Final Comprehensive Project

7/30/2019 Final Comprehensive Project

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INTRODUCTION


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DECLARATION


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ACKNOWLEDGEMENT


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EXECUTIVE SUMMARY


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INDEX


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CHAPTER 01.INTRODUCTION


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BANKI NG INDUSTRY OVERVIEW

INTRODUCTION:

Banking in India originated in the last decades of the 18th century. The oldest bank in existence

in India is the State Bank of India, a government-owned bank that traces its origins back to June

1806 and that is the largest commercial bank in the country. Central banking is the responsibility

of the Reserve Bank of India, which in 1935 formally took over these responsibilities from the

then Imperial Bank of India, relegating it to commercial banking functions. 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 sixnext largest in 1980. Currently, India has 96 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


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HHIISSTTOORRYY OOFF IINNDDIIAANN BBAANNKKIINNGG

EARLY HISTORY:

Banking in India originated in the last decades of the 18th century. The first banks were The

General Bank of India which started in 1786, and the Bank of Hindustan, both of which are now

defunct. The oldest bank in existence in India is the State Bank of India, which originated in the

Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was

one of the three presidency banks, the other two being the Bank of Bombay and the Bank of

Madras, all three of which were established under charters from the British East India Company.

For many years the Presidency banks acted as quasi-central banks, as did their successors. The

three banks merged in 1921 to form the Imperial Bank of India, which, upon India's

independence, became the State Bank of India.

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a

consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and

still functioning today, is the oldest Joint Stock bank in India. It was not the first though. That

honor belongs to the Bank of Upper India, which was established in 1863, and which survived

until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance

Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from


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the Confederate States, promoters opened banks to finance trading in Indian cotton. With large

exposure to speculative ventures, most of the banks opened in India during that period failed.

The depositors lost money and lost interest in keeping deposits with banks. Subsequently,

banking in India remained the exclusive domain of Europeans for next several decades until the

beginning of the 20th century. Foreign banks too started to arrive, particularly in Calcutta, in the

1860s. The Comptoired'Escompte de Paris opened a branch in Calcutta in 1860, and another in

Bombay in 1862; branches in Madras and Pondichery, then a French colony, followed. HSBC

established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly

due to the trade of the British Empire, and so became a banking center.

The Bank of Bengal, which later became the State Bank of India.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in

Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in

1895, which has survived to the present and is now one of the largest banks in India. Around the

turn of the 20th Century, the Indian economy was passing through a relative period of stability.

The presidency banks dominated banking in India but there were also some exchange banks anda number of Indian joint stock banks. All these banks operated in different segments of the

economy. Indian joint stock banks were generally undercapitalized and lacked the experience

and maturity to compete with the presidency and exchange banks. This segmentation let Lord

Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old

fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome


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compartments." The period between 1906 and 1911, saw the establishment of banks inspired by

the Swedish movement. The Swedish movement inspired local businessmen and political figures

to found banks of and for the Indian community. A number of banks established then have

survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda,

Canara Bank and Central Bank of India. The fervor of Swedish movement lead to establishing of

many private banks in Dakshina Kannada and Udupi district which were unified earlier and

known by the name South Canara ( South Kanara ) district. Four nationalized banks started in

this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is

known as "Cradle of Indian Banking".

FROM WORLD WAR I TO INDEPENDENCE:

The period during the First World War (1914-1918) through the end of the Second World War

(1939-1945), and two years thereafter until the independence of India were challenging for

Indian banking. The years of the First World War were turbulent, and it took its toll with banks

simply collapsing despite the Indian economy gaining indirect boost due to war-related economic

activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following

table:

years Number of

banks that

failed

Authorized

capital (Rs.

Lakh)

Paid up capital

(Rs. Lakh)

1913 12 274 35

1914 42 710 109

1915 11 56 5

1916 13 231 4

1917 9 76 25

1918 7 209 1


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POST INDEPENDENCE:

The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal,

paralyzing banking activities for months. India's independence marked the end of a regime of the

Laissez-faire for the Indian banking. The Government of India initiated measures to play an

active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the

government in 1948 envisaged a mixed economy. This resulted into greater involvement of the

state in different segments of the economy including banking and finance.

The major steps to regulate banking included:

In 1948, the Reserve Bank of India, India's central banking authority, was nationalized,and it became an institution owned by the Government of India.

In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bankof India (RBI) "to regulate, control, and inspect the banks in India."

The Banking Regulation Act also provided that no new bank or branch of an existingbank could be opened without a license from the RBI, and no two banks could have

common directors.

However, despite these provisions, control and regulations, banks in India except the State Bank

of India, continued to be owned and operated by private persons. This changed with the

nationalization of major banks in India on 19 July 1969.

NATIONALIZATION:

By the 1960s, the Indian banking industry had become an important tool to facilitate the

development of the Indian economy. At the same time, it had emerged as a large employer, and a

debate had ensued about the possibility to nationalise the banking industry. Indira Gandhi, the-

then Prime Minister of India expressed the intention of the GOI in the annual conference of the


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All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalisation." The

paper was received with positive enthusiasm. Thereafter, her move was swift and sudden, and

the GOI issued an ordinance and nationalised the 14 largest commercial banks with effect from

the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the

step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the

Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it

received the presidential approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980. The stated

reason for the nationalization was to give the government more control of credit delivery. With

the second dose of nationalization, the GOI controlled around 91% of the banking business of

India. Later on, in the year 1993, the government merged New Bank of India with Punjab

National Bank. It was the only merger between nationalized banks and resulted in the reduction

of the number of nationalized banks from 20 to 19. After this, until the 1990s, the nationalized

banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy. The

nationalized banks were credited by some; including Home minister P. Chidambaram, to have

helped the Indian economy withstand the global financial crisis of 2007-2009.

LIBERALIZATION:

In the early 1990s, the then NarsimhaRao government embarked on a policy of liberalization,

licensing a small number of private banks. These came to be known as New Generation tech-

savvy banks, and included Global Trust Bank (the first of such new generation banks to be set

up), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI

Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of

India, revitalized the banking sector in India, which has seen rapid growth with strong

contribution from all the three sectors of banks, namely, government banks, private banks and

foreign banks. The next stage for the Indian banking has been setup with the proposed relaxation

in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given

voting rights which could exceed the present cap of 10%,at present it has gone up to 74% with

some restrictions. The new policy shook the Banking sector in India completely. Bankers, till


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this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%;Go home at 4) of

functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for

traditional banks. All this led to the retail boom in India. People not just demanded more from

their banks but also received more.

Currently (2007), banking in India is generally fairly mature in terms of supply, product range

and reach-even though reach in rural India still remains a challenge for the private sector and

foreign banks. In terms of quality of assets and capital adequacy, Indian banks are considered to

have clean, strong and transparent balance sheets relative to other banks in comparable

economies in its region. With the growth in the Indian economy expected to be strong for quite

some time-especially in its services sector-the demand for banking services, especially retail

banking, mortgages and investment services are expected to be strong. In March 2006, the

Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak Mahindra Bank (a

private sector bank) to 10%. This is the first time an investor has been allowed to hold more than

5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5%

in the private sector banks would need to be vetted by them. In recent years critics have charged

that the non-government owned banks are too aggressive in their loan recovery efforts in

connection with housing, vehicle and personal loans.

RECENT HISTORY OF INDIAN BANKING:

Indian banking system, over the years has gone through various phases after establishment of

Reserve Bank of India in 1935 during the British rule, to function as Central Bank of the country.


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Earlier to creation of RBI, the central bank functions were being looked after by the Imperial

Bank of India. With the 5-year plan having acquired an important place after the independence,

the Govt. felt that the private banks may not extend the kind of cooperation in providing credit

support, the economy may need. In 1954 the All India Rural Credit Survey Committee submitted

its report recommending creation of a strong, integrated, State-sponsored, State-partnered

commercial banking institution with an effective machinery of branches spread all over the

country. The recommendations of this committee led to establishment of first Public Sector Bank

in the name of State Bank of India on July 01, 1955 by acquiring the substantial part of share

capital by RBI, of the then Imperial Bank of India. Similarly during 1956-59, as a result of re-

organization of princely States, the associate banks came into fold of public sector banking.

Another evaluation of the banking in India was undertaken during 1966 as the private banks

were still not extending the required support in the form of credit disbursal, more particularly to

the unorganized sector. In February 1966, a Scheme of Social Control was set-up whose main

function was to periodically assess the demand for bank credit from various sectors of the

economy to determine the priorities for grant of loans and advances so as to ensure optimum and

efficient utilization of resources.

On July 19, 1969, the Govt. promulgated Banking Companies (Acquisition and Transfer of

Undertakings) Ordinance 1969 to acquire 14 bigger commercial bank with paid up capital of

Rs.28.50 cr, deposits of Rs.2629 cr, loans of Rs.1813 cr and with 4134 branches accounting for

80% of advances. Subsequently in 1980, 6 more banks were nationalized which brought 91% of

the deposits and 84% of the advances in Public Sector Banking. During December 1969, RBI

introduced the Lead Bank Scheme on the recommendations of FK Nariman Committee.

Meanwhile, during 1962 Deposit Insurance Corporation was established to provide insurance

cover to the depositors. In the post-nationalization period, there was substantial increase in the

no. of branches opened in rural/semi-urban centre bringing down the population per bank branch

to 12000 apex. During 1976, RRBs were established (on the recommendations of M.

Narasimham Committee report) under the sponsorship and support of public sector banks as the

3rd component of multi-agency credit system for agriculture and rural development. The Service

Area Approach was introduced during 1989. While the 1970s and 1980s saw the high growth


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rate of branch banking net-work, the consolidation phase started in late 80s and more particularly

during early 90s, with the submission of report by the Narasimham Committee on Reforms in

Financial Services Sector during 1991.

Cur rent Scenar io:

The industry is currently in a transition phase. On the one hand, the PSBs, which are the

mainstay of the Indian Banking system are in the process of shedding their flab in terms of

excessive manpower, excessive non Performing Assets (Npas) and excessive governmental

equity, while on the other hand the private sector banks are consolidating themselves through

mergers and acquisitions.

PSBs, which currently account for more than 78 percent of total banking industry assets are

saddled with NPAs (a mind-boggling Rs 830 billion in 2000), falling

revenues from traditional sources, lack of modern technology and a massive workforce while the

new private sector banks are forging ahead and rewriting the traditional banking business model

by way of their sheer innovation and service. The PSBs are of course currently working out

challenging strategies even as 20 percent of their massive employee strength has dwindled in the

wake of the successful Voluntary Retirement Schemes (VRS) schemes.

The private players however cannot match the PSBs great reach, great size and access to low

cost deposits. Therefore one of the means for them to combat the PSBs has been through the

merger and acquisition (M& A) route. Over the last two years, the industry has witnessed several

such instances. For instance, Hdfc Banks merger with Times Bank Icici Banks acquisition of

ITC Classic, Anagram Finance and Bank of Madura. Centurion Bank, Indusind Bank, Bank of

Punjab, Vysya Bank are said to be on the lookout. The UTI bank- Global Trust Bank merger

however opened a pandoras box and brought about the realization that all was not well in the

functioning of many of the private sector banks.

Private sector Banks have pioneered internet banking, phone banking, anywhere banking, mobile

banking, debit cards, Automatic Teller Machines (ATMs) and combined various other services


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and integrated them into the mainstream banking arena, while the PSBs are still grappling with

disgruntled employees in the aftermath of successful VRS schemes. Also, following Indias

commitment to the W To agreement in respect of the services sector, foreign banks, including

both new and the existing ones, have been permitted to open up to 12 branches a year with effect

from 1998-99 as against the earlier stipulation of 8 branches.

Talks of government diluting their equity from 51 percent to 33 percent in November 2000 has

also opened up a new opportunity for the takeover of even the PSBs. The FDI rules being more

rationalized in Q1FY02 may also pave the way for foreign banks taking the M& A route to

acquire willing Indian partners.

Meanwhile the economic and corporate sector slowdown has led to an increasing number of

banks focusing on the retail segment. Many of them are also entering the new vistas of

Insurance. Banks with their phenomenal reach and a regular interface with the retail investor are

the best placed to enter into the insurance sector. Banks in India have been allowed to provide

fee-based insurance services without risk participation, invest in an insurance company for

providing infrastructure and services support and set up of a separate joint-venture insurance

company with risk participation.


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INTRODUCTIONOF

THE TOPIC


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BASEL I I :-

Basel II is the second ofthe Basel Accords, (now extended and effectively superseded by BaselIII), which are recommendations on banking laws and regulations issued by the Basel Committee

on Banking Supervision.

Basel II, initially published in June 2004, was intended to create an international standard for

banking regulators to control how much capital banks need to put aside to guard against the types

of financial and operational risks banks (and the whole economy) face. One focus was to

maintain sufficient consistency of regulations so that this does not become a source of

competitive inequality amongst internationally active banks. Advocates of Basel II believed that

such an international standard could 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 theory,

Basel II attempted to accomplish this by setting up riskand capital management requirements

designed to ensure that a bank has adequate capital for 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.

Politically, it was difficult to implement Basel II in the regulatory environment prior to 2008, and

progress was generally slow until that year's major banking crisis caused mostly by credit default

swaps, mortgage-backed security markets and similarderivatives. As Basel III was negotiated,

this was top of mind, and accordingly much more stringent standards were contemplated, and

quickly adopted in some key countries including the USA.

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

(2)supervisory reviewand (3)market discipline.

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.
http://en.wikipedia.org/wiki/Basel_Accordshttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervisionhttp://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervisionhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Capital_adequacyhttp://en.wikipedia.org/wiki/Solvencyhttp://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Mortgage-backed_securityhttp://en.wikipedia.org/wiki/Derivativehttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Capital_requirementhttp://en.wikipedia.org/wiki/Capital_requirementhttp://en.wikipedia.org/wiki/Capital_requirementhttp://en.wikipedia.org/wiki/Bank_regulation#Supervisory_reviewhttp://en.wikipedia.org/wiki/Bank_regulation#Supervisory_reviewhttp://en.wikipedia.org/wiki/Bank_regulation#Supervisory_reviewhttp://en.wikipedia.org/wiki/Market_disciplinehttp://en.wikipedia.org/wiki/Market_disciplinehttp://en.wikipedia.org/wiki/Market_disciplinehttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Operational_riskhttp://en.wikipedia.org/wiki/Market_riskhttp://en.wikipedia.org/wiki/Market_riskhttp://en.wikipedia.org/wiki/Operational_riskhttp://en.wikipedia.org/wiki/Credit_riskhttp://en.wikipedia.org/wiki/Market_disciplinehttp://en.wikipedia.org/wiki/Bank_regulation#Supervisory_reviewhttp://en.wikipedia.org/wiki/Capital_requirementhttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Derivativehttp://en.wikipedia.org/wiki/Mortgage-backed_securityhttp://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Solvencyhttp://en.wikipedia.org/wiki/Capital_adequacyhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervisionhttp://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervisionhttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Basel_IIIhttp://en.wikipedia.org/wiki/Basel_Accords


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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, pensionrisk, concentration risk, strategic risk, reputational risk, liquidity riskand 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

This pillar aims to complement the minimum capital requirements and supervisory review

process by developing a set of disclosure requirements which will allow the market participants

to gauge the capital adequacy of an institution.
http://en.wikipedia.org/wiki/Bank_regulationhttp://en.wikipedia.org/wiki/Systemic_riskhttp://en.wikipedia.org/w/index.php?title=Pension_risk&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pension_risk&action=edit&redlink=1http://en.wikipedia.org/wiki/Concentration_riskhttp://en.wikipedia.org/w/index.php?title=Strategic_risk&action=edit&redlink=1http://en.wikipedia.org/wiki/Reputational_riskhttp://en.wikipedia.org/wiki/Liquidity_riskhttp://en.wikipedia.org/wiki/Legal_riskhttp://en.wikipedia.org/wiki/Legal_riskhttp://en.wikipedia.org/wiki/Liquidity_riskhttp://en.wikipedia.org/wiki/Reputational_riskhttp://en.wikipedia.org/w/index.php?title=Strategic_risk&action=edit&redlink=1http://en.wikipedia.org/wiki/Concentration_riskhttp://en.wikipedia.org/w/index.php?title=Pension_risk&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pension_risk&action=edit&redlink=1http://en.wikipedia.org/wiki/Systemic_riskhttp://en.wikipedia.org/wiki/Bank_regulation


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ZScore Model :-

The Z-score formula for predicting bankruptcy was published in 1968 byEdward I.Altman, who was, at the time, an Assistant Professor of Finance atNew York University.

The formula may be used to predict the probability that a firm will go

intobankruptcywithin two years. Z-scores are used to predict corporate defaults and an

easy-to-calculate control measure for thefinancial distressstatus of companies in

academic studies. The Z-score uses multiple corporate income and balance sheet values

to measure the financial health of a company.

The Z-score is a linear combination of four or five common business ratios, weighted bycoefficients. The coefficients were estimated by identifying a set of firms which had

declared bankruptcy and then collecting amatched sampleof firms which had survived,

with matching by industry and approximate size (assets).

Altman applied the statistical method ofdiscriminant analysisto a dataset of publiclyheld manufacturers. The estimation was originally based on data from publicly held

manufacturers, but has since been re-estimated based on other datasets for private

manufacturing, non-manufacturing and service companies.

All businesses in the database were manufacturers, and small firms with assets of < $1million were eliminated.

The original Z-score formula was as follows:.

Z = 0.012T1 + 0.014T2 + 0.033T3 + 0.006T4 + 0.999T5
http://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/Financial_distresshttp://en.wikipedia.org/wiki/Financial_distresshttp://en.wikipedia.org/wiki/Financial_distresshttp://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/wiki/Financial_distresshttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altman


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T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the

company.

T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and

earning power.

T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from

tax and leveraging factors. It recognizes operating earnings as being important to long-term

viability.

T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can

show up security price fluctuation as a possible red flag.

T5 = Sales/ Total Assets. Standard measure for total asset turnover (varies greatly from industryto industry).

Altman found that the ratio profile for the bankrupt group fell at -0.25 avg, and for the non-

bankrupt group at +4.48 avg.


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CAMEL Model:-

In the early 1970s, federal regulators in USA developed the CAMEL rating system to help

structure the bank examination process. In 1979, the Uniform Financial Institutions Rating

Systemwas adopted to provide federal bank regulatory agencies with a framework for rating

financial condition and performance of individual banks (Siems and Barr; 1998). Since then, the

use of the CAMEL factors in evaluating a banks financial health has become widespread among

regulators. Piyu (1992) notes currently, financial ratios are often used to measure the overall

financial soundness of a bank and the quality of it management. Bank regulators, for example,

use financial ratios to help evaluate a banks performance as part of the CAMEL system. The

evaluation factors are as follows;

C = Capital adequacy

A = Asset quality

M = Management quality

E = Earnings ability

L = Liquidity.

Each of the five factors is scored from one to five, with one being the strongest rating. An overall

composite CAMEL rating, also ranging from one to five, is then developed from this evaluation.

As a whole, the CAMEL rating, which is determined after an on-site examination, provides a

means to categorize banks based on their overall health, financial status, and management. The

Commercial Bank Examination Manual produced by the Board of Governors of the Federal

Reserve System in U.S describes the five composite rating levels as follows (Siems and Barr,

1998).

- CAMEL = 1 an institution that is basically sound in every respect

- CAMEL = 2 an institution that is fundamentally sound but has modestWeaknesses.


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- CAMEL = 3 an institution with financial, operational, or complianceweaknesses that give cause for supervisory concern.

- CAMEL = 4 an institution with serious financial weaknesses that couldimpair future viability.

- CAMEL = 5 an institution with critical financial weaknesses that renderthe probability of failure extremely high in the near term.

In Nigeria, commercial banks are examined annually for safety and soundness by the Banking

Supervision Department of the Central Bank of Nigeria (CBN).


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LI TERATURE REVIEW

Baral (2005) study the performance of joint ventures banks in Nepal by applying the CAMEL

Model. His study was mainly based on secondary data drawn from the annual reports published

by joint venture banks. His report analyzed the financial health of joint ventures banks in the

CAMEL parameters. His findings of the study revealed that the financial health of joint ventures

is more effective than that of commercial banks. Moreover, the components of CAMEL showed

that the financial health of joint venture banks was not difficult to manage the possible impact to

their balance sheet on a large scale basis without any constraints inflicted to the financial health.

Bodla & Verma (2006) examined the performance of SBI and ICICI through CAMEL model.

Data set for the period of 2000-01 to 2004-05 were used for the purpose of the study. With the

reference to the Capital Adequacy, it concluded that SBI has an advantage over ICICI. Regarding

to assets quality, earning quality and management quality, it can be said that ICICI has an edge

upon SBI. Therefore the liquidity position of both banks was sound and did not differ much.Gupta and Kaur (2008) conducted a research on the sole aim of examining the performance of


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Indian private Sector banks by using CAMEL model and by assigning rating to the top five and

bottom five banks. They rated 20 old and 10 new private sector banks based on CAMEL

framework. The study covered financial data for the period of 5 years i.e. from 2003-07. The

research as determined by CAMEL Model revealed that HDFC was at its higher position of all

private sectors banks in India succeeded by the Karur Vyasa and the Tamilnad Mercantile Bank.

However the Gobal Trust Bank and the Nedungradi Banks was considered as bad management

The findings summarized that new private sector of banks have attained the higher position due

to core banking, aggressive marketing strategies and high level of technology. To attain

perfection banks should always concentrate on new financial assets, excellent service and

customer loyalty.

Hays, Lurgio & Arthur (2009) have utilized CAMEL model to examine the performance of

low efficiency vs. high efficiency community banks in conjunction with the logistical regression

analysis. The analysis used data which are based on quarterly reports by commercial banks. The

discriminant model derived from the CAMEL parameters is tested among data for 2006, 2007,

2008. Its results concluded that the model accuracy floats from approximately 88% to 96% for

both original and cross-validations data sets.

Agarwal & Sihna (2010) have analyzed the financial performance and thereby the sustainability

of micro finance institutions (MFIs) in India by employing the CAMEL model.

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