COMMERCIAL BANKING PROJECT

Submitted to : Professor Shiva Reddy

“ANALYSIS OF FINANCIAL PERFORMANCE

OF BANKS USING CAMELS APPROACH”

Submitted by :
Aashi Gupta – FE 1702
Prakhar Sikka – FE 1730

M.Sc Financial Economics | Gokhale Institute of Politics & Economics

ANALYSIS OF FINANCIAL PERFORMANCE
OF BANKS USING CAMELS APPROACH

Abstract: Commercial banks play an important role in the financial system and the
economy. As a key component of the financial system, banks allocate funds from savers
to borrowers in an efficient manner. They provide specialized financial services, which
reduce the cost of obtaining information about both savings and borrowing
opportunities. These financial services help to make the overall economy more efficient.
The function and significance of banking sector cannot be under-estimated in the
development of an economy. The strength of economy of any country basically hinges
on the strength and efficiency of financial system, which, in turn, depends upon a sound
banking system. Reserve Bank of India has recommended a supervisory rating model
named as CAMELS (Capital Adequacy, Assets Quality, Management, Earning,
Liquidity, Systems and Controls) and for rating of Indian commercial, private and
foreign banks operating in India. The present study attempts to evaluate the
performance of three banks in India using CAMEL approach for the period of 2017.

I. AN INTRODUCTION TO THE CAMELS FRAMEWORK

CAMELS is a recognized international rating system that bank supervisory authorities use in order to
rate financial institutions according to six factors represented by its acronym. Supervisory authorities
assign each bank a score on a scale. A rating of one is considered the best, and a rating of five is
considered the worst for each factor. Banks that are given an average score of less than two are
considered to be high-quality institutions. Banks with scores greater than three are considered to be
less-than-satisfactory institutions.

The acronym CAMELS stand for the following factors that examiners use to rate bank institutions:

Capital Adequacy - Capital adequacy represents the overall financial position of a bank. It
reflects whether the bank has sufficient capital to bear unexpected losses in the future and bank
leverage. The capital adequacy of a bank is assessed through the following ratios:

a) Capital to Risk-weighted Assets Ratio (CRAR) - This ratio is advocated to ensure that banks
can bear a reasonable amount of losses occurring during the operations and to ascertain bank’s
loss bearing capacity.
CRAR = [(Tier I capital + Tier II capital)/ Risk-weighted assets] x 100

Asset Quality - Asset quality ratios are one of the main risks that banks face. As loans have the
highest default risk, an increasing number of non-performing loans shows a deterioration of asset
quality. The asset quality of a bank is assessed through the following ratios:
 a) Net Non-performing asset (NPA) to advances ratio - The net NPA to loans (advances) ratio is
used as a measure of the overall quality of the bank's loan book. An NPA are those assets for
which interest is overdue for more than 90 days (or 3 months).

b) Gross NPA to Advances - Gross NPA is the sum of all loan assets that are classified as
NPA as per RBI guidelines. Gross NPA Ratio is the ratio of gross NPA to gross
advances (loans) of the bank.

Management - As management is a qualitative issue, such as the ability for risk taking, it is
usually difficult to measure the quality of management. Efficiency of management decides the future
of a business. The management quality of a bank can be measured by some important ratios such as :

a) Return on net worth : Return on equity (ROE) is a measure of profitability that calculates
how many dollars of profit a company generates with each dollar of shareholders' equity. The
formula for ROE is: ROE = Net Income/Shareholders' Equity. ROE is sometimes called
"return on net worth."

b) Net profit to total funds : NPTF shows the output of management decision in selection of
asset & investment quality of the bank. It is a tool to compute the Net Profit gain by
utilization of the total fund.

c) Total assets turnover ratio (TOTR) : The asset turnover ratio is calculated by dividing net
sales by average total assets. Net sales, found on the income statement, are used to calculate
this ratio returns and refunds must be backed out of total sales to measure the truly measure
the firm'sassets' ability to generate sales.


Earning Quality - High earnings quality should reflect the firm’s current operating performance
and a good indicator of future operating performance. The quality of earnings is an extremely
significant parameter which expresses the quality of profitability and capability of a bank to sustain
quality and earning consistently. It primarily reflects the profitability of bank and enlightens
consistency of future earnings. The following ratios are required to assess earning quality:

a) Return on Assets (ROA) -It measures the efficiency of the banks to generate the profits from
its operations for every rupee invested in its total assets. A higher ratio would be the result of
optimum utilization of its assets. It is calculated by dividing the net profits (after interest and
taxes) by the average assets of the bank.

b) Operating Profit per share (OP): This calculates bank earnings from operations for each rupee
spent as working fund per share.

Liquidity - Liquidity is another noteworthy aspect which expresses the financial performance of
banks. Liquidity means the ability of the bank to honour its obligations toward depositors. Bank can
preserve adequate liquidity position either by increasing current liabilities or by converting its assets
in to cash quickly. It also denotes the fund available with bank to meet its credit demand and cash
flow requirements. The following ratio is required to assess the liquidity:

a) Liquid Assets to Total Assets - This ratio expresses the overall liquidity position of a bank.
The liquid assets include cash in hand, money at call and short notice, balance with Reserve
Bank of India and balance with other financial institutions and banks. Liquidity management
 is one of the most imperative aspects of a bank. If available funds are not properly utilized,
the bank may suffer loss because idle cash has no return.

b) Cash to Deposit Ratio (CD Ratio): This is an important parameter to measure liquidity as it
evaluates the amount of cash that the bank has from the deposits that it has generated. Cash
being liquid of all the assets gives the complete picture of the liquidity of the bank.
Symbolically, CD Ratio = Cash / Total Deposits.

Sensitivity - Sensitivity covers how particular risk exposures can affect institutions. Examiners
assess an institution's sensitivity to market risk by monitoring the management of credit
concentrations. In this way, examiners are able to see how lending to specific industries affects an
institution. These loans include agricultural lending, medical lending, credit card lending and energy
sector lending. Exposure to foreign exchange, commodities, equities and derivatives are also
included in rating the sensitivity of a company to market risk.

Sensitivity to 'market risk', the "S" in CAMELS is a complex and evolving measurement area. Thus
for now, we have not measured this feature for rating the three banks.

Once the ratios are computed, the CAMELS approach gives ratings to the institution which means
the following :

Rating Meaning of Rating

1 Bank is sound in every aspect.

2 Bank is fundamentally sound but with moderate weakness.

3 Financial, operational or compliance weaknesses that give cause for supervisory

concern.

4 Serious financial, operational and managerial weaknesses that could impair future
viability.

5 Critical financial weaknesses and there is high possibility of failure in the future.

II. LITERATURE REVIEW

1. THE CAMEL RATING SYSTEM IN BANKING SUPERVISION - A CASE

STUDY - Uyen Dang, 2011: The paper aims to determine whether the CAMEL
framework plays a crucial role in banking supervision. Furthermore, the purpose is to
identify the benefits as well as drawbacks which the CAMEL system brings to AIA.
The research problem was explored by quantitatively analysing a bank’s overall
performance. The paper firstly starts to collect theory relevant to the empirical
research, and then draws conclusions from the findings by relating them back to the
literature stated in the early stage. Although this study is based on collected data and
 numerical figures, it is a qualitative study. The findings revealed that CAMEL rating
system is a useful supervisory tool in the U.S. CAMEL analysis approach is beneficial
as it is an internationally standardized rating and provides flexibility between on-site
and off-site examination; hence, it is the main model in assessing banks’ performance
in AIA. On the other hand, it has disadvantages of not following the Vietnamese bank
closely, ignoring the interaction with bank’s top management and overlooking the
provisions as well as allowance for loan loss ratios. The paper further discusses the
current financial crisis and the banking supervisory tool in Europe by an in- depth
interview with a banker.

2. CAMELS' ANALYSIS IN BANKING INDUSTRY - Global Journal of

Engineering Science and Research Management – November, 2015 : In this study
some important ratios are chosen and calculated to evaluate bank's performance. Data
which is used in this study is gathered from annual financial reports of an Iranian
bank. Then data is compared with other bank's ratios and reports. Certainly, the trends
of calculations and relevant figures show important points for managers and also,
CAMELS rating can be an efficient tool to manage and control and decide in
management accounting view.

3. CAMELS RATING MODEL FOR EVALUATING FINANCIAL

PERFORMANCE OF BANKING SECTOR- A Theoretical Perspective, 2016 :
The study describes the various financial ratios used in the CAMELS and CACS
models to measure the financial performance of banking sector. The nature of study is
mainly qualitative and does not make use of any statistical technique for analysis. The
study has been done mainly on the basis of literature review and secondary
information available from various journals, conference proceedings and reports of
professional bodies.

III. RESEARCH METHODOLOGY

a) Objective of the study

The prime objective of the study is to analyse and discuss the various theoretical
aspects ratios used in CAMELS rating model for the assessment of financial
performance of banking sector. For this purpose, three banks’ financial performance
namely ICICI Bank, HDFC Bank and Axis Bank has been assessed for the period
2014-18 using CAMELS approach. Once soundness across banks is determined using
the CAMELS approach, inferences can be drawn about the financial performance
across these three banks.

b) Data collection
Secondary Sources of data collection have been used, viz. statistics tables published
by Reserve bank of India and annual reports published by the banks given at
moneycontrol.com

IV. ABOUT THE BANKS :

• ICICI Bank Limited is an Indian multinational banking and financial services company
headquartered in Mumbai, Maharashtra, India, with its registered office in Vadodara. In
 2014, it was the second largest bank in India in terms of assets and third in term of market
capitalisation. It offers a wide range of banking products and financial services for corporate
and retail customers through a variety of delivery channels and specialised subsidiaries in the
areas of investment banking, life, non-life insurance, venture capital and asset management.
The bank currently has a network of 4867 branches and 14367 ATMs across India and has a
presence in 19 countries including India. ICICI Bank is one of the Big Four banks of India,
along with State Bank of India, Bank of Baroda and Punjab National Bank.
• HDFC Bank Limited is an Indian banking and financial services company headquartered
in Mumbai, Maharashtra. It has 88,253 permanent employees as on 31 March 2018 and has a
presence in Bahrain, Hong Kong and Dubai. HDFC Bank is India’s largest private sector
lender by assets. It is the largest bank in India by market capitalization as of February 2016. It
was ranked 69th in 2016 BrandZ Top 100 Most Valuable Global Brands.
• Axis Bank is the third largest of the private-sector banks in India offering a comprehensive
suite of financial products. The bank has its head office in Mumbai and registered office in
Ahmedabad. It has 3,703 branches, 13,814 ATMs, and nine international offices. The bank
employs over 55,000 people and had a market capitalization of ₹1.31 trillion (US$18 billion)
(as on March 31, 2018). It sells financial services to large and mid-size corporates, SME, and
retail businesses.

V. ANALYSIS OF COMPONENTS OF CAMEL FRAMEWORK

1. Capital Adequacy

The capital adequacy is measured by Capital Adequacy Ratio or CAR. Higher ratio reflects that
banks are stronger and the investors are more protected. An adequate capital is required to run the
banking business but very high level of CAR badly affect the investment capacity of the bank.

The capital norms recommend Capital Adequacy ratio (CAR) to be at 8 % internationally,

while in India it is 9 per cent. CAR is a ratio of a bank’s capital to its risk. This capital is
further classified into two – Tier 1 (the main portion of the banks’ capital, usually in the form
of equity shares) and Tier 2 capital. Out of the 9 per cent of CAR, 7 per cent has to be met by
Tier 1 capital while the remaining 2 per cent by Tier 2 capital.

The following table shows Capital Adequacy ratios for three private sector banks for 2014-2018

CAR (%) HDFC Bank ICICI Bank Axis Bank

Mar 18 14.82 18.42 16.57
Mar 17 14.6 17.39 14.95
Mar 16 15.53 16.64 15.29
Mar 15 16.79 17.02 15.09
Mar 14 16.07 17.7 16.07
Average 15.56 17.43 15.59
Rank 3 1 2
Source: RBI, moneycontrol.com

All the three banks have CAR higher than the prescribed set by RBI. According to the average of
CAR for the five years taken, ICICI has the highest CAR followed by Axis and HDFC Bank.
2. Asset Quality

Asset quality is measured by the average of Gross NPA to total advances and Net
NPA to total advances. Higher ratio reflects rising bad quality of loans.

The following table shows Asset Quality ratios for three private sector banks for 2014-2018

Gross NPA (%) HDFC Bank ICICI Bank Axis Bank

Mar 18 13 10 7
Mar 17 10 9 5
Mar 16 9 6 2
Mar 15 9 4 1
Mar 14 9 3 1
Average 10 6.4 3.2

Net NPA (%) HDFC Bank ICICI Bank Axis Bank

Mar 18 3 5 4
Mar 17 3 5 2
Mar 16 2 3 1
Mar 15 2 2 0.5
Mar 14 2 1 0.4
Average 2.4 3.2 1.58
Combined average 6.2 4.8 2.39
Rank 3 2 1
Source: RBI, moneycontrol.com

HDFC bank has highest NPA level followed by ICICI and Axis Bank. This implies the poor asset
quality of HDFC bank .

3. Management

Management efficiency is key to judge the decision making capacity of managing board, as
ingredients of the CAMEL Model. The ratio is to capture the possible subjective dynamics of the
effectiveness of management.

The following table shows the measures of management efficiency for the period 2014-2018

Return on net HDFC Bank ICICI Bank Axis Bank

worth (%)
Mar 18 16.45 6.63 0.43
Mar 17 16.26 10.11 6.59
Mar 16 16.91 11.19 15.46
 Mar 15 16.47 13.89 16.46
Mar 14 19.5 13.4 16.26
Average 17.12 11.04 11.04

Net profit/ Total HDFC Bank ICICI Bank Axis Bank

Funds
Mar 18 1.81 0.82 0.04
Mar 17 1.85 1.32 0.65
Mar 16 1.89 1.43 1.67
Mar 15 1.89 1.8 1.74
Mar 14 1.9 1.73 1.72
Average 1.87 1.42 1.16

Total asset HDFC Bank ICICI Bank Axis Bank

turnover ratio
Mar 18 0.08 0.07 0.07
Mar 17 0.09 0.07 0.08
Mar 16 0.09 0.08 0.08
Mar 15 0.09 0.08 0.08
Mar 14 0.09 0.08 0.08
Average 0.09 0.08 0.08
Combined Average 6.36 4.18 4.09
Rank 1 2 3
Source: RBI, moneycontrol.com

According the combined average of Return on net worth, Net profit/ Total Funds and Total asset
turnover ratio, HDFC Bank has the strongest management efficiency followed by ICICI and Axis
Bank.

4. Earning Quality

The excellence of earnings determines the capability of a bank to earn consistently. It mainly
determines the profitability and productivity of the bank, explains the growth and sustainability in
future earnings capacity.

The following table shows the measures of earning quality for the period 2014-2018

ROA HDFC Bank ICICI Bank Axis Bank

Mar 18 409.6 175.38 247.2
Mar 17 349.12 166.37 232.83
Mar 16 287.47 149.47 223.12
Mar 15 247.39 138.72 188.47
Mar 14 181.23 634.6 813.47
Average 294.96 252.91 341.02
 Operating profit HDFC Bank ICICI Bank Axis Bank
per share
Mar 18 70.56 13.91 20.24
Mar 17 55.68 13.29 26.73
Mar 16 44.77 15.89 30.12
Mar 15 36.16 14.15 22.89
Mar 14 29.65 58.45 93.96
Average 47.36 23.14 38.79
Combined Average 342.32 138.02 189.90
Rank 1 3 2
Source: RBI, moneycontrol.com

According to the combined average of Return on Assets and Operating profit per share, HDFC
Bank has the strongest earning quality followed by Axis and ICICI Banks.

5. Liquidity

Liquidity is measured by calculating the average of Cash to deposit ratio (CDR) and liquid assets to
total assets ratio. Liquid assets include Cash and Balances with Reserve Bank of India and Balances
with Banks Money at Call and Short Notice.

The following table shows the measures of liquidity for the period 2014-2018

CDR HDFC Bank ICICI Bank Axis Bank

Mar 18 9.95 6.17 7.64
Mar 17 5.71 6.45 6.89
Mar 16 5.77 6.74 6.20
Mar 15 6.46 6.85 6.11
Mar 14 6.02 6.54 5.97
Average 6.78 6.55 6.56

Liquid assets/ HDFC Bank ICICI Bank Axis Bank

Total assets
Mar 18 0.11 0.09 0.062
Mar 17 0.05 0.09 0.08
Mar 16 0.05 0.08 0.06
Mar 15 0.06 0.06 0.07
Mar 14 0.08 0.06 0.07
Average 0.07 0.08 0.068
Combined Average 3.42 3.315 3.314
Rank 1 2 3
Source: RBI, moneycontrol.com

HDFC Bank is top in Liquid position followed by ICICI bank. This implies that these banks are in
a better position to meet immediate and long term financial needs with a quality investment asset.
 VI. OVERALL RANKING

As stated in the initial part of this paper, CAMEL Model is used to rate the banks according to their
performance.

RANKS HDFC Bank ICICI Bank Axis Bank

C 3 1 2
A 3 2 1
M 1 2 3
E 1 3 2
L 1 2 3
Combined Average Rank 1.8 2 2.2
Overall Rank 1 3 2

We can observe the HDFC Bank has the strongest financial position followed by
Axis and ICICI banks for the time period 2014-18 using the CAMELS approach.
 VII. CONCLUSION
The sample banks (ICICI Bank, HDFC Bank and Axis Bank) have been ranked on CAMEL
parameters. Ranking these profitable banks is complicated to the level, that any type of such ranking
is question of ambiguity as the ratios selected for the computation of ranking can be interpreted in
the way one likes. The opted method provides a simplistic way of presenting difficult data
concerning performance of the top players of the industry.

The Growth of Banking industry is one of the most important factors of Economic development of a
country. The current study has been done to find the economic soundness of commercial banks in
India using CAMEL model for the period 2014-18.
The main findings of this study are as follows:

• ICICI has the highest Capital adequacy ratio followed by Axis and HDFC Bank.
• HDFC bank has poorest asset quality level followed by ICICI and Axis Bank.
• HDFC Bank has the strongest management efficiency followed by ICICI and Axis Bank.
• HDFC Bank has the strongest earning quality followed by Axis and ICICI Banks.
• HDFC Bank is top in Liquid position followed by ICICI bank.
• Using the CAMELS Approach, we can see that HDFC has the most efficient financial
position among the three sample banks we have chosen.

BIBLIOGRAPHY

1. “The camel rating system in banking supervision a case study” - uyen dang - arcada university of
applied sciences international business 2011

2. “Camels' analysis in banking industry” - malihe rostami- department of management, university of

grenoble, france - global journal of engineering science and research management, nov 2015

3. “Camels rating model for evaluating financial performance of banking sector: a theoretical
perspective” - international journal of system modeling and simulation vol 1(3) oct-dec 2016

4. Rao, s. And datta, l., “Benchmarking in Banking: a camel approach towards sound and strong
banking”, becon-98, canara bank, pp.156-167, 1998.

5. Hirtle, beverly j. And lopez, jose a., “Supervisory information and the frequency of bank
examination”, frbnc economic review, vol. April, pp. 1-19, 1999.