Financial Institutions play an
important role and work as backbone of economy. Hence it is mendatory to setup a framework
which can ensure the reliable Banking System .
Here , our purpose is to understand the complex nature of business of Privte and Public sector
Banks which works under the purview of Indian Legal Environment.
Apart from this , assessment of Banks’ performance in continuously changing environment and
identification of most important factors responsible for the overall performance of a bank.
Using CAMEL model as an assessment tool , I want to know whether our leading banks are
suitable for international standards or not? And at what point of scale they rate themselves. This
study will help me to understand the complex process of Off-site examination ( CAMEL) and it’s
relevance with the on-site monitoring system, and by providing the idea of Bank Rating process
it will guide the future researchers for indepth study and model development in this & related
areas.
Research Objectives:
Overall hypothesis in this study is that “ more efficient institutions differ significantly from
less efficient institutions” in measurable ways, and these results can be used for benchmarking.
To test this alternative hypothesis , we have checked the following hypothesis –
1)
Ho: There is no difference between PSBs and PvSBs in terms of liquidity.
H1: There is significant difference between PSBs and PvSBs in terms of liquidity.
2)
H0- Indian Banks are ready for BASEL II norms in terms of the CRAR .
H1 : Indian Banks are not ready for BASEL II norms in terms of CRAR.
( i.e. They have CAR below 9% )
3)
4)
H1 : Management of ICICI (PvSB) is more efficient and effective than SBI (PSB).
Ho : Management of ICICI ( PvSB) and SBI (PSB) are equally efficient and effective
Type of research: This is historical research as the historical information of Banks is used for
analysis and interpretation. It is also a quantitative and analytical research.
Sampling technique: Non – probability, purposive. The researcher attempts to obtain sample
that appears to him/her to be representative of the population . Sample units are
6 Banks , each three from PSB and PvSB.
Sampling frame: Sampling Frame is the Public (PSB)and Private Sector Banks (PvSB) of India.
42 Banks ( PSB = 15 , PvSB = 27)
Sample: The initial sample comprised of 6 banks , out of those , 3 are from Public Sector and 3
from Private Sector. It was a simple random sampling of Banks, whose financial data is publicly
available.
Selection Criteria
From the entire population of banks (contains private ,public sector ,co-operative banks ,foreign
banks and regional rural banks ) , I have chosen my sampling frame , which-
3. Banks which are not focusing on special type of business (like NABARD , SME development
orientation etc.)
Time frame of the study: Time period in a Year , and analysis has done for 10 years.
Data
The data for the calculations has been used from CAPITAL LINE database. Data for calculation
is gathered from Publicly available information ,like bank’s financial statements and methodology
adopted as per the regulatory guidelines ,RBI .
The period, for evaluating performance of banks through CAMEL in this study, ranges from
1999 to 2007-08, i.e., for 10 years.
Data sources
a) Most of the data used for calculation are from annual Reports of banks.
b) Data of the previous years are collected from the annual publication on bank’s website and
from Indian Bonking Association Journal, Reserve Bank of India (RBI) Bulletin, Journal of Banking
Studies, Journal of Accounting and Finance and related journals.
c) Internet has been an important source of secondary data. The site assessed for this research is
www.rbi.org .
1.Statistical tools –
p-P
Z= -------------------
SE
Why Z Test ? - Zest has used to measure a specified value among the entire finite
population and to test the significance .
(ii) t –Test - Test for between the values , Independent Sample with
Unequal variance
|x1^ - x2^ |
t = ---------------
S √[ 1/n1 + 1/n2]
This test used to test between the values test for two different banks /sector and
compare the variance , assuming unequal variance and indepent samples from the
population .
Where,
q = number of banks
N = total number of observations (number of banks x number of time series observations for
each ratio),
CESS = Combined sum of squared errors when both the banks and their observations are used
to estimate the regression equation above (for each ratio);
MESS = Sum of the two banks sums of squared errors for each bank estimated from the
regression applied to each bank (each ratio) separately:
F test has used to test the difference in policies of banks on a particular parameter , and to check
whether policies/ attitude towards the parameter is same among all the banks or not.
• Time Frame for the study is 10 years, data prior to the time frame are not considered.
• The CAMEL rating, while not a comprehensive indicator of all this information,
nonetheless provides a convenient summary measure of the examination findings.
• Auditor choice is not explicitly defined as an input to the CAMEL in the regulatory
process, but could be incorporated subjectively through the regulator's personal judgment.
• CAMEL ratings are not publicly available. So it is difficult to verify research variations
from final outcomes of Bank’s Supervisors.
• Although CAMEL model is widely used in advanced economy as a part of their
supervision process , yet individual banks can change their parameter. So there may
difference exist between our Independent variables set (now onwards called as CAMEL
parameters ) .
• CAMEL ratings are a based on publicly available information and is direct output
measure of the regulator's onsite examination and are based on objective and subjective
measures of bank financial condition. Ie Assumption is all the information available to
public through financial statement reflects true data.
• The sample is limited (6 versus 42 banks in the current study), which reduces the power of
our tests. Reason is limited resources , time constraints and motive of making it “simple
to understand .“
• As ,this sample is not a random draw from the general population of Indian banks. This
would reduce the external validity of testing.
• The structure of the auditing and banking industries might have been changed over last 10
years period , as both industries have consolidated significantly. To make our study
contemporaneously relevant, we examine a current sample of banks and auditors with
current regulations and norms.
Chapter 2 : Research Design- This chapter concentrates on the problem statement, literature
survey, objectives of the study , operational definitions, construction of the hypothesis. Research
Methodology which consists of type of research, sample method used, tools for data collection,
limitation of the research and chapter scheme.
Chapter 3 : Industry Profile- This chapter deals with the brief description of Indian Banking
industry, on which the research work has been conducted. The industry includes central bank-
regulatory body, PSB and private sector banks.
Chapter 4 : Data Analysis and Interpretation This chapter concentrates on comparative analysis
and interpretion of various ratios , the relationship and impact on industry with the given
sample ,hpothesis testing and finally composite CAMEL rating.
Chapter 5 : Research Findings, Suggestion and Conclusion This chapter focuses on findings of
the research which were found from the data analysis. It also consists of suggestions and
conclusion prescribed by the researcher.
Annexure and Bibliography : This includes the data used for analysis and the text books &
websites referred during the study
Introduction
Banking is one of the most heavily regulated businesses in the world and it is no
Undoubtedly the world economy has slowed down, recession is at its peak, globally stock
markets have tumbled and business itself is getting hard to do. The Indian economy has been
much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system,
cutting of exposures to emerging markets by FIIs, etc.
Further, international rating agencies like, Standard & Poor have lowered India' s credit
rating to su-binvestment grade. Such negative aspects have often outweighed positives such as
increasing forex reserves and a manageable inflation rate.
Under such a situation, it goes without saying that banks are no exception and are bound to
face the heat of a global downturn. One would be surprised to know that the banks and financial
institutions in India hold non-performing assets worth Rs. 1, 10, 000 crores. Bankers have realized
that unless the level of NPAs is reduced drastically, they will find it difficult to survive.
The whole Indian banking industry consists of commercial banks, all India financial institutions,
regional rural banks and co-operative banks. This report focuses on commercial banks,
which have three categories of banks (PSBs- government owned banks), private sector
banks (old and new), and foreign banks.
The banking sector in India functions under the purview of the Reserve Bank of India
(RBI) the central bank of the country. The Banking Regulation Act passed in 1949 provides
RBI with wide range of powers for supervision and regulation of banks, licensing power and
authority to conduct inspection.
A sound and efficient banking system is a sine qua non for maintaining financial
stability. Therefore, considerable emphasis has been placed on strengthening the capital
requirements in recent years. The capital to risk-weighted assets ratio (CRAR) of SCBs, a
measure of the capacity of the banking system to absorb unexpected losses, improved further to
13.0 per cent at end-March 2008 from 12.3 per cent at end-March 2007. Asset quality of SCBs
also improved consistently in the past few years as reflected in the decline in non- performing
assets (NPAs) as percentage of total advances. During 2007-08, while overall gross NPAs of
SCBs declined to 2.3 per cent of gross advances from 2.5 per cent in the previous year, net NPAs
as percentage of net advances remained at the previous year’s level of 1.0 per cent. Thus, in
terms of the two crucial soundness indicators, viz., capital and asset quality, the Indian
banking sector showed further improvement during 2007-08
The trend of improvement in the asset quality of banks continued during the year. Indian banks
recovered a higher amount of NPAs during 2007-08 than that during the previous year.
Though the total amount recovered and written-off at Rs.28,283 crore in 2007-08 was higher
than Rs.26,243 crore in the previous year, it was lower than fresh addition of NPAs (Rs.34,420
crore) during the year. As a result, the gross NPAs of SCBs increased by Rs.6,136 crore in
2007-08. This is the first time since 2001-02 that gross NPAs increased in absolute terms (Table
III.26). In this context, it may be noted that banks had registered rapid credit growth during the
previous three years. Some slippage in NPAs, therefore, could be expected. Besides, some other
developments such as hardening of interest rates might have also resulted in increased
NPAs. Banks had extended housing loans at floating interest rates. The hardening of interest
rates might have made the repayment of loans difficult for some borrowers, resulting in
some increase in NPAs in this sector. It may be noted that the increase in gross NPAs was more
noticeable in respect of new private sector and foreign banks, which have been more active in the
real estate and
Among the various channels of recovery available to banks for dealing with bad loans ,the
SARFAESI Act and the debt recovery tribunals (DRTs) have been the most effective in terms
of amount recovered. The amount recovered as percentage of amount involved was the highest
under the SARFAESI Act, followed by DRTs .
In India banking industry is divided into sub categories of Scheduled Commercial Bank and
scheduled cooperative bank. Commercial Bank again is subcategorized as: (a) public sector
bank; (b) private sector bank; (c) foreign banks; (d) Regional Rural Bank
The main legislation governing commercial banks in India is the Banking Regulation
Act 1949. The provisions of the Banking Regulation Act 1949 are in addition to the
Companies Act, 1956 and any other law for the time being in force is applied in
management of banks in India. Other important laws include the Reserve Bank of India
Act.The Central Bank in India is known as Reserve Bank of India. The Central
Bank issues , from time to time, additional guidelines /directions to be followed by
the commercial bank in India.
Central Bank in India is known as the Reserve Bank of India, was established
as a shareholders bank on April, 1935. Its share capital was Rs.5 crores divided into 5
lakhs fully paid up shares of Rs.100 each. In the beginning except shares of Rs.
2,20,000, the entire share capital was owned by private shareholders. The Central
Government had acquired 2,200 shares which made it eligible to appoint its own
nominees on the Reserve Bank’s Board of Directors. The Reserve Bank of India
Over this period important changes had taken place in the country. Indiagot freedom
on August 15, 1947 and the nationalist government decided to initiate the process
of planned economic development. It was felt that a state owned Central Bank was
better suited to the requirement of the country. The issue of Reserve Bank’s
nationalization had first come to the fore at the close of the World War II, but the
actual nationalization was done on January 1,1949.
The last two decades saw unprecedented changes in the banking and financial systems all over
the world. While England, the historical seat of banking, witnessed a process of
deregulation of the financial system at the beginning of the 1970s (which was soon to
cross the Atlantic to the United States), India moved in the opposite direction, tightening
controls over the financial system by nationalizing the major commercial banks of the
country. It was done at a time when the Indian banking system, having established itself
domestically in strength and stability, was about to move towards global integration. For that,
it had to wait for a quarter of a century.
In India, the decade beginning 1990 saw the cumulation of the crisis of the regulated
regime with the worsening of the external balance of payments, a low foreign exchange
reserve, raging inflation and dwindling GNP. It was felt that a major restructuring of the
Indian economy was needed. On the external front, the signing of the General
Agreement on Tariffs and Trade, (GATT) fo llowed by membership of the World Trade
Organization (WTO), paved the way for global integration.
Financial Sector Reforms: While the real sectors of the economy were being liberated
The objectives of the reforms package were threefold: (a) liberalization of all markets by
quickening the process of deregulation; (b) increasing competitiveness in all spheres of
economic activity, and (c) ensuring financial/fiscal discipline in all economic agents, be it
the public or private sector.
In the late 1980s, the Basel Committee on Banking Supervision took initiative to develop
a risk-based capital adequacy standard that would lead to international convergence of
supervisory regulations governing the capital adequacy of internationally active banks.
The dual objectives for the framework were to strengthen the soundness and stability of
the international banking system and, by ensuring a high degree of consistency in the
framework’s application, to diminish the sources of competitive inequality among
This initiative resulted in the Basel Capital Accord of 1988. The Basel Accord comprises
a definition of regulatory capital, measures of risk exposure, and rules specifying the
level of capital to be maintained in relation to these risks. It introduced a de facto capital
adequacy standard, based on the risk-weighted composition of a bank’s assets and off-
balance sheet exposures, that ensures that an adequate amount of capital and reserves is
maintained to safeguard solvency. While the original targets of the Accord were
international banks, the capital adequacy standard has been adopted and implemented in more
than 100 countries and now forms an integral part of any risk-based bank supervisory
approach.
Constant review of the le vel of capital maintained in both the banking system and in
individual banks is an important part of the financial risk management process, which
seeks to ensure that a bank’s capital position is consistent with its overall risk profile and
business strategy.
Reserve Bank of India, Indian Central Bank responded to Basle Capital Accord of 1988,
by issuing necessary guidelines and directives to time Indian banking practice at par with
international norms keeping the Indian practices and economic within the preview
and consideration.
Indian Central Bank took prompt initiative to respond to the framework of Basle in terms
of implementation of the 1988 Accord. In an effort to implement, monitor prudential
norms in the area of credit, advances and control the functioning of the banks, the Central Bank
of the country came out with comprehensive guidelines in the following areas:
: Pre conditions of effective Banking and Supervision;
Licensing Requirement: Commercial banks in India are required under the Banking
Regulation Act 1949 to obtain a license from the Central Bank to carry on banking
business. Before granting the license, the Central Bank satisfies itself necessary that
conditions are complied with, including (i) that the bank has the ability to pay its present and
future depositors in full as their claims accrue; (ii) that the affairs of the bank will not
be or are not likely to be conducted in a manner detrimental to the interests of present or
future depositors; (iii) that the bank has adequate capital and earnings prospects; and (iv) that
the public interest will be served if such license is granted to the bank. The Central Bank
can cancel the license if the bank fails to meet the above conditions or if the bank
ceases to carry on banking operations in India. The Central Bank requires banks to
furnish statements, information and certain details relating to their business. It issues
guidelines for commercial banks on several matters including recognition of income,
classification of assets, valuation of investments, maintenance of capital adequacy and
provisioning for impaired assets.
Supervision of Banks: The Central Bank has set up a Board for Financial Supervision,
under the chairmanship of the Governor of the Central Bank . The appointment of the
auditors of banks is subject to the approval of the Central Bank . The Central Bank can direct
a special audit of banks in the interest of the depositors or in the public interest.
Regulations relating to the Opening of Branches: Banks are required to obtain licenses from
the Central Bank to open new branches. Permission is granted based on factors such
as the financ ial condition and history of the company, its management, adequacy of capital
structure and earning prospects and the public interest. The Central Bank has the right to
cancel the license for violations of the conditions under which it was granted. In India
branches are located in rural and semi- urban areas. Central Bank may require the
Banks to open branches in rural areas. Rural area is defined as a center with a
population of less than 10,000. A semi-urban area is defined as a center with a
population of greater than 10,000 but less than 100,000.
Asset Classification and Provisioning: In April 1992, the Central Bank issued formal
guidelines on income recognition, asset classification, provisioning standards and
valuation of investments applicable to banks, which are revised from time to time. The
principal features of these Central Bank guidelines, in relation to loans, debentures, lease assets,
hire purchases and bills are set forth below:
Sub-Standard Assets: Assets that are non-performing assets for a period not exceeding 12
months. In such cases, the current net worth of the borrower / guarantor or the current
market value of the security charged is not enough to ensure recovery of dues to the
banks in full. Such an asset has well-defined credit weaknesses that jeopardize the
liquidation of the debt and are characterised by the distinct possibility that the bank will
sustain some loss, if deficiencies are not corrected.
There are separate guidelines for projects under implementation which are based on the
achievement of financial closure and the date of approval of the project financing.
Restructured Assets: The Central Bank has separate guidelines for restructured assets. A fully
secured standard asset can be restructured by reschedulement of principal
repayments and/ or the interest element, but must be separately disclosed as a restructured asset.
The amount of sacrifice, if any, in the element of interest, measured in present value
terms, is either written off or provision is made to the extent of the sacrifice involved.
Similar guidelines apply to sub-standard assets. The sub-standard accounts which have
been subjected to restructuring, whether in respect of principal instalment or interest
amount are eligible to be upgraded to the standard category only after the specified
period, i.e., a period of one year after the date when first payment of interest or of
principal, whichever is earlier, falls due, subject to satisfactory performance during the
period. To put in place an institutional mechanism for the restructuring of corporate debt,
the Central Bank has devised a corporate debt restructuring system.
Regulations relating to Making Loans: The provisions of the Banking Regulation Act
govern the making of loans by banks in India. The Central Bank issues directions
covering the loan activities of banks. Some of the major guidelines of Central Bank,
which are now in effect, are as follows:
(a) The Central Bank has prescribed norms for bank lending to non-bank financial
companies and financing of public sector disinvestments.
(b) Banks are free to determine their own lending rates but each bank need to declare its
prime lending rate as approved by its Board of Directors. Each bank should also
indicate the maximum spread over the prime lending rate for all credit exposures
other than retail loans. Banks are also given freedom to lend at a rate below the prime
lending rate in respect of creditworthy borrowers and exposures. Interest rates for
certain catego ries of advances are regulated by the Central Bank.
Domestic time deposits have a minimum maturity of 15 days and a maximum maturity
of 10 years. Time deposits from non-resident Indians denominated in foreign currency
have a minimum maturity of one year and a maximum maturity of three years.
Deposit Insurance
Demand and time deposits of up to Rs. 1,00,000 accepted by Indian banks have to be
mandatorily insured with the Deposit Insurance and Credit Guarantee Corporation, a
wholly-owned subsidiary of the Central Bank. Banks are required to pay the insurance
premium for the eligible amount to the Deposit Insurance and Credit Guarantee
Corporation on a semi-annual basis. The cost of the insurance premium cannot be passed
on to the customer.
Reserve Fund
Any bank incorporated in India is required to create a reserve fund to which it must
transfer not less than 20% of the profits of each year before dividends. If there is an
appropriation from this account, the bank is required to report the same to the Central
Bank within 21 days, explaining the circumstances leading to such appropriation. The
Government of India may, on the recommendation of the Central Bank, exempt a bank
from the requirements relating to reserve fund.
In terms of Section 25 of The Banking Regulation Act 1949, each banking company has
to maintain assets in India which is not less than 75% of its demand and time liabilities in India
which in turn may prevent the Bank from creating the overseas assets and exploiting
overseas business opportunities.
The Central Bank also conducts on-site supervision of selected branches with respect to their
general operations and foreign exchange related transactions.
Every Bank required to obtain prior approval of the Central Bank before it appoints its
Central Bank has issued separate guidelines effective June 25, 2004 laying down the due
diligence and “fit and proper” criteria applicable to Directors of private banks.
Penalties
The Central Bank may impose penalties on banks and their employees in case of
infringement of regulations under the Banking Regulation Act 1949. The penalty may be
a fixed amount or may be related to the amount involved in any contravention of the
regulations. The penalty may also include imprisonment.
Institutions Act, 1993, and the Securitisation Act. As a bank, they are entitled to certain benefits
under various statutes including the following:
The Securitisation Act focuses on improving the rights of banks and financial institutions and
other specified secured creditors as well as asset reconstruction companies by providing
that such secured creditors can take over management control of a borrower company
upon default and/or sell assets without the intervention of courts, in accordance with the
provisions of the Securitisation Act.
Central Bank Guidelines on Ownership and Governance in Private Sector Banks Central
Bank has laid down a comprehensive framework of policy in a transparent manner relating
to ownership and governance in the Indian private sector banks. The broad princip les
underlying the framework of policy relating to ownership and governance of private
sector banks would have to ensure that:
(i) The ultimate ownership and control of private sector banks is well diversified. While
diversified ownership minimises the risk of misuse or imprudent use of leveraged
funds, it is no substitute for effective regulation. Further, the fit and proper criteria, on
a continuing basis, has to be the overriding consideration in the path of ensuring
adequate investments, appropriate restructuring and consolidation in the banking
sector. The pursuit of the goal of diversified ownership will take account of these
basic objectives, in a systematic manner and the process will be spread over time as
appropriate.
(ii) Important Shareholders (i.e., shareholding of 5 per cent and above) are ‘fit and
proper’, as laid down in the guidelines dated February 3, 2004 on acknowledgement for
allotment and transfer of shares.
(iii) The directors and the CEO who manage the affairs of the bank are ‘fit and proper’ as
indicated in circular dated June 25, 2004 and observe sound corporate governance
principles.
(iv) Private sector banks have minimum capital/net worth for optimal operations and
systemic stability.
(v) The policy and the processes are transparent and fair.
Minimum capital
The capital requirement of existing private sector banks should be on par with the entry
capital requirement for new private sector banks prescribed in Central Bank guidelines of
Shareholding
i. The Central Bank guidelines on acknowledgement for acquisition or transfer of shares
issued on February 3, 2004 will be applicable for any acquisition of shares of 5 per cent
and above of the paid up capital of the private sector bank.
ii. In the interest of diversified ownership of banks, the objective will be to ensure that no
single entity or group of related entities has shareholding or control, directly or
indirectly, in any bank in excess of 10 per cent of the paid up capital of the private
sector bank. Any higher level of acquisition will be with the prior approval of Central Bank
and in accordance with the guidelines of February 3, 2004 for grant of
acknowledgement for acquisition of shares.
iii. Where ownership is that of a corporate entity, the objective will be to ensure that no
single individual/entity has ownership and control in excess of 10 per cent of that
entity. Where the ownership is that of a financial entity the objective will be to ensure that
it is a well established regulated entity, widely held, publicly listed and enjoys good
standing in the financial community.
iv. Banks (including foreign banks having branch presence in India)/FIs should not
acquire any fresh stake in a bank’s equity shares, if by such acquisition, the investing bank’s/
FI’s holding exceeds 5 per cent of the investee bank’s equity capital as
indicated in Central Bank circular dated July 6, 2004.
v. As per existing policy, large industrial houses will be allowed to acquire, by way of
strategic investment, shares not exceeding 10 per cent of the paid up capital of the
bank subject to Central Bank’s prior approval. Furthermore, such a limitation will
also be considered if appropriate, in regard to important shareholders with other
commercial affiliations.
vi. In case of restructuring of problem/weak banks or in the interest of consolidation in
the banking sector, Central Bank may permit a higher level of shareholding, including
by a bank.
The a new framework aimed to provide a comprehensive approach to measuring banking risks,
its fundamental objectives remain the same as those of the 1988 Accord: to promote
safety and soundness of the banking system and to enhance the competitive equity of
banks.
Although the framework has been developed keeping in mind the internationally active
banks, supervisory authorities worldwide are being encouraged to consider adopting this
revised framework at such time as consistent with their broader supervisory priorities.
Each national supervisor is expected to consider carefully the benefits of the revised
framework in the context of its domestic banking system when developing a timetable and
approach for implementation. Given the resource and other constraints, these plans may
extend beyond the Committee's implementation dates, and also implementation of Basel II
in the near future may not be the first priority for supervisors in several non-G 10 countries.
The IMF and World Bank are of the view that future financial sector assessments
would not be conducted on the basis of adoption of or compliance with the revised
framework, but would be based on the country's performance relative to the chosen
standards. Supervisors are being encouraged to consider implementing key elements of
the supervisory review and market discipline components of the new framework even if
In the revised framework, some of the key elements of the 1988 capital adequacy framework
have been retained, including the general requirement for banks to hold total capital equivalent
to at least 9% of their risk-weighted assets. An attempt has been made to arrive at
significantly more risk-sensitive capital requirements -to institute internal ratings- based
(IRB) approach in place of the broad brush standardized approach of 1988 Accord, that are
conceptually sound and at the same time pay due regard to particular features of the
present supervisory and accounting systems in individual member countries. A range
of options for determining the capital requirements for credit risk and operational risk have
been provided.
The need for banks and supervisors to give appropriate attention to the second
(supervisory review) and third (market discipline) pillars of the revised Framework has
also been highlighted. The interactions between regulatory and accounting approaches at both
the national and international level can have significant consequences for the measures of
capital adequacy and for the costs associated with the implementation of these approaches.
In the most recent consultations, issues such as changes in the approach
to the treatment of expected losses and unexpected losses and to the treatment of
securitisation exposures, changes in the treatments of credit risk mitigation and revolving retail
exposures, have been incorporated. The need for banks using the advanced IRB approach
to incorporate the effects arising from economic downturns into their loss- given-default
(LGD) parameters - has also been highlighted. It is, however, necessary to ensure that the
Framework keeps pace with market developments and advances in risk management
practices.
With regard to the timeframe for adopting the new capital adequacy framework, Basel II
has implemented from 31 march2008 .One of the major drivers for moving to Basel II in
non-BCBS jurisdictions seems to be the intended implementation of this framework
locally by foreign controlled banks or local branches of foreign banks. For Pillar I -minimum
capital requirements -the foundation internal ratings-based (IRB) approach is envisaged
Basel - II
With increasing financial sector liberalization and emergence of financial conglomerates, financial
sector stability has emerged as a key objective of the Central Bank in India. The recent
emphasis in the regulatory frame work in India is on ensuring good governance
through “fit and proper” owners, directors and senior managers of the banks infuses a
qualitative dimension to the conventional discharge of financial regulation through
prescribing prudential norms and encouraging market discipline.
In totality, however, these measures interact to produce a positive impact on the overall
efficiency and stability of the banking system in India. There has been a marked improvement
in capital adequacy, asset quality and the profitability of the banking system. Commercial banks
in India will start implementing Basel II with effect from March 31, 2007. They will adopt the
Standardised Approach for credit risk and the Basic Indicator Approach for operational risk,
initially. After adequate skills are developed, both at the banks and also at supervisory levels,
some banks may be allowed to migrate to the Internal Rating Based Approach. Banks have also
been advised to formulate and operationalise the Capital Adequacy Assessment Process as
required under Pillar II of the New Framework.
Above all, capacity building, both in banks and the regulatory bodies is a serious
challenge, especially with regard to adoption of the advanced approaches. The Central Bank
has accordingly initiated supervisory capacity-building measures to identify the gaps and
to assess as well as quantify the extent of additional capital which may be required to
be maintained by such banks. As of now banks are constantly pushing the frontiers of
risk management. Compulsions arising out of increasing competition, as well a agency
problems between management, owners and other stakeholders are inducing banks to look
at newer avenues to augment revenues, while trimming costs.
Summary - To day Indian banking industry is in change. Rather than being something in
particular, it is continually booming something new - offering new services, merging
and consolidating into much larger and more complex businesses adopting new technologies that
seem to change faster than most of us can comprehend and facing a new and changing set
of rules. Despite all of these changes sweeping through this vital industry, there are still
something in banking that never seem to change. It is an probably will always remain to
be service industry providing an intangible product that is hard to differentials from the
products offered by competitors.
Indian banking has come a long way in the post reform era. There is significant
Besides India has got in succession Central Bankers and professional team who has left their
mark in managing the banking system despite turbulence in neighbouring countries especially
the financial turmoil which struck Asia in mid 1997 and 2007-8.