PROJECT REPORT

ON

“To study the strength of using CAMELS

framework as a tool of performance

evaluation for banking institutions”(2007-09)

Submitted in partial fulfillment of the requirement for the degree of

MASTERS OF BUSINESS ADMINISTRATION

SUBMITTED TO:-

PUNJAB TECHINCAL UNIVERSITY,

JALANDHAR

SUBMITTED BY:

Poonam Rani

MBA(4th Sem.)

Roll No.7116223088

REGIONAL INSTITUTE OF

MANAGEMENT AND TECHNOLOGY

MANDI GOBINDGARH. DISTT.FATEHGARH SAHIB (PB.)

CERTIFICATE

This is to certify that Miss. Poonam Rani has completed her project report titled “To

study the strength of using CAMELS framework as a tool of performance

evaluation for banking institutions” under my supervision. To the best of my

knowledge and belief this is her original work and this, wholly or partially, has not been

submitted for any degree of this or any other University.

Date: Mrs. Manjri Tejpal

(Prof. RIMT-IMCT)

DECLARATION

I hereby declare that this project work entitled To study the strength of using CAMELS

framework as a tool of performance evaluation for banking institutions is my work,

carried out under the guidance of my company guide MR. SOURABH BANSAL &

MRS. MANJRI TEJPAL. My report neither fully nor partially has ever been submitted

for award of any other degree to either this university or any other university.

POONAM RANI

ACKNOWLEDGMENT

Words are the dress of thoughts, appreciating and acknowledging those who are

responsible for the successful completion of the project.

My sincerity gratitude goes to Mr. SOURABH BANSAL & MRS. MANJRI

TEJPAL who assigned me responsibility to work on this project and provided me all

the help, guidance and encouragement to complete this project.

The encouragement and guidance given by Mr. SOURABH BANSAL have made

this a personally rewarding experience. I thank him for his support and inspiration,

without which, understanding the intricacies of the project would have been

exponentially difficult.

I am sincerely grateful to my parents and friends who provided me with the time and

financial assistance and inspiration needed to prepare this training report in congenial

manner.

WITH SINCERE THANKS

POONAM RANI

EXECUTIVE SUMMARY

The banking sector has been undergoing a complex, but comprehensive phase of

restructuring since 1991, with a view to make it sound, efficient, and at the same time

forging its links firmly with the real sector for promotion of savings, investment and

growth. Although a complete turnaround in banking sector performance is not expected

till the completion of reforms, signs of improvement are visible in some indicators under

the CAMEL framework. Under this bank is required to enhance capital adequacy,

strengthen asset quality, improve management, increase earnings and reduce sensitivity to

various financial risks. The almost simultaneous nature of these developments makes it

difficult to disentangle the positive impact of reform measures. Keeping this in mind,

signs of improvements and deteriorations are discussed for the three groups of scheduled

banks in the following sections.

CAMELS Framework

Supervisory framework, consistent with international norms, covers risk-monitoring

factors for evaluating the performance of banks. This framework involves the analyses of

six groups of indicators reflecting the health of financial institutions. The indicators are as

follows:

CAPITAL ADEQUACY

ASSET QUALITY

MANAGEMENT SOUNDNESS

EARNINGS & PROFITABILITY

LIQUIDITY

SENSITIVITY TO MARKET RISK

The whole banking scenario has changed in the very recent past on the recommendations

of Narasimham Committee. Further BASELL II Norms were introduced to

internationally standardize processes and make the banking industry more adaptive to the

sensitive market risks. The fact that banks work under the most volatile conditions and

the banking industry as such in the booming phase makes it an interesting subject of

study. Amongst these reforms and restructuring the CAMELS Framework has its own

contribution to the way modern banking is looked up on now. The attempt here is to see

how various ratios have been used and interpreted to reveal a banks performance and how

this particular model encompasses a wide range of parameters making it a widely used

and accepted model in today’s scenario.

CONTENTS PAGE NO.

CHAPTER 1: INTRODUCTION TO THE STUDY 1

INTRODUCTION TO THE BANKING REFORMS 2

INTRODUCTION TO BASEL II ACCORD 7

CHAPTER 2: INDUSTRY PROFILE 12

ICICI BANK

HDFC BANK

AXIS BANK

CHAPTER 3: CAMELS FRAMEWORK 19

CAPITAL ADEQUACY

ASSET MANAGEMENT

MANAGEMENT SOUNDNESS

EARNINGS & PROFITABILITY

LIQUIDITY

SENSITIVITY TO MARKET RISK

CHAPTER 4: RESERCH METHODOLOGY 37

OBJECTIVES OF THE STUDY

SCPOE OF THE STUDY

METHODOLOGY ADOPTED

LIMITATIONS

CHAPTER 5: DATA ANALYSIS & INTERPRETATION 41

CHAPTER 6:FINDINGS, RECOMMENDATIONS &

SUGGESTIONS

55

BIBLIOGRAPHY 59

CONTENTS PAGE NO.

TABLES & GRAPHS

Table No.1 42

Graph No.1 43

Table No.2 44

Graph No.2 44

Table No.3 45

Graph No.3 45

Table No.4 46

Graph No.4 46

Table No.5 47

Graph No.5 47

Table No.6 48

Graph No.6 48

CHAPTER 1:

INTRODUCTION TO THE STUDY

INTRODUCTION TO THE BANKING

REFORMS

INTRODUCTION TO BASEL II ACCORD

INTRODUCTION TO THE BANKING REFORMS

In 1991, the Indian economy went through a process of economic liberalization, which

was followed up by the initiation of fundamental reforms in the banking sector in 1992.

The banking reform package was based on the recommendations proposed by the

Narsimhan Committee Report (1991) that advocated a move to a more market oriented

banking system, which would operate in an environment of prudential regulation and

transparent accounting. One of the primary motives behind this drive was to introduce an

element of market discipline into the regulatory process that would reinforce the

supervisory effort of the Reserve Bank of India (RBI). Market discipline, especially in

the financial liberalization phase, reinforces regulatory and supervisory efforts and

provides a strong incentive to banks to conduct their business in a prudent and efficient

manner and to maintain adequate capital as a cushion against risk exposures. Recognizing

that the success of economic reforms was contingent on the success of financial sector

reform as well, the government initiated a fundamental banking sector reform package in

1992.

Banking sector, the world over, is known for the adoption of multidimensional strategies

from time to time with varying degrees of success. Banks are very important for the

smooth functioning of financial markets as they serve as repositories of vital financial

information and can potentially alleviate the problems created by information

asymmetries. From a central bank’s perspective, such high-quality disclosures help the

early detection of problems faced by banks in the market and reduce the severity of

market disruptions. Consequently, the RBI as part and parcel of the financial sector

deregulation, attempted to enhance the transparency of the annual reports of Indian banks

by, among other things, introducing stricter income recognition and asset classification

rules, enhancing the capital adequacy norms, and by requiring a number of additional

disclosures sought by investors to make better cash flow and risk assessments.

During the pre economic reforms period, commercial banks & development financial

institutions were functioning distinctly, the former specializing in short & medium term

financing, while the latter on long term lending & project financing.

Commercial banks were accessing short term low cost funds thru savings investments

like current accounts, savings bank accounts & short duration fixed deposits, besides

collection float. Development Financial Institutions (DFIs) on the other hand, were

essentially depending on budget allocations for long term lending at a concessionary rate

of interest.

The scenario has changed radically during the post reforms period, with the resolve of the

government not to fund the DFIs through budget allocations. DFIs like IDBI, IFCI &

ICICI had posted dismal financial results. Infact, their very viability has become a

question mark. Now they have taken the route of reverse merger with IDBI bank & ICICI

bank thus converting them into the universal banking system.

Major Recommendations by the Narasimham Committee on Banking

Sector Reforms

Strengthening Banking System

Capital adequacy requirements should take into account market risks in addition to the

credit risks.

In the next three years the entire portfolio of government securities should be marked to

market and the schedule for the same announced at the earliest (since announced in the

monetary and credit policy for the first half of 1998-99); government and other approved

securities which are now subject to a zero risk weight, should have a 5 per cent weight for

market risk.

Risk weight on a government guaranteed advance should be the same as for other

advances. This should be made prospective from the time the new prescription is put in

place.

Foreign exchange open credit limit risks should be integrated into the calculation of risk

weighted assets and should carry a 100 per cent risk weight.

Minimum capital to risk assets ratio (CRAR) be increased from the existing 8 per cent to

10 per cent; an intermediate minimum target of 9 per cent be achieved by 2000 and the

ratio of 10 per cent by 2002; RBI to be empowered to raise this further for individual

banks if the risk profile warrants such an increase. Individual banks' shortfalls in the

CRAR are treated on the same line as adopted for reserve requirements, viz. uniformity

across weak and strong banks. There should be penal provisions for banks that do not

maintain CRAR.

Public Sector Banks in a position to access the capital market at home or abroad be

encouraged, as subscription to bank capital funds cannot be regarded as a priority claim

on budgetary resources.

Asset Quality

An asset is classified as doubtful if it is in the substandard category for 18 months in the

first instance and eventually for 12 months and loss if it has been identified but not

written off. These norms should be regarded as the minimum and brought into force in a

phased manner.

For evaluating the quality of assets portfolio, advances covered by Government

guarantees, which have turned sticky, be treated as NPAs. Exclusion of such advances

should be separately shown to facilitate fuller disclosure and greater transparency of

operations.

For banks with a high NPA portfolio, two alternative approaches could be adopted. One

approach can be that, all loan assets in the doubtful and loss categories should be

identified and their realisable value determined. These assets could be transferred to an

Assets Reconstruction Company (ARC) which would issue NPA Swap Bonds.

An alternative approach could be to enable the banks in difficulty to issue bonds which

could from part of Tier II capital, backed by government guarantee to make these

instruments eligible for SLR investment by banks and approved instruments by LIC, GIC

and Provident Funds.

The interest subsidy element in credit for the priority sector should be totally eliminated

and interest rate on loans under Rs. 2 lakhs should be deregulated for scheduled

commercial banks as has been done in the case of Regional Rural Banks and cooperative

credit institutions.

Prudential Norms and Disclosure Requirements

In India, income stops accruing when interest or installment of principal is not paid

within 180 days, which should be reduced to 90 days in a phased manner by 2002.

Introduction of a general provision of 1 per cent on standard assets in a phased manner be

considered by RBI.

As an incentive to make specific provisions, they may be made tax deductible.

Systems and Methods in Banks

There should be an independent loan review mechanism especially for large borrowal

accounts and systems to identify potential NPAs. Banks may evolve a filtering

mechanism by stipulating in-house prudential limits beyond which exposures on

single/group borrowers are taken keeping in view their risk profile as revealed through

credit rating and other relevant factors.

Banks and FIs should have a system of recruiting skilled manpower from the open

market.

Public sector banks should be given flexibility to determined managerial remuneration

levels taking into account market trends.

There may be need to redefine the scope of external vigilance and investigation agencies

with regard to banking business.

There is need to develop information and control system in several areas like better

tracking of spreads, costs and NPSs for higher profitability, , accurate and timely

information for strategic decision to Identify and promote profitable products and

customers, risk and asset-liability management; and efficient treasury management.

Structural Issues

With the conversion of activities between banks and DFIs, the DFIs should, over a period

of time convert them to bank. A DFI which converts to bank be given time to face in

reserve equipment in respect of its liability to bring it on par with requirement relating to

commercial bank.

Mergers of Public Sector Banks should emanate from the management of the banks with

the Government as the common shareholder playing a supportive role. Merger should not

be seen as a means of bailing out weak banks. Mergers between strong banks/FIs would

make for greater economic and commercial sense.

‘Weak Banks' may be nurtured into healthy units by slowing down on expansion,

eschewing high cost funds/borrowings etc.

The minimum share of holding by Government/Reserve Bank in the equity of the

nationalised banks and the State Bank should be brought down to 33%. The RBI

regulator of the monetary system should not be also the owner of a bank in view of the

potential for possible conflict of interest.

There is a need for a reform of the deposit insurance scheme based on CAMELs ratings

awarded by RBI to banks.

Inter-bank call and notice money market and inter-bank term money market should be

strictly restricted to banks; only exception to be made is primary dealers.

Non-bank parties are provided free access to bill rediscounts, CPs, CDs, Treasury Bills,

and MMMF.

RBI should totally withdraw from the primary market in 91 days Treasury Bills.

BASEL II ACCORD

 Bank capital framework sponsored by the world's central banks designed to promote

uniformity, make regulatory capital more risk sensitive, and promote enhanced risk

management among large, internationally active banking organizations. The International

Capital Accord, as it is called, will be fully effective by January 2008 for banks active in

international markets. Other banks can choose to "opt in," or they can continue to follow

the minimum capital guidelines in the original Basel Accord, finalized in 1988. The

revised accord (Basel II) completely overhauls the 1988 Basel Accord and is based on

three mutually supporting concepts, or "pillars," of capital adequacy. The first of these

pillars is an explicitly defined regulatory capital requirement, a minimum capital-to-asset

ratio equal to at least 8% of risk-weighted assets. Second, bank supervisory agencies,

such as the Comptroller of the Currency, have authority to adjust capital levels for

individual banks above the 8% minimum when necessary. The third supporting pillar

calls upon market discipline to supplement reviews by banking agencies.

Basel II is the second of the Basel Accords, which are recommendations on banking laws

and regulations issued by the Basel Committee on Banking Supervision. The purpose of

Basel II, which was initially published in June 2004, is to create an international standard

that banking regulators can use when creating regulations about how much capital banks

need to put aside to guard against the types of financial and operational risks banks face.

Advocates of Basel II believe that such an international standard can help protect the

international financial system from the types of problems that might arise should a major

bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by

setting up rigorous risk and capital management requirements designed to ensure that a

bank holds capital reserves appropriate to the risk the bank exposes itself to through its

lending and investment practices. Generally speaking, these rules mean that the greater

risk to which the bank is exposed, the greater the amount of capital the bank needs to

hold to safeguard its solvency and overall economic stability.

The final version aims at:

1. Ensuring that capital allocation is more risk sensitive;

2. Separating operational risk from credit risk, and quantifying both;

3. Attempting to align economic and regulatory capital more closely to reduce the scope for

regulatory arbitrage.

While the final accord has largely addressed the regulatory arbitrage issue, there are still

areas where regulatory capital requirements will diverge from the economic.

Basel II has largely left unchanged the question of how to actually define bank capital,

which diverges from accounting equity in important respects. The Basel I definition, as

modified up to the present, remains in place.

The Accord in operation

Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing

risk), (2) supervisory review and (3) market discipline – to promote greater stability in

the financial system.

The Three Pillars of Basel II

The Basel I accord dealt with only parts of each of these pillars. For example: with

respect to the first Basel II pillar, only one risk, credit risk, was dealt with in a simple

manner while market risk was an afterthought; operational risk was not dealt with at all.

The First Pillar

The first pillar deals with maintenance of regulatory capital calculated for three major

components of risk that a bank faces: credit risk, operational risk and market risk. Other

risks are not considered fully quantifiable at this stage.

The credit risk component can be calculated in three different ways of varying degree of

sophistication, namely standardized approach, Foundation IRB and Advanced IRB. IRB

stands for "Internal Rating-Based Approach".

For operational risk, there are three different approaches - basic indicator approach or

BIA, standardized approach or TSA, and advanced measurement approach or AMA.

For market risk the preferred approach is VaR (value at risk).

As the Basel 2 recommendations are phased in by the banking industry it will move from

standardised requirements to more refined and specific requirements that have been

developed for each risk category by each individual bank. The upside for banks that do

develop their own bespoke risk measurement systems is that they will be rewarded with

potentially lower risk capital requirements. In future there will be closer links between

the concepts of economic profit and regulatory capital.

Credit Risk can be calculated by using one of three approaches

1. Standardized Approach

2. Foundation IRB (Internal Ratings Based) Approach

3. Advanced IRB Approach

The standardized approach sets out specific risk weights for certain types of credit risk.

The standard risk weight categories are used under Basel 1 and are 0% for short term

government bonds, 20% for exposures to OECD Banks, 50% for residential mortgages

and 100% weighting on commercial loans. A new 150% rating comes in for borrowers

with poor credit ratings. The minimum capital requirement( the percentage of risk

weighted assets to be held as capital) remains at 8%.

For those Banks that decide to adopt the standardized ratings approach they will be

forced to rely on the ratings generated by external agencies. Certain Banks are developing

the IRB approach as a result.

The Second Pillar

The second pillar deals with the regulatory response to the first pillar, giving regulators

much improved 'tools' over those available to them under Basel I. It also provides a

framework for dealing with all the other risks a bank may face, such as systemic risk,

pension risk, concentration risk, strategic risk, reputation risk, liquidity risk and legal

risk, which the accord combines under the title of residual risk. It gives banks a power to

review their risk management system.

The Third Pillar

The third pillar greatly increases the disclosures that the bank must make. This is

designed to allow the market to have a better picture of the overall risk position of the

bank and to allow the counterparties of the bank to price and deal appropriately.

The new Basel Accord has its foundation on three mutually reinforcing pillars that allow

banks and bank supervisors to evaluate properly the various risks that banks face and

realign regulatory capital more closely with underlying risks. The first pillar is

compatible with the credit risk, market risk and operational risk. The regulatory capital

will be focused on these three risks. The second pillar gives the bank responsibility to

exercise the best ways to manage the risk specific to that bank. Concurrently, it also casts

responsibility on the supervisors to review and validate banks’ risk measurement models.

The third pillar on market discipline is used to leverage the influence that other market

players can bring. This is aimed at improving the transparency in banks and improves

reporting.

CHAPTER-2

INDUSTRY PROFILE

ICICI Bank

HDFC Bank

AXIS Bank

INDUSTRY PROFILE

The following discussion deals with the 6 parameters & 3 major banks in India have been

taken for study. The following banks have been taken for the study:

ICICI Bank

HDFC Bank

AXIS Bank

ICICI Bank

Overview

ICICI Bank is India's second-largest bank with total assets of Rs. 3,744.10 billion (US$

77 billion) at December 31, 2008 and profit after tax Rs. 30.14 billion for the nine months

ended December 31, 2008. The Bank has a network of 1,420 branches and about 4,644

ATMs in India and presence in 18 countries. ICICI Bank offers a wide range of banking

products and financial services to corporate and retail customers through a variety of

delivery channels and through its specialised subsidiaries and affiliates in the areas of

investment banking, life and non-life insurance, venture capital and asset management.

The Bank currently has subsidiaries in the United Kingdom, Russia and Canada, branches

in United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai

International Finance Centre and representative offices in United Arab Emirates, China,

South Africa, Bangladesh, Thailand, Malaysia and Indonesia. Our UK subsidiary has

established branches in Belgium and Germany.

ICICI Bank's equity shares are listed in India on Bombay Stock Exchange and the

National Stock Exchange of India Limited and its American Depositary Receipts (ADRs)

are listed on the New York Stock Exchange (NYSE).

History

ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial

institution, and was its wholly-owned subsidiary. ICICI's shareholding in ICICI Bank was

reduced to 46% through a public offering of shares in India in fiscal 1998, an equity

offering in the form of ADRs listed on the NYSE in fiscal 2000, ICICI Bank's acquisition

of Bank of Madura Limited in an all-stock amalgamation in fiscal 2001, and secondary

market sales by ICICI to institutional investors in fiscal 2001 and fiscal 2002.

ICICI was formed in 1955 at the initiative of the World Bank, the Government of India

and representatives of Indian industry. The principal objective was to create a

development financial institution for providing medium-term and long-term project

financing to Indian businesses. In the 1990s, ICICI transformed its business from a

development financial institution offering only project finance to a diversified financial

services group offering a wide variety of products and services, both directly and through

a number of subsidiaries and affiliates like ICICI Bank.

In 1999, ICICI become the first Indian company and the first bank or financial institution

from non-Japan Asia to be listed on the NYSE.

After consideration of various corporate structuring alternatives in the context of the

emerging competitive scenario in the Indian banking industry, and the move towards

universal banking, the managements of ICICI and ICICI Bank formed the view that the

merger of ICICI with ICICI Bank would be the optimal strategic alternative for both

entities, and would create the optimal legal structure for the ICICI group's universal

banking strategy. The merger would enhance value for ICICI shareholders through the

merged entity's access to low-cost deposits, greater opportunities for earning fee-based

income and the ability to participate in the payments system and provide transaction-

banking services. The merger would enhance value for ICICI Bank shareholders through

a large capital base and scale of operations, seamless access to ICICI's strong corporate

relationships built up over five decades, entry into new business segments, higher market

share in various business segments, particularly fee-based services, and access to the vast

talent pool of ICICI and its subsidiaries.

In October 2001, the Boards of Directors of ICICI and ICICI Bank approved the merger

of ICICI and two of its wholly-owned retail finance subsidiaries, ICICI Personal

Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. The

merger was approved by shareholders of ICICI and ICICI Bank in January 2002, by the

High Court of Gujarat at Ahmedabad in March 2002, and by the High Court of Judicature

at Mumbai and the Reserve Bank of India in April 2002. Consequent to the merger, the

ICICI group's financing and banking operations, both wholesale and retail, have been

integrated in a single entity.

ICICI Bank has formulated a Code of Business Conduct and Ethics for its directors and

employees.

HDFC Bank

The Housing Development Finance Corporation Limited (HDFC) was amongst the first

to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a

bank in the private sector, as part of the RBI's liberalisation of the Indian Banking

Industry in 1994. The bank was incorporated in August 1994 in the name of 'HDFC Bank

Limited', with its registered office in Mumbai, India. HDFC Bank commenced operations

as a Scheduled Commercial Bank in January 1995.

Promoter

HDFC is India's premier housing finance company and enjoys an impeccable track record

in India as well as in international markets. Since its inception in 1977, the Corporation

has maintained a consistent and healthy growth in its operations to remain the market

leader in mortgages. Its outstanding loan portfolio covers well over a million dwelling

units. HDFC has developed significant expertise in retail mortgage loans to different

market segments and also has a large corporate client base for its housing related credit

facilities. With its experience in the financial markets, a strong market reputation, large

shareholder base and unique consumer franchise, HDFC was ideally positioned to

promote a bank in the Indian environment.

Capital Structure

The authorised capital of HDFC Bank is Rs550 crore (Rs5.5 billion). The paid-up capital

is Rs424.6 crore (Rs.4.2 billion). The HDFC Group holds 19.4% of the bank's equity and

about 17.6% of the equity is held by the ADS Depository (in respect of the bank's

American Depository Shares (ADS) Issue). Roughly 28% of the equity is held by Foreign

Institutional Investors (FIIs) and the bank has about 570,000 shareholders. The shares are

listed on the Stock Exchange, Mumbai and the National Stock Exchange. The bank's

American Depository Shares are listed on the New York Stock Exchange (NYSE) under

the symbol 'HDB'.

Management

Mr. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr.

Capoor was a Deputy Governor of the Reserve Bank of India.

The Managing Director, Mr. Aditya Puri, has been a professional banker for over 25

years, and before joining HDFC Bank in 1994 was heading Citibank's operations in

Malaysia.

The Bank's Board of Directors is composed of eminent individuals with a wealth of

experience in public policy, administration, industry and commercial banking. Senior

executives representing HDFC are also on the Board.

Senior banking professionals with substantial experience in India and abroad head

various businesses and functions and report to the Managing Director. Given the

professional expertise of the management team and the overall focus on recruiting and

retaining the best talent in the industry, the bank believes that its people are a significant

competitive strength.

AXIS BANK

Axis Bank, previously called UTI Bank, was the first of the new private banks to have

begun operations in 1994, after the Government of India allowed new private banks to be

established. The Bank was promoted jointly by the Administrator of the Specified

Undertaking of the Unit Trust of India (UTI-I), Life Insurance Corporation of India

(LIC), General Insurance Corporation Ltd., National Insurance Company Ltd., The New

India Assurance Company, The Oriental Insurance Corporation and United Insurance

Company Ltd. UTI-I holds a special position in the Indian capital markets and has

promoted many leading financial institutions in the country. The bank changed its name

to Axis Bank in April 2007 to avoid confusion with other unrelated entities with similair

name. Shikha Sharma was named as the bank's managing director and CEO on 20 April

2009.

The Bank today is capitalized to the extent of Rs. 358.97 crores with the public holding

(other than promoters) at 57.59%.As on the year ended March 31, 2009 the Bank had a

total income of Rs. 8801 crores and a net profit of Rs 581.45 crores.

Branch Network

At the end of March 2009,the Bank has a very wide network of more than 726 branch

offices and Extension Counters. The Bank hasloans now (as of June 2007) account for as

much as 70 per cent of the bank’s total loan book of Rs 2,00,000 crore. For HDFC Bank,

retail assets are around 57 per cent (Rs 28,000 crore) of the total loans as of March 2007.

In the case of Axis Bank, retail loans have declined from 30 per cent of the total loan

book of Rs 25,800 crore in June 2006 to around 23 per cent of loan book of Rs.41,280

crore (as of June 2007). Even over a longer period, while the overall asset growth for

Axis Bank has been quite high and has matched that of the other banks, retail exposures

grew at a slower pace.

If the sharp decline in the retail asset book in the past year in the case of Axis Bank is

part of a deliberate business strategy, this could have significant implications (not

necessarily negative) for the overall future profitability of the business.

Despite the relatively slower growth of the retail book over a period of time and the

outright decline seen in the past year, the bank’s fundamentals are quite resilient. With

the high level of mid-corporate and wholesale corporate lending the bank has been doing,

one would have expected the net interest margins to have been under greater pressure.

The bank, though, appears to have insulated such pressures. Interest margins, while they

have declined from the 3.15 per cent seen in 2003-04, are still hovering close to the 3 per

cent mark.

Risk and earnings perspective

Such strong emphasis and focus on lending also does not appear to have had any

deleterious impact on the overall asset quality. The bank’s non-performing loans are even

now, after five years of extremely rapid asset build-up, below 1 per cent of its total loans.

From a medium-term perspective, it appears that Axis Bank could be charting out a niche

for itself in the private bank space. It appears to be following a business strategy quite

different from the high-volume and commodity-style approach of ICICI Bank and HDFC

Bank. That strategy also has its pluses in terms of the relatively higher margins in some

segments of the retail business and the in-built credit risk diversification (and mitigation)

achieved through a widely dispersed retail credit portfolio. But, as indicated above, Axis

Bank has been to able to maintain the quality of its loan portfolio despite the concentrated

nature of wholesale corporate lending.

CHAPTER 3

CAMELS FRAMEWORK

The CAMELS FRAMEWORK

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. (Note that the bulk of the academic literature is based on pre-

1997 data and is thus based on CAMEL ratings.) 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) was 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, wich focus on supervisory concerns

such as capital adequacy, asset 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. Padmanabhan

to review the banking supervision system. The Committee certain recommendations and

based on such suggetions 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.

CAMELS ratings in the supervisory monitoring of banks

Several academic studies have examined whether and to what extent private supervisory

information is useful in the supervisory monitoring of banks. With respect to predicting

bank failure, Barker and Holdsworth (1993) find evidence that CAMEL ratings are

useful, even after controlling for a wide range of publicly available information about the

condition and performance of banks. Cole and Gunther (1998) examine a similar question

and find that although CAMEL ratings contain useful information, it decays quickly. For

the period between 1988 and 1992, they find that a statistical model using publicly

available financial data is a better indicator of bank failure than CAMEL ratings that are

more than two quarters old.

Hirtle and Lopez (1999) examine the usefulness of past CAMEL ratings in assessing

banks' current conditions. They find that, conditional on current public information, the

private supervisory information contained in past CAMEL ratings provides further

insight into bank current conditions, as summarized by current CAMEL ratings. The

authors find that, over the period from 1989 to 1995, the private supervisory information

gathered during the last on-site exam remains useful with respect to the current condition

of a bank for up to 6 to 12 quarters (or 1.5 to 3 years). The overall conclusion drawn from

academic studies is that private supervisory information, as summarized by CAMELS

ratings, is clearly useful in the supervisory monitoring of bank conditions.

CAMELS ratings in the public monitoring of banks

Another approach to examining the value of private supervisory information is to

examine its impact on the market prices of bank securities. Market prices are generally

assumed to incorporate all available public information. Thus, if private supervisory

information were found to affect market prices, it must also be of value to the public

monitoring of banks.

Such private information could be especially useful to financial market participants,

given the informational asymmetries in the commercial banking industry. Since banks

fund projects not readily financed in public capital markets, outside monitors should find

it difficult to completely assess banks' financial conditions. In fact, Morgan (1998) finds

that rating agencies disagree more about banks than about other types of firms. As a

result, supervisors with direct access to private bank information could generate

additional information useful to the financial markets, at least by certifying that a bank's

financial condition is accurately reported.

The direct public beneficiaries of private supervisory information, such as that contained

in CAMELS ratings, would be depositors and holders of banks' securities. Small

depositors are protected from possible bank default by FDIC insurance, which probably

explains the finding by Gilbert and Vaughn (1998) that the public announcement of

supervisory enforcement actions, such as prohibitions on paying dividends, did not cause

deposit runoffs or dramatic increases in the rates paid on deposits at the affected banks.

However, uninsured depositors could be expected to respond more strongly to such

information. Jordan, et al., (1999) find that uninsured deposits at banks that are subjects

of publicly-announced enforcement actions, such as cease-and-desist orders, decline

during the quarter after the announcement.

The holders of commercial bank debt, especially subordinated debt, should have the most

in common with supervisors, since both are more concerned with banks' default

probabilities (i.e., downside risk). As of year-end 1998, bank holding companies (BHCs)

had roughly $120 billion in outstanding subordinated debt. DeYoung, et al., (1998)

examine whether private supervisory information would be useful in pricing the

subordinated debt of large BHCs. The authors use an econometric technique that

estimates the private information component of the CAMEL ratings for the BHCs' lead

banks and regresses it onto subordinated bond prices. They conclude that this aspect of

CAMEL ratings adds significant explanatory power to the regression after controlling for

publicly available financial information and that it appears to be incorporated into bond

prices about six months after an exam. Furthermore, they find that supervisors are more

likely to uncover unfavorable private information, which is consistent with managers'

incentives to publicize positive information while de-emphasizing negative information.

These results indicate that supervisors can generate useful information about banks, even

if those banks already are monitored by private investors and rating agencies.

The market for bank equity, which is about eight times larger than that for bank

subordinated debt, was valued at more than $910 billion at year-end 1998. Thus, the

academic literature on the extent to which private supervisory information affects stock

prices is more extensive. For example, Jordan, et al., (1999) find that the stock market

views the announcement of formal enforcement actions as informative. That is, such

announcements are associated with large negative stock returns for the affected banks.

This result holds especially for banks that had not previously manifested serious

problems.

Focusing specifically on CAMEL ratings, Berger and Davies (1998) use event study

methodology to examine the behavior of BHC stock prices in the eight-week period

following an exam of its lead bank. They conclude that CAMEL downgrades reveal

unfavorable private information about bank conditions to the stock market. This

information may reach the public in several ways, such as through bank financial

statements made after a downgrade. These results suggest that bank management may

reveal favorable private information in advance, while supervisors in effect force the

release of unfavorable information.

Berger, Davies, and Flannery (1998) extend this analysis by examining whether the

information about BHC conditions gathered by supervisors is different from that used by

the financial markets. They find that assessments by supervisors and rating agencies are

complementary but different from those by the stock market. The authors attribute this

difference to the fact that supervisors and rating agencies, as representatives of

debtholders, are more interested in default probabilities than the stock market, which

focuses on future revenues and profitability. This rationale also could explain the authors'

finding that supervisory assessments are much less accurate than market assessments of

banks' future performances.

In summary, on-site bank exams seem to generate additional useful information beyond

what is publicly available. However, according to Flannery (1998), the limited available

evidence does not support the view that supervisory assessments of bank conditions are

uniformly better and more timely than market assessments.

(A) Capital Adequacy

Capital base of financial institutions facilitates depositors in forming their risk perception

about the institutions. Also, it is the key parameter for financial managers to maintain

adequate levels of capitalization. Moreover, besides absorbing unanticipated shocks, it

signals that the institution will continue to honor its obligations. The most widely used

indicator of capital adequacy is capital to risk-weighted assets ratio (CRWA). According

to Bank Supervision Regulation Committee (The Basle Committee) of Bank for

International Settlements, a minimum 8 percent CRWA is required.

Capital adequacy ultimately determines how well financial institutions can cope with

shocks to their balance sheets. Thus, it is useful to track capital-adequacy ratios that take

into account the most important financial risks—foreign exchange, credit, and interest

rate risks—by assigning risk weightings to the institution’s assets.

A Capital Adquecy Ratio is a measure of a bank's capital. It is expressed as a percentage

of a bank's risk weighted credit exposures.

Also known as ""Capital to Risk Weighted Assets Ratio (CRAR).

Capital adequacy is measured by the ratio of capital to risk-weighted assets (CRAR). A

sound capital base strengthens confidence of depositors.

This ratio is used to protect depositors and promote the stability and efficiency of

financial systems around the world.

(B) Asset Quality:

Asset quality determines the robustness of financial institutions against loss of value in the

assets. The deteriorating value of assets, being prime source of banking problems, directly

pour into other areas, as losses are eventually written-off against capital, which ultimately

jeopardizes the earning capacity of the institution. With this backdrop, the asset quality is

gauged in relation to the level and severity of non-performing assets, adequacy of

provisions, recoveries, distribution of assets etc. Popular indicators include non-

performing loans to advances, loan default to total advances, and recoveries to loan default

ratios.

The solvency of financial institutions typically is at risk when their assets become

impaired, so it is important to monitor indicators of the quality of their assets in terms of

overexposure to specific risks, trends in nonperforming loans, and the health and

profitability of bank borrowers— especially the corporate sector. Share of bank assets in

the aggregate financial sector assets: In most emerging markets, banking sector assets

comprise well over 80 per cent of total financial sector assets, whereas these figures are

much lower in the developed economies. Furthermore, deposits as a share of total bank

liabilities have declined since 1990 in many developed countries, while in developing

countries public deposits continue to be dominant in banks. In India, the share of

banking assets in total financial sector assets is around 75 per cent, as of end-March

2008. There is, no doubt, merit in recognising the importance of diversification in the

institutional and instrument-specific aspects of financial intermediation in the interests of

wider choice, competition and stability. However, the dominant role of banks in financial

intermediation in emerging economies and particularly in India will continue in the

medium-term; and the banks will continue to be “special” for a long time. In this regard,

it is useful to emphasise the dominance of banks in the developing countries in promoting

non-bank financial intermediaries and services including in development of debt-markets.

Even where role of banks is apparently diminishing in emerging markets, substantively,

they continue to play a leading role in non-banking financing activities, including the

development of financial markets.

One of the indicators for asset quality is the ratio of non-performing loans to total loans

(GNPA). The gross non-performing loans to gross advances ratio is more indicative of

the quality of credit decisions made by bankers. Higher GNPA is indicative of poor credit

decision-making.

NPA: Non-Performing Assets

Advances are classified into performing and non-performing advances (NPAs) as per

RBI guidelines. NPAs are further classified into sub-standard, doubtful and loss assets

based on the criteria stipulated by RBI. An asset, including a leased asset, becomes non-

performing when it ceases to generate income for the Bank.

An NPA is a loan or an advance where:

1. Interest and/or instalment of principal remains overdue for a period of more than 90

days in respect of a term loan;

2. The account remains "out-of-order'' in respect of an Overdraft or Cash Credit (OD/CC);

3. The bill remains overdue for a period of more than 90 days in case of bills purchased

and discounted;

4. A loan granted for short duration crops will be treated as an NPA if the installments of

principal or interest thereon remain overdue for two crop seasons; and

5. A loan granted for long duration crops will be treated as an NPA if the installments of

principal or interest thereon remain overdue for one crop season.

The Bank classifies an account as an NPA only if the interest imposed during any quarter

is not fully repaid within 90 days from the end of the relevant quarter.

This is a key to the stability of the banking sector. There should be no hesitation in stating

that Indian banks have done a remarkable job in containment of non-performing loans

(NPL) considering the overhang issues and overall difficult environment. For 2008, the

net NPL ratio for the Indian scheduled commercial banks at 2.9 per cent is ample

testimony to the impressive efforts being made by our banking system. In fact, recovery

management is also linked to the banks’ interest margins. The cost and recovery

management supported by enabling legal framework hold the key to future health and

competitiveness of the Indian banks. No doubt, improving recovery-management in India

is an area requiring expeditious and effective actions in legal, institutional and judicial

processes.

(C)Management Soundness

Management of financial institution is generally evaluated in terms of capital adequacy,

asset quality, earnings and profitability, liquidity and risk sensitivity ratings. In addition,

performance evaluation includes compliance with set norms, ability to plan and react to

changing circumstances, technical competence, leadership and administrative ability. In

effect, management rating is just an amalgam of performance in the above-mentioned

areas.

Sound management is one of the most important factors behind financial institutions’

performance. Indicators of quality of management, however, are primarily applicable to

individual institutions, and cannot be easily aggregated across the sector. Furthermore,

given the qualitative nature of management, it is difficult to judge its soundness just by

looking at financial accounts of the banks.

Nevertheless, total expenditure to total income and operating expense to total expense

helps in gauging the management quality of the banking institutions. Sound management

is key to bank performance but is difficult to measure. It is primarily a qualitative factor

applicable to individual institutions. Several indicators, however, can jointly serve—as,

for instance, efficiency measures do—as an indicator of management soundness.

The ratio of non-interest expenditures to total assets (MGNT) can be one of the measures

to assess the working of the management. . This variable, which includes a variety of

expenses, such as payroll, workers compensation and training investment, reflects the

management policy stance.

Efficiency Ratios demonstrate how efficiently the company uses its assets and how

efficiently the company manages its operations.

Asset Turnover Ratio

=Revenue

Total Assets

Indicates the relationship between assets and revenue.

Things to remember Companies with low profit margins tend to have high asset turnover,

those with high profit margins have low asset turnover - it indicates pricing strategy.

This ratio is more useful for growth companies to check if in fact they are growing revenue in proportion to sales.

Asset Turnover Analysis:This ratio is useful to determine the amount of sales that are generated from each dollar of assets. As noted above, companies with low profit margins tend to have high asset turnover, those with high profit margins have low asset turnover.

.

(D)Earnings & Profitability

Earnings and profitability, the prime source of increase in capital base, is examined with

regards to interest rate policies and adequacy of provisioning. In addition, it also helps to

support present and future operations of the institutions. The single best indicator used to

gauge earning is the Return on Assets (ROA), which is net income after taxes to total

asset ratio.

Strong earnings and profitability profile of banks reflects the ability to support present

and future operations. More specifically, this determines the capacity to absorb losses,

finance its expansion, pay dividends to its shareholders, and build up an adequate level of

capital. Being front line of defense against erosion of capital base from losses, the need

for high earnings and profitability can hardly be overemphasized. Although different

indicators are used to serve the purpose, the best and most widely used indicator is Return

on Assets (ROA). However, for in-depth analysis, another indicator Net Interest Margins

(NIM) is also used. Chronically unprofitable financial institutions risk insolvency.

Compared with most other indicators, trends in profitability can be more difficult to

interpret—for instance, unusually high profitability can reflect excessive risk taking.

ROA-Return On Assets

An indicator of how profitable a company is relative to its total assets. ROA gives an

idea as to how efficient management is at using its assets to generate earnings. Calculated

by dividing a company's annual earnings by its total assets, ROA is displayed as a

percentage. Sometimes this is referred to as "return on investment".

The formula for return on assets is:

ROA tells what earnings were generated from invested capital (assets). ROA for public

companies can vary substantially and will be highly dependent on the industry. This is

why when using ROA as a comparative measure, it is best to compare it against a

company's previous ROA numbers or the ROA of a similar company. 

The assets of the company are comprised of both debt and equity. Both of these types of

financing are used to fund the operations of the company. The ROA figure gives

investors an idea of how effectively the company is converting the money it has to invest

into net income. The higher the ROA number, the better, because the company is earning

more money on less investment. For example, if one company has a net income of $1

million and total assets of $5 million, its ROA is 20%; however, if another company

earns the same amount but has total assets of $10 million, it has an ROA of 10%. Based

on this example, the first company is better at converting its investment into profit. When

you really think about it, management's most important job is to make wise choices in

allocating its resources. Anybody can make a profit by throwing a ton of money at a

problem, but very few managers excel at making large profits with little investment

(E) Liquidity

An adequate liquidity position refers to a situation, where institution can obtain sufficient

funds, either by increasing liabilities or by converting its assets quickly at a reasonable

cost. It is, therefore, generally assessed in terms of overall assets and liability

management, as mismatching gives rise to liquidity risk. Efficient fund management

refers to a situation where a spread between rate sensitive assets (RSA) and rate sensitive

liabilities (RSL) is maintained. The most commonly used tool to evaluate interest rate

exposure is the Gap between RSA and RSL, while liquidity is gauged by liquid to total

asset ratio.

Initially solvent financial institutions may be driven toward closure by poor management

of short-term liquidity. Indicators should cover funding sources and capture large

maturity mismatches.

The term liquidity is used in various ways, all relating to availability of, access to, or

convertibility into cash.

An institution is said to have liquidity if it can easily meet its needs for cash either

because it has cash on hand or can otherwise raise or borrow cash.

A market is said to be liquid if the instruments it trades can easily be bought or sold in

quantity with little impact on market prices.

An asset is said to be liquid if the market for that asset is liquid.

The common theme in all three contexts is cash. A corporation is liquid if it has ready

access to cash. A market is liquid if participants can easily convert positions into cash—

or conversely. An asset is liquid if it can easily be converted to cash.

The liquidity of an institution depends on:

the institution's short-term need for cash;

cash on hand;

available lines of credit;

the liquidity of the institution's assets;

The institution's reputation in the marketplace—how willing will counterparty is to

transact trades with or lend to the institution?

The liquidity of a market is often measured as the size of its bid-ask spread, but this is an

imperfect metric at best. More generally, Kyle (1985) identifies three components of

market liquidity:

Tightness is the bid-ask spread;

Depth is the volume of transactions necessary to move prices;

Resiliency is the speed with which prices return to equilibrium following a large trade.

Examples of assets that tend to be liquid include foreign exchange; stocks traded in the

Stock Exchange or recently issued Treasury bonds. Assets that are often illiquid include

limited partnerships, thinly traded bonds or real estate.

Cash maintained by the banks and balances with central bank, to total asset ratio (LQD)

is an indicator of bank's liquidity. In general, banks with a larger volume of liquid assets

are perceived safe, since these assets would allow banks to meet unexpected withdrawals.

Credit deposit ratio is a tool used to study the liquidity position of the bank. It is

calculated by dividing the cash held in different forms by total deposit. A high ratio

shows that there is more amounts of liquid cash with the bank to met its clients cash

withdrawals.

(F) 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

commodity exchanges, there is also a need to monitor indicators of equity and

commodity price risk.

Interest Rate Risk Basics

In the most simplistic terms, interest rate risk is a balancing act. Banks are trying to

balance the quantity of repricing assets with the quantity of repricing liabilities. For

example, when a bank has more liabilities repricing in a rising rate environment than

assets repricing, 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 repricing at higher rates.

An extreme example of a repricing imbalance would be funding 30-year fixed-rate

mortgages with 6-month CDs. You can see that in a rising rate environment the impact

on the NIM could be devastating as the liabilities reprice at higher rates but the assets do

not. Because of this exposure, banks are required to monitor and control IRR and to

maintain a reasonably well-balanced position.

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.

Liquidity risk tends to compound other risks. If a trading organization has a position in an

illiquid asset, its limited ability to liquidate that position at short notice will compound its

market risk. Suppose a firm has offsetting cash flows with two different counterparties on

a given day. If the counterparty that owes it a payment defaults, the firm will have to

raise cash from other sources to make its payment. Should it be unable to do so, it too we

default. Here, liquidity risk is compounding credit risk.

Accordingly, liquidity risk has to be managed in addition to market, credit and other

risks. Because of its tendency to compound other risks, it is difficult or impossible to

isolate liquidity risk. In all but the most simple of circumstances, comprehensive metrics

of liquidity risk don't exist. Certain techniques of asset-liability management can be

applied to assessing liquidity risk. If an organization's cash flows are largely contingent,

liquidity risk may be assessed using some form of scenario analysis. Construct multiple

scenarios for market movements and defaults over a given period of time. Assess day-to-

day cash flows under each scenario. Because balance sheets differed so significantly from

one organization to the next, there is little standardization in how such analyses are

implemented.

Regulators are primarily concerned about systemic implications of liquidity risk.

Business activities entail a variety of risks. For convenience, we distinguish between

different categories of risk: market risk, credit risk, liquidity risk, etc. Although such

categorization is convenient, it is only informal. Usage and definitions vary. Boundaries

between categories are blurred. A loss due to widening credit spreads may reasonably be

called a market loss or a credit loss, so market risk and credit risk overlap. Liquidity risk

compounds other risks, such as market risk and credit risk. It cannot be divorced from the

risks it compounds.

An important but somewhat ambiguous distinguish is that between market risk and

business risk. Market risk is exposure to the uncertain market value of a portfolio.

Business risk is exposure to uncertainty in economic value that cannot be marked-to-

market. The distinction between market risk and business risk parallels the distinction

between market-value accounting and book-value accounting.

The distinction between market risk and business risk is ambiguous because there is a

vast "gray zone" between the two. There are many instruments for which markets exist,

but the markets are illiquid. Mark-to-market values are not usually available, but mark-to-

model values provide a more-or-less accurate reflection of fair value. Do these

instruments pose business risk or market risk? The decision is important because firms

employ fundamentally different techniques for managing the two risks.

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.

CHAPTER 4

RESERCH METHODOLOGY

DESIGN OF THE STUDY

STATEMENT OF THE PROBLEM

In the recent years the financial system especially the banks have undergone numerous

changes in the form of reforms, regulations & norms. CAMELS framework for the

performance evaluation of banks is an addition to this. The study is conducted to analyze

the pros & cons of this model.

OBJECTIVES OF STUDY

To do an in-depth analysis of the model .

To analyze 3 banks to get the desired results by using CAMELS as a tool of measuring

performance.

RESEARCH PROPOSAL

The Bank after the implementation of the balanced scorecard in 2002 has under gone a

drastic change. Both its peoples and process perspectives have changed visibly and the

employees have full faith in the new strategy to produce quick results and keep them

ahead in the industry. The balanced scorecard approach has brought about more role

clarity in the job profile and has improved processes. In short it focuses not only on short

term goals but is very clear about its way to achieve the long term goal.

SCOPE OF THE RESEARCH

“To study the strength of using CAMELS framework as a tool of performance evaluation

for banking institutions.”

1. Type of research: Descriptive

METHODOLOGY

i) AREA OF SURVEY:

The survey was done for three banks. The study environment was the Banking industry.

ii) DATA SOURCE:

Primary Data: Primary data was collected from the company balance sheets and company

profit and loss statements.

Secondary Data: Secondary data on the subject was collected from ICFAI journals,

company prospectus, company annual reports and IMF websites.

iii) SAMPLING TECHNIQUE :

Convenience sampling: Convenience sampling was done for the selection of the banks.

iv) PLAN OF ANALYSIS:

The data analysis of the information got from the balance sheets was done and ratios

were used. Graph and charts were used to illustrate trends..

LIMITATIONS OF THE STUDY

1) The study was limited to three banks.

2) Time and resource constrains.

3) The method discussed pertains only to banks though it can be used for performance

evaluation of other financial institutions.

4) The study was completely done on the basis of ratios calculated from the balance

sheets.

5) It has not been possible to get a personal interview with the top management

employees of all banks under study.

CHAPTER 5

DATA ANALYSIS &

INTERPRETATION

ANALYSIS AND INTERPRETATION

Now each parameter will be taken separately & discussed in detail.

(A)CAPITAL ADEQUACY:

Capital adequacy ratio is defined as

where Risk can either be weighted assets ( ) or the respective national regulator's

minimum total capital requirement. If using risk weighted assets,

≥ 8%.

The percent threshold (8% in this case, a common requirement for regulators conforming

to the Basel Accords) is set by the national banking regulator.

Two types of capital are measured: tier one capital, which can absorb losses without a

bank being required to cease trading, and tier two capital, which can absorb losses in the

event of a winding-up and so provides a lesser degree of protection to depositors.

THE CAPITAL ADEQUACY RATIO FOR 3 MAJOR BANKS IN INDIA

Particulars 2004 2005 2006 2007 2008

ICICI Bank 10.36% 11.78% 13.35% 11.69% 13.97%

HDFC Bank 11.66% 12.16% 11.40% 13.08% 13.73%

AXIS Bank 11.21% 12.66% 11.08% 11.57% 13.99%

Table No.1

2004 2005 2006 2007 20080.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

ICICI BankHDFC BankAXIS Bank

Graph No.1

INTERPRETATIONS:-

Reserve Bank of India prescribes Banks to maintain a minimum Capital to risk-weighted

Assets Ratio (CRAR) of 9 percent with regard to credit risk, market risk and operational

risk on an ongoing basis, as against 8 percent prescribed in Basel Documents. Capital

adequacy ratio of the ICICI Bank, was well above the industry average of 13.97% t.CAR

of HDFC bank is below the ratio of ICICI bank. HDFC Bank’s total Capital Adequacy

stood at 13.6% as of March 31, 2008. The Bank adopted the Basel 2 framework as of

March 31, 2009 and the CAR computed as per Basel 2 guidelines stands higher against

the regulatory minimum of 9.0%.And the capital adequacy ratio of Axis bank is the

highest among the three banks and it is above the industry average, which shows the

improvement from the last 5 years. Higher the ratio the banks are in a comfortable

position to absorb losses.

(B)ASSET QUALITY:

TABLES SHOWING THE NPA OF 3 MAJOR BANKS IN INDIA

Gross NPA

Particulars March,08 March,07 March,06 March,05 March,04

ICICI Bank 1.43% 1.40% 1.45% 1.72% 1.89%

HDFC Bank 3.01% 1.95% 1.14% 2.87% 4.69%

AXIS Bank .83% 1.14% 1.69% 1.99% 2.93%

Table No.2

March,2008 March,2007 March,2006 March,2005 March,20040.00%

0.50%

1.00%

1.50%

2.00%

2.50%

ICICI BankHDFC BankAXIS Bank

Graph No.2

Net NPA

Particulars March, 08 March, 07 March, 06 March, 05 March, 04

ICICI Bank 1.39% .94% .67% 1.56% 2.19%

HDFC Bank .47% .43% .44% .24% .16%

AXIS Bank .42% .72% .99% 1.39% 1.20%

Table No.3

March,2008 March,2007 March,2006 March,2005 March,20040.00%

0.50%

1.00%

1.50%

2.00%

2.50%

ICICI BankHDFC BankAXIS Bank

Graph No.3

INTERPRETATIONS:

Above ratios show the highest NPA of ICICI bank from the last 5 years among the 3

banks. HDFC Bank’s asset quality is the best in the Indian banking sector despite the

bank sustaining aggressive growth for the past several quarters. The bank has maintained

its net NPAs at 0.47% as at end FY08. It has continued to make general provisions and

holds specific general provisions on its standard customer assets that are higher than

regulatory requirements. Axis bank is also approaching to this level.

( C )MANAGEMENT SOUNDNESS

Asset Turnover Ratio

Particulars 2004 2005 2006 2007 2008

ICICI Bank 2.26% 2.14% 2.94% 4.52% 5.61%

HDFC Bank 2.80% 2.89% 3.50% 4.33% 5.18%

AXIS Bank 3.56% 3.01% 4.00% 4.97% 6.32%

Table No.4

2004 2005 2006 2007 20080.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

ICICI BankHDFC BankAXIS Bank

Graph No.4

INTERPRETATION:

Asset turnover measures a firm's efficiency at using its assets in generating sales or

revenue - the higher the number the better. From the above information,it is clear that the

asset turnover ratio of axis bank is increasing every year and highest comparing with the

ICICI and HDFC bank in 2008.It shows the bank’s efficiency in using its assets to

generate high revenue .

(D) EARNINGS & PROFITABILITY

The ratio that is used for the profitability for the 3 banks are as follows:

ROA-Return On Assets

Particulars 2004 2005 2006 2007 2008

ICICI Bank 1.32% 1.17% 1.05% 0.78% 0.71%

HDFC Bank 1.40% 1.42% 1.41% 1.40% 1.42%

Axis Bank 1.27% 1.08% 1.11% 1.06% 1.16%

Table No.5

2004 2005 2006 2007 20080.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

ICICI BankHDFC BankAxis Bank

Graph No.5

INTERPRETATIONS:

A measure of a company's profitability, equal to a fiscal year's earnings divided by its

total assets, expressed as a percentage. The above table shows the highest ratio of HDFC

Bank for the last 5 years.ROA of ICICI bank is falling every year .And Axis Bank has

maintained almost the same level of the ratio for the last 5 years.

(E) LIQUIDITY:

Credit Deposit Ratio

Banks 2004 2005 2006 2007 2008

ICICI Bank 97.38% 89.17% 87.59% 83.83% 84.99%

HDFC Bank 55.89% 64.87% 65.79% 66.08% 65.28%

Axis Bank 43.63% 47.40% 52.79% 59.85% 65.94%

Table No.6

2004 2005 2006 2007 20080.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

ICICI BankHDFC BankAxis Bank

Graph No.6

INTERPREATIONS:

Credit deposit ratio is a tool used to study the liquidity position of the bank. A high ratio

shows that there is more amounts of liquid cash with the bank to met its clients cash

withdrawals. We can find from the above table, ICICI bank has maintained high ratio

during the period of study. But the AXIS Bank has maintained a least ratio during all

years of study. HDFC Bank has maintained the cdr ratio lower than ICICI but higher than

Axis bank.But in 2008 CDR of Axis bank was more than HDFC bank.

(F) Sensitivity to market risk

Some key issues under this are as follows:

Internal Control Systems

Like the central banks in developed supervisory regimes, RBI also has started placing an

increasing reliance on professional accountants in the assessment of internal control

systems of the banks and non-bank financial institutions. Over the period, the

responsibilities of auditors have been delineated not only to make the audit more detailed

but also to make them accountable. The methodology and processes used to generate

available data as certified by audit profession would improve the reliability of financial

statements as regards their conformity with national accounting and disclosure standards.

Another area of crucial importance is strengthening of internal control systems in banks.

The Reserve Bank has, over the years, emphasised the need for having an effective

internal control system in banks. Banks have also been advised to introduce the system of

Concurrent Audit in major and specialized branches. As a result, all commercial banks

have introduced concurrent audit since 1993 by using external auditors as a major

resource. The banks are now required to set up Audit Committees to follow up on the

reports of the statutory auditors and inspection by RBI. Similarly, immediate action is

warranted on reconciliation of inter branch accounts which if left unreconciled, is fraught

with grave risks. Substantial progress has been made by banks in reconciliation of the

outstanding entries, and BFS reviews the progress in this area at quarterly intervals.

Technology is the key

The decade of 90s has witnessed a sea change in the way banking is done in India.

Technology has made tremendous impact in banking. Anywhere banking and anytime

banking has become a reality. This has thrown new challenges in the banking sector and

new issues have started cropping up which is going to pose certain problems in the near

future. The new entrants in the banking are with computer background. However, over a

period of time they would acquire banking experience. Whereas the middle and senior

level people have rich banking experience but their computer literacy is at a low level.

Therefore, they feel the handicap in this regard since technology has become an

indispensable tool in banking.

Foreign banks and the new private sector banks have embraced technology right from the

inception of their operations and therefore, they have adapted themselves to the changes

in the technology easily. Whereas the Public Sector Banks (PSBs) and the old private

sector banks (barring a very few of them) have not been able to keep pace with these

developments. In this regard, one can cite historical, political and other factors like work

culture and working relations (which are mainly governed by bipartite settlements

between the managements and the staff members) as the main constraints. Added to these

woes, the PSBs were also saddled with some nonviable and loss making branches, thanks

to the social banking concept thrust upon them by the regulatory authorities in 1960s.

Retail Banking:

Retail banking is quite broad in nature - it refers to the dealing of commercial banks with

individual customers, both on liabilities and assets sides of the balance sheet. Fixed,

current / savings accounts on the liabilities side; and mortgages, loans (e.g., personal,

housing, auto, and educational) on the assets side, are the more important of the products

offered by banks. Related ancillary services include credit cards, or depository services.

Today’s retail banking sector is characterized by three basic characteristics:

multiple products (deposits, credit cards, insurance, investments and securities);

multiple channels of distribution (call centre, branch, Internet and kiosk); and

multiple customer groups (consumer, small business, and corporate).

What is the nature of retail banking? In a recent book, retail banking has been described

as “hotter than vindaloo”1. Considering the fact that vindaloo, the Indian-English

innovative curry available in umpteen numbers of restaurants of London, is indeed very

hot and spicy, it seems that retail banking is perceived to be the in-thing in today’s world

of banking.

Opportunities and Challenges of Retail Banking in India

Opportunities

1

Retail banking has immense opportunities in a growing economy like India. India has

been recently identified as the "second most attractive retail destination" of 30 emergent

markets by A. T. Kearney.

The rise of the Indian middle class is an important contributory factor in this regard. The

percentage of middle to high income Indian households is expected to continue rising.

The younger population not only wields increasing purchasing power, but as far as

acquiring personal debt is concerned, they are perhaps more comfortable than previous

generations. Improving consumer purchasing power, coupled with more liberal attitudes

toward personal debt, is contributing to India's retail banking segment.

The combination of the above factors promises substantial growth in the retail sector,

which at present is in the nascent stage. Due to bundling of services and delivery

channels, the areas of potential conflicts of interest tend to increase in universal banks

and financial conglomerates. Some of the key policy issues relevant to the retail banking

sector are: financial inclusion, responsible lending, and access to finance, long-term

savings, financial capability, consumer protection, regulation and financial crime

prevention.

Challenges

What are the challenges for the industry and its stakeholders? First, retention of

customers is going to be a major challenge. Thus, banks need to emphasise retaining

customers and increasing market share.

Second, rising indebtedness could turn out to be a cause for concern in the future. India's

position, of course, is not comparable to that of the developed world where household

debt as a proportion of disposable income is much higher. Such a scenario creates high

uncertainty.

Third, information technology poses both opportunities and challenges. Even with ATM

machines and Internet Banking, many consumers still prefer the personal touch of their

neighborhood branch bank. Technology has made it possible to deliver services

throughout the branch bank network, providing instant updates to checking accounts and

rapid movement of money for stock transfers. However, this dependency on the network

has brought IT departments’ additional responsibilities and challenges in

managing, maintaining and optimizing the performance of retail banking networks.

Fourth, KYC Issues and money laundering risks in retail banking is yet another important

issue. Retail lending is often regarded as a low risk area for money laundering because of

the perception of the sums involved. However, competition for clients may also lead to

KYC procedures being waived in the bid for new business. Banks must also consider

seriously the type of identification documents they will accept and other processes to be

completed. The Reserve Bank has issued details guidelines on application of KYC norms

in November 2004.

FUTURE:

How do we see the future of retail banking? What are the major attributes of the shape of

things to come in this sector? First, customer service should be the be-all and end-all of

retail banking. The codes and standards, together with the institutional mechanism to

monitor them, are expected to enhance the quality of customer service, to the individual

customer in particular. The codes will bring about greater transparency in the system and

also tackle the issue of information asymmetry. The codes would establish the banking

industry’s key commitments and obligations to customers on standards of practice,

disclosure and principles of conduct for their banking services.

Second, sharing of information about the credit history of households is extremely

important as far retail banking is concerned. Perhaps due the confidential nature of

banker-customer, banks have a traditional resistance to share credit information on the

client, not only with one another, but also across sectors.

Third, outsourcing has become an important issue in the recent past. With the increasing

market orientation of the financial system and to cope with the competition as also to

benefit from the technological innovations such as, e-banking, the banks are making

increasing use of "outsourcing" as a means of both reducing costs and achieving better

efficiency. While outsourcing does have various cost advantages, it has the potential to

transfer risk, management and compliance to third parties who may not be regulated.

Finally, retail banking does not refer to lending only. In the whole story of retailing one

should not forget the role played by retail depositors. The homemaker, the retail shop

keeper, the pensioners, self-employed and those employed in unorganised sector - all

need to get a place in the banks. Furthermore, the nature, scope and cost of services need

to be monitored to assess whether there is any denial, implicit or explicit, of basic

banking services to the common person and banks have been urged to review their

existing practices to align them with the objective of financial inclusion.

ICICI Bank- Risk management is a key focus area at ICICI Bank and viewed as a

strategic tool for competitive advantage. In the Indian context ICICI Bank has been doing

pioneering work in this area since 1996, when a specailised risk management group was

set up within the Bank.

RCAG is a centralised group based at Mumbai with the responsibility of enterprise wide

risk management. RCAG is headed by a senior executive of the rank of General Manager

who reports to the Executive Director (Corporate Center). The philosophy at ICICI Bank

is to have a separate risk management group (independent of the business group) whose

mandate is to analyse, measure, monitor and manage risks.

Risk management is done under the overall supervision of the Board of Directors and

sub committees of the Board - Risk Committee, Credit Committee and Audit Committee.

RCAG is comprised of six groups - Corporate Credit Risk, Retail Risk, Market Risk,

Credit Policies & Compliance, Risk Analytics and Internal Audit

CHAPTER 6

FINDINGS

, RECOMMENDATIONS &

SUGGESTIONS

FINDINGS

Capital adequacy:

The capital adequacy ratio of all the three banks is above the minimum requirements and

above the industry average.

Assets:

HDFC Bank has maintained a standard for the NPA’s in the period of 2004-2008. AXIS

has shown remarkable decrease in NPA’s in the same period. But the NPA of ICICI bank

is increasing every year.

Management:

Professional approach that has been adopted by the banks in the recent past is in right

direction & also it is the right decision.

Earnings:

HDFC has shown a good growth record for its ROA. But ICICI Bank has gone down in

its performance with negative growth. AXIS’s performance has been average.

Liquidity:

Banks should maintain quality securities with good liquidity to meet contingencies. ICICI

Bank is fulfilling this requirement by maintaining highest credit deposit ratio.

Sensitivity to Market Risks:

All banks have ventured into many financial areas and are in the league of Universal

Banking. They have also become sensitive to customer needs.

RECOMMENDATIONS

1) The banks should adapt themselves quickly to the changing norms.

2) The system is getting internationally standardized with the coming of BASELL II

accords so the Indian banks should strengthen internal processes so as to cope with the

standards.

3) The banks should maintain a 0% NPA by always lending and investing or creating

quality assets which earn returns by way of interest and profits.

4) The banks should find more avenues to hedge risks as the market is very sensitive to risk

of any type.

5) Have good appraisal skills, system, and proper follow up to ensure that banks are above

the risk.

S UGGESTIONS FOR FURTHER RESEARCH

Research on which industries are best suited for the use of the CAMELS Framework.

Research on how other variables can be added or how variables can be selected to suit

the industry needs.

Research on why the CAMELS Framework can not be used as a tool of performance

evaluation.

BIBLIOGRAPHY

Bibliography

Books

Kothari, C.R., “Research Methodology: Methods and Techniques”, Wishwa

Publication, Delhi

Websites Visited

http://www.stock-picks-focus.com/hdfc-bank.html

http://www.stock-picks-focus.com/axis-bank.html

http://www.stock-picks-focus.com/icici-bank.html

http://www.basel2implementation.com/pillars.htm

http://www.icicibank.com

http:// www.hdfcbank.com

http:// www.axisbank.com

http://www.allbankingsolutions.com/camels.htm

http://www.shkfd.com.hk/glossary/eng/RA.htm

"http://www.wikinvest.com/wiki/CAPITAL_ADEQUACY_RATIO"

http://www.answers.com/topic/basel-ii