An Assessment of Financial Performance of Banks: A Case of the Nainital Bank Ltd.

INTRODUCTION

Nainital Bank was established in 1922 by the veteran freedom fighter Late Bharat Ratna Pandit Gobind Ballabh Pant and few other prominent personalities in Nainital. The operations of the Bank were confined to the Kumaun region of the erstwhile Uttar Pradesh, till 1973, having 9 branches only. In the year 1973, RBI directed that Bank of Baroda, should manage the affairs of Nainital Bank Ltd. The Bank was included in the 2nd schedule of Reserve Bank of India Act, 1934 on 28th November, 1978. Original Share holding of BOB was 30%, currently it is 98.57%. Bank has been earning continuous profits since 1973. Business undertaken by the bank is very simple in nature as Bank has no active treasury, no securitization exposure, no Forex business and does not have any subsidiary of its own. The business affairs of bank is supervised and controlled by Board of Directors consisting of representative from different fields. The chairman and CEO of the bank is a scale-VI officer (Deputy General Manager) of Bank of Baroda on deputation for 3 years term .The Nainital Bank has 139 branches in all in U.P., Uttarakhand, Haryana, Rajasthan and Delhi. The economy of the country largely depends on the financial system of the country by providing necessary resources for the development and growth of different sectors of economy, viz., agriculture, industry, services and transport etc. Financial system inter alia comprises of banks, capital market and money market etc. Banks ensure the stability of economy as central/major part of financial system. Health of banking system is necessary pre condition for healthy economy. Stability and soundness of banks is measured in terms of financial performance of banks. Nowadays assessment of financial performance of banks has gained paramount importance due to the dynamic and volatile environment of business, high competition and increasing risk leading to insolvency of business, like financial crisis of US banks in 2008 (Kumar Krishna and Kavita, 2017)1. Good financial performance of banks is an indicator of consistent growth and it ensures security to depositors, shareholders, employees and economy. The menace of non-performing assets has dented profitability of banks in two pronged manner by not booking profit for non-performing accounts and by providing from the profits for those NPAs and simultaneously keeping aside the capital for unforeseen events through capital adequacy measure as a statutory Thus, assessment of financial performance has become imperative in today‘s world of uncertainty, risk and competition.

In literature many studies focus on financial performance of banks. Ramachandran A and Kavitha N (2009) presented a census study of profitability of all the scheduled commercial banks of India for a period of 10 years. It further divides this period of 10 years into two parts. It uses step by step multiple regressions for analysis. Bank-wise suggestions have been given to increase the profitability of different banks. Uppal R.K. and Juneja Amit (2012) have analyzed the performance of Indian Banks by dividing it in 4 groups, i.e., public sector banks, old private sector banks, new private sector banks and foreign banks in respect of various parameters of the balance sheet. Dr. Khalil Elian Abdelrahim (2013) has studied the credit risk management in Saudi Banks in detail through CAMEL model. It has concluded that capital adequacy, asset quality, management soundness and earnings have a significant effect on effectiveness of credit risk management while liquidity has a significant positive impact, whereas size of bank has a strong negative impact on effectiveness of credit risk management. Githaiga Joyce Wangari (2015) has attempted to investigate relationship between determinants of credit risk management and financial performance of commercial banks in Kenya by use of CAMEL indicators. Secondary data was analyzed with multiple regression techniques. It was found that CAMEL parameters have strong impact on financial performance of banks. Kumar Krishna and Kavita (2017) analyzed financial health of selected Indian Commercial Banks through Altman‘s Z-Score Model for a period of 8 years (2009-2016). Overall Z-Score was calculated on the basis of liquidity position, retained earnings, profitability and equity ratios of the banks. Rahman Md. Zahidurand and Islam Md. Shohidul (2018) evaluated the performance of banking sectors of Bangladesh by taking a sample of 17 private commercial banks and considering the data from annual reports for 2010-2016.Comparative analysis showed that the Eastern Bank topped the list of the selected banks in performance compared through CAMELS method.

Mainly the following tools are used for this purpose: 1. Altman‟s Z score Model – This tool is known as multiple discriminate analysis for evaluation of possibility of solvency within a period of two years with high accuracy. It was first evolved in 1968 for manufacturing companies, but in 1983 it was revised for private firms. The latest version is the revised one (1993) for emerging firms and non-manufacturing firms including four variables namely working capital to total assets ratio, retained earnings to total assets ratio, earnings before interest and taxes, book value of equity to total assets. The equation for Z score is as under:-

Z = 6.56X1 + 3.26X2 + 6.73 X3 + 1.04X4

X1 = Capital to total assets ratio X2 = Retained earnings to total assets ratio X3 = Earnings before interest and taxes to total assets ratio X4 = Book value of equity to total assets ratio The interpretation of Z score is given in table below:- 2. CAMELS Method – The main objective of banking supervision by RBI is to ensure depositors interest and financial stability. RBI has adopted CAMELS framework for supervision of banks including evaluation of performance with reference to the following: i. Bank‟s Financial Performance – It highlights asset quality, solvency, capital adequacy, earning performance and liquidity. ii. Management and Operating Conditions – It focuses on management (board and senior

iii. Compliance to Regulations – It assesses timely submission of various reports including integrity of reporting and compliance to various RBI guidelines. Under CAMEL framework, annual financial inspection of RBI findings are recorded and on the basis of scores obtained by them a supervisory rating of public/private sector bank is done by RBI. Prompt corrective action triggers are activated on the position of capital adequacy ratio, net NPA and ROA. The objective of CAMEL rating is to take stock of bank‘s financial, operational and managerial position. It utilizes financial reports and other related information as base material for making analysis. In reviewing these ratios the benchmarks as well as the trends are to be considered. It revaluates management practices in combination with performance measures. Composite Rating: The CAMEL rating components are allocated different weights and final judgment rests on a scale from 1 to 5. The meaning of each rating is summarized below: 1. CAMEL Rating Grade-1: Rating grade 1 signifies sound banking in all respects. It is a depiction of strong performance and risk management practices and the positive trends for key performance measures and in the compliance area. 2. CAMEL Rating Grade-2: Rating grade 2 indicates towards fundamentally sound bank with some moderate weakness. It evidences the identification of risks in a prudent manner and mitigation of those risks accordingly. The risk mitigation measures and performance indicators are positive and banks sound business operation is not affected. Hence the weaknesses are managed well and the compliance of laws and regulations is also done regularly. 3. CAMEL Rating Grade-3: Rating grade 3 depicts the presence of functional weaknesses causing supervisory concern to set right the difficulties. Such banks do not comply with regulations and the performance does not need expectations and management lacks the ability to overcome weakness efficiently. 4. CAMEL Rating Grade-4: Rating grade 4 expresses serious or moderate operational failure sthat can question future viability of banks. Bank‘s risk management is operative on a lower efficiency scale. Key performance potential for failure is not yet imminent but it has a high potential in future. Supervisory review is very much attracted in such cases. 5. CAMEL Rating Grade-5: Rating grade 5 signifies critical financial weakness leading towards high possibility of failure in near future. The viability of bank is threatened by unsatisfactory performance and serious financial restructuring is needed. Management is not able to combat with the volume and severity of problems. The six parameters of CAMEL rating are measured through different variables. Researchers decide by their experience to choose the option of variables based on intuition and knowledge.

Retained Earnings = Profit after Tax - Dividend Paid/Proposed

Nainital Bank‘s performance for years 2012-13 to 2016-17 in terms of CAMEL framework has been calculated as under:

Since there is no active treasury in Nainital Bank and Nainital Bank is having all the systems and procedures prescribed by RBI and in the line with

CAMELS Score = 0.2 x Average Marks for Capital Adequacy + 0.2 x Average Marks for Asset Quality + 0.25 x Average Marks for Management Quality + 0.15 x Average Marks for Earning Quality + 0.1 x Average Marks for Liquidity + 0.1 x Average Marks for Sensitivity to Market = 0.2 x C + 0.2 x A + 0.25 x M + 0.15 x E + 0.1 x L + 0.1 x S = 0.2 x 20.25 + 0.2 x 1 + 0.25 x 2.50 + 0.15 x 2.00 + 0.10 x 1.33 + 0.1 x 1

The weights in the formula for C, A, M, E, L and S are as per RBI prescription. Marks allotted are researcher‘s own calculations.

Kumar Krishan and Kavita (2017) have analyzed Altman‘s ‗Z‘ score for different banks and concluded that financial health of banks under study is strong and satisfactory. Researchers found average ‗Z‘ score for SBI, BOB, ICICI and Kotak Mahindra Bank (from 2009 to 2016) to be 6.191, 5.656, 4.997 and 4.995 respectively. The ‗Z‘ score computed in this study for Nainital Bank is4.82 ( for 2013) ,4.39 (for 2014), 4.95 (for 2015), 4.61 (for 2016) and 5.04 (for 2017) which is very high than required therefore it can be safely inferred that for next 2 years bank is not going to fail or to be liquidated except for external reasons. Mittal Manish and Dhade Arun (2009) analyzed awareness of CAMELS amongst bank employees in India in public , private sector and foreign banks and found the comparative awareness to be 83%, 43% and 93% respectively. Saji Thazhungal Govindan Nair and Sableyeibiyo Asghede (2015) found that BOB was fundamentally sound with some minor flaws in certain areas (mortgage weakness). They had computed CAMELS composite score of Bank of Baroda to be 2.28. Nainital Bank‘s CAMELS composite rating (average) had been calculated to be 1.80 which can be easily approximated to 2. The rating 2 is awarded to banks with relatively good performance profile and only minor flaws in their operations are present. Going into the further details the challenging areas identified for improvement are advances, investment in government securities, profit, return on equity and dividend upon net profit. It is easily inferred that the growth in advances will change the ratings as it will also change the investment pattern of bank and profits. If bank enhances its credit portfolio in quantity and quality

Z score & Camel‘s Score are static approaches as these do not capture the changes between the yearly intervals. In depth analysis of investment & advances portfolio can also give new insights for financial performance of banks for further research.

Kumar Krishan and Kavita (2017). An Analysis of the Financial Performance of Indian Commercial Banks, IUP, pp. Mittal Manish and Dhade Aruna (2009). Awareness and Perception of CAMEL Rating Across Banks: Some Survey Evidence, The ICFAI University Journal of Bank Management, Vol. VIII, No. 2. Githaiga Joyce Wangari (2015). Effects of Credit Risk Management on the Financial Performance of Commercial Banks in Kenya, D61/65647/2013, October 2015 Uppal R. K. and Juneja Amit (2012). Determining Factors of Profitability and Banks Performance – An Empirical Study, APJEM Arth Prabhand: A Journal of Economics and Management, Vol. 1 Issue 3, June 2012 Abdel Rahim Khalil Elian (2013). Effectiveness of Credit Risk Management of Saudi Banks in the Light of Global Financial Crisis: A Qualitative Study, Asian Transaction on Basic and Applied Sciences (ATBAS ISSB: 2221-4291) Volume 03 Issue 02, 2013 Ramachandran A. and Kavitha N. (2009). Profitability of the Indian Scheduled Commercial Banks: A Case Analysis, The ICFAI University Press. Walia Kranti and Kaur Prabhjot (2015). Performance Evaluation of the Indian Banking Sector: A Study of Selected Commercial Banks, IUP Journal of Bank Management, pp. 38-48 Rahman Md. Zahidur and Islam Md. Shohidul (2018). Use of CAMEL Rating Framework: A Comparative Performance Evaluation of Selected Bangladeshi Private Commercial Banks, International Journal of Economics and Finance, Vol. 10, No. 1: 2018 Saji Thazhungal Govindan Nair and Sableyeibiyo Asghede (2015). CAMELS and Bank Performance Measurement: A Case Study of Bank of Baroda, International Journal of Banking, Risk and Insurance Voulme 3, Issue 1, March 2015.

Research Scholar, Uttarakhand Open University, Haldwani deep_chandra56@yahoo.co.in