Financial Statement of Banks

Format of Balance sheet –

It is mandated in Form A of the schedule III of Banking Regulation Act, 1949
The third Schedule (See Section 29)
Form ‘A’
Form of Balance Sheet
Balance Sheet of __________
Balance Sheet as on 31st March………
ScheduleCurrent Year Previous year
Capital & Liabilities
Capital 1
Reserve & Surplus 2
Deposits 3
Borrowings 4
Other Liabilities & Provisions 5
Total ---------------- --------------------

========== ============
 ScheduleCurrent Year Previous year
Assets
Cash & balance with RBI6
Balance with banks and money at call
and short notice7
Investments 8
Advances 9
Fixed Assets10
Other Assets11
Total ---------------- --------------------

========== ============
Contingent Liabilities
Bills for Collection12
Format of Profit & Loss –
It is mandated in Form B of the schedule III of Banking Regulation Act, 1949
Form ‘B’
Form of Profit & Loss Account for the year ended 31st March
ScheduleCurrent Year Previous year
I. Income
Interest Earned 13
Other Income 14
Total ---------------- --------------------
========== ============
II. Expenditure
Interest expanded 15
Operating Expenses 16
Provisions and contingencies
Total ---------------- --------------------
========== ============
III. Profit/Loss
Net Profit/Loss (-) for the year
Profit/Loss(-) brought forward
Total ---------------- --------------------
========== ============
IV. Appropriations
Transfer of Statutory Reserves
Transfer to Other Reserves
Transfer to Government/proposed dividends
Balance carried over to Balance Sheet
Total ---------------- --------------------
========== ============
Explanation of items of balance sheet and income
statement
• https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/78904.pdf

• TIER 1 Capital :
• It is the core capital of the bank and majorly consist of paid up capital, statutory reserves and other disclosed free
reserves as reduced by equity investments in subsidiary, intangible assets, current & brought-forward losses.

• Tier 1 is subdivided into Common Equity Tier 1 and additional Tier 1 capital.
• The distinction is important because security instruments included in Tier 1 capital have the highest level of
subordination. Common Equity Tier 1 capital includes equity instruments that have discretionary dividends and
no maturity, while additional Tier 1 capital comprises securities that are subordinated to most subordinated
debt, have no maturity and their dividends can be cancelled at any time.
• TIER 2 Capital :
• It is supplementary capital of the bank and it includes undisclosed Reserves, General Loss reserves ,hybrid debt
capital instruments and subordinated debts with an original maturity of at least five years.

• https://www.icicibank.com/managed-assets/docs/investor/basel-investor-disclosure/Capital-composition-and-reconciliation-at-Mar
ch-31-2021.pdf
https://www.icicibank.com/managed-assets/docs/inve
stor/annual-reports/2021/Financial-Statements.pdf
Performance Evaluation of
banks
The purpose of this session is to discover what
analytical tools can be applied to a bank’s
financial statements so that management and
the public can identify the most critical
problems inside each bank and develop ways
to deal with those problems
Introduction
• Two important dimensions for any bank-profitability and risk

• Some banks want to grow faster and achieve some long range growth
objectives. Others seem to prefer a quiet life, minimising risk and conveying
the image of a sound bank but with modest rewards for their shareholders

• If stock fails to rise in value correspond to stockholders expectations, current

investors may seek to unload their shares and the bank will have difficulty in
raising new capital to support its future growth.
Evaluating Bank Performance
• Outline
• A Framework for Evaluating Bank Performance
Internal Performance
External Performance
Presentation of Bank Financial Statements
• Analyzing Bank Performance with Financial Ratios
Profit Ratios
Risk Ratios
• Internal Performance Evaluations Based on Economic Profit
RAROC (Risk-Adjusted Return on Capital)
EVA (Economic Value Added)
Parameters of performance evaluation
• Ratios
• Regulatory ratios
• Ratios based on risk
• Ratios based on financial performance
• NPA
• Ratings
• CAMEL
• CAMELS
• OTHERS
• Regulator criteria
• Indradhanush
• Others
Non Performing Assets
• 2.1.1 An asset, including a leased asset, becomes non performing when it ceases to generate income for the
bank.
• 2.1.2 A non performing asset (NPA) is a loan or an advance where;
i. interest and/ or instalment of principal remains overdue for a period of more than 90 days in respect of a term loan,
ii. the account remains ‘out of order’ as indicated at paragraph 2.2 below, in respect of an Overdraft/Cash Credit (OD/CC),
iii. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
iv. the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
v. the instalment of principal or interest thereon remains overdue for one crop season for long duration crops,
vi. the amount of liquidity facility remains outstanding for more than 90 days, in respect of a Securitisation transaction
undertaken in terms of the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021.
vii. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative
contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
• 2.1.3 In case of interest payments, banks should, classify an account as NPA only if the interest due and
charged during any quarter is not serviced fully within 90 days from the end of the quarter.
• 2.2 ‘Out of Order’ status
• An account should be treated as 'out of order' if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing power for 90 days. In cases
where the outstanding balance in the principal operating account is less than the
sanctioned limit/drawing power, but there are no credits continuously for 90 days
as on the date of Balance Sheet or credits are not enough to cover the interest
debited during the same period, these accounts should be treated as 'out of order'.

• 2.3 ‘Overdue’
• Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid
on the due date fixed by the bank.
• Income Recognition Policy
• 3.1.1 The policy of income recognition has to be objective and based on the record of
recovery. Therefore, the banks should not charge and take to income account interest on
any NPA. This will apply to Government guaranteed accounts also.

• 3.1.2 However, interest on advances against Term Deposits, National Savings Certificates
(NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies may be
taken to income account on the due date, provided adequate margin is available in the
accounts.

• 3.1.3 Fees and commissions earned by the banks as a result of renegotiations or

rescheduling of outstanding debts should be recognized on an accrual basis over the period
of time covered by the renegotiated or rescheduled extension of credit.
 Fig 1: Asset Classification

Assets

Performing Non Performing Assets

Assets (NPA)

Standard Sub -Standard Doubtful Loss

Assets Assets Assets Assets
Performing Assets
• An account does not disclose any problems and carry more than
normal risk attached to the business

• All loan facilities which are regular !

Non-Performing Assets
• Non Performing Asset means a loan or an account of borrower, which has been classified
by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance
with the directions or guidelines relating to asset classification issued by RBI.

• With effect form March 31, 2004 a non-performing asset (NPA) shell be a loan or an
advance where;
• interest and /or installment of principal remain overdue for a period of more than 90 days in respect of
a Term Loan,
• the account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash
Credit(OD/CC),
• the bill remains overdue for a period of more than 90 days in the case of bills purchased and
discounted,
• Banks should classify an account as NPA only if the interest charged during any quarter is not
serviced fully within 90 days from the end of the quarter
Classification of assets
• Standard Assets : Arrears of interest and the principal amount of loan does not exceed 90
days at the end of financial year

• Substandard Assets : Which has remained NPA for a period less than or equal to 12 months
and provision is made for 10% of the secured portion and 20% of the unsecured portion of
the outstanding.

• Doubtful Assets : Which has remained in the sub-standard category for a period of 12
months. Provisioning is made at 100% of the unsecured portion of the outstanding and for
secured portion
• D1 i.e. up to 1 year : 20% provision is made by the bank
• D2 i.e. up to 2 year : 30% provision is made by the bank
• D3 i.e. up to 3 year : 100% provision is made by the bank
• Loss Assets : where loss has been identified by the bank or internal or
external auditors or the RBI inspection but the amount has not been
written off wholly. In other words such an assets is considered
uncollectable and of such little value that it’s continuance as a
bankable assets is not warranted although there may be some salvage
value .
• Gross NPA is the summation of the principal and the interest to be
paid on it. It shows that the landed amount is at the potential risk of
being unpaid. In other words, Gross NPA is the sum of all NPA assets.
The formula for calculating Gross NPA is-

• Gross NPA= (A1+A2+A3+A4+……………..+An)/Gross Advances

• Here, A1 to An represents the amount of loan for the person 1 to n.

• Net NPA is the difference in gross NPA and provisions for bad and
doubtful debt. It is the amount obtained when the principal amount is
deducted by the payments received from the person who has lent the
amount. Net NPA is calculated by the following formula-

• Net NPA= ( Gross NPA- provisions of unpaid debt)/ Gross Advances

Provision coverage ratio
• A Provisioning Coverage Ratio or PCR is the percentage of funds that
a bank sets aside for losses due to bad debts. A high PCR can be
beneficial to banks to buffer themselves against losses if the NPAs
start increasing faster. ... Provision Coverage Ratio = Total provisions /
Gross NPAs
Ratio analysis in banks
Profitability Ratios in Banking
• Banks normally borrow from savers and lend to the investors. A key
measure of the success of this intermediation function is certainly the
spread between the yield on average earning assets to the cost rate on
interest-bearing sources of funds. That is, to measure the true cost of
intermediation, we must look at:

• Yield Spread = (Percent yield on average earning assets - Percent cost on

interest-earning sources of funds)
Evaluating Performance (continued)
• Another traditional measure of earnings efficiency is the earnings spread

• Measures the effectiveness of a financial firm’s intermediation function in

borrowing and lending money and also the intensity of competition in the
firm’s market area
• Greater competition tends to squeeze the difference between average asset
yields and average liability costs
• If other factors are held constant, the spread will decline as competition
increases
Profitability Ratios in Banking
• Are ROA and ROE equal good proxies for the return of ownership of a financial
institution? Does it matter which earnings ratio we use?

• The answer is yes, because ROA and ROE reveal different information about a
bank or other financial institution.

• ROA is a measure of efficiency. It conveys information on how well the

institution’s resources are being used in order to generate income.
Profitability Ratios in Banking
• ROE is a more direct measure of returns to the shareholders. Since
the reward to the owners are a key goal for the whole organization,
ROE is generally superior to ROA as a measure of profitability.

• One point should be obvious here: ROE is strongly influenced by the

capital structure of a financial institution, in particular, how much use
it makes of equity financing.
Profitability Ratios in Banking
• Bank Profitability: The net after tax income or net earning of a bank (usually
divided by a measure of bank size).
• Some of key ratios are given below:
Net Income After Taxes
Return on Equity Capital (ROE) 
Total Equity Capital

Net Income After Taxes

Return on Assets (ROA) 
Total Assets

Net Interest Income

Net Interest Margin 
Total Assets
Profitability Ratios in Banking

Net Noninteres t Income

Net Noninteres t Margin 
Total Assets

Total Operating Revenues -

Total Operating Expenses
Net Bank Operating Margin 
Total Assets

Net Income After Taxes

Earnings Per Share (EPS) 
Common Equity Shares Outstandin g
Evaluating Performance

• The net operating margin, net interest margin, and net noninterest margin are
efficiency measures as well as profitability measures
• The net interest margin measures how large a spread between interest
revenues and interest costs management has been able to achieve
• The net noninterest margin measures the amount of noninterest revenues
stemming from service fees the financial firm has been able to collect relative
to the amount of noninterest costs incurred
• Typically, the net noninterest margin is negative
Profitability Ratios in Banking
• ROE = (Profit margin x Asset utilization x Equity multiplier)

• The importance of the above formula is that it can aid management in

pinpointing where the problem lies if a financial institution’s ROE is lower or
falling.

• For example, if the profit margin is falling, this implies that less net income is
being recovered from each dollar of operating revenue.
Profitability Ratios in Banking
• The causes of this problem would be due to:
• lack of adequate expense control
• below-par tax management practices
• inappropriate pricing of services
• ineffective marketing strategies

• However, if ROE, is low or declining due to a decreasing asset utilization ratio,

we need to review the institution’s asset management policies-particularly the
yield and mix of its loans and security investment and the size of its cash or
liquidity.
Profitability Ratios in Banking
• Finally, the equity multiplier sheds light on the financing mix of the
institution -- what proportion of assets are supported by owner’s
equity (particularly stock and retained earnings) as opposed to debt
capital.
Evaluating Performance (continued)
• Useful Profitability Formulas for Banks and Other Financial-Service Companies
Evaluating Performance (continued)

• or

where
Elements That Determine the Rate of Return Earned on the
Stockholders’ Investment (ROE) in a Financial Firm
Evaluating Performance (continued)
• A slight variation of the simple ROE model produces an efficiency equation
useful for diagnosing problems in four different areas in the management of
financial-service firms

or
Evaluating Performance (continued)
• We can also divide a financial firm’s return on assets into its component parts
Calculating Return on Assets (ROA)
Evaluating Performance (continued)

• Other Goals in Banking and Financial-Services Management

• A rise in the value of the operating efficiency ratio often indicates an expense
control problem or a falloff in revenues, perhaps due to declining market demand
• In contrast, a rise in the employee productivity ratio suggests management and
staff are generating more operating revenue and/or reducing operating expenses
per employee, helping to squeeze out more product with a given employee base
However…
• Profitability taken in isolation is only half the story.

• We also need to know about risk exposure….

Evaluating Performance (continued)
• Achieving superior profitability for a financial institution depends upon several
crucial factors
1. Careful use of financial leverage (or the proportion of assets financed by
debt as opposed to equity capital)
2. Careful use of operating leverage from fixed assets (or the proportion of
fixed-cost inputs used to boost operating earnings as output grows)
3. Careful control of operating expenses so that more dollars of sales revenue
become net income
4. Careful management of the asset portfolio to meet liquidity needs while
seeking the highest returns from any assets acquired
5. Careful control of exposure to risk so that losses don’t overwhelm income
and equity capital
Evaluating Performance (continued)
• Risk to the manager of a financial institution or to a regulator
supervising financial institutions means the perceived uncertainty
associated with a particular event
• Among the more popular measures of overall risk for a financial
firm are the following
• Standard deviation (σ) or variance (σ2) of stock prices
• Standard deviation or variance of net income
• Standard deviation or variance of return on equity (ROE) and return on assets
(ROA)
• The higher the standard deviation or variance of the above
measures, the greater the overall risk
Evaluating Performance (continued)
• Bank Risks
• Credit Risk
• Liquidity Risk
• Market Risk
• Interest Rate Risk
• Operational Risk
• Legal and Compliance Risk
• Reputation Risk
• Strategic Risk
• Capital Risk
Credit Risk
• The Probability that Some of the Bank’s Assets Will Decline in Value
and Perhaps Become Worthless

• Credit risk measures

• Non-performing Loans/Total Loans
• Net Charge-Offs (Written Off Loans)/Total Loans
• Provision for Loan Losses/Total Loans
• Provision for Loan Losses/Equity Capital
• Total Loans/Total Deposits
Liquidity Risk
• Probability the Bank Will Not Have Sufficient Cash and Borrowing
Capacity to Meet Deposit Withdrawals and Other Cash Needs

• Liquidity risk measures

• Purchased Funds (Eurodollars, federal funds, large value certificate of
deposits (CDs) and commercial papers)/Total Assets
• Net Loans/Total Assets
• Cash assets and Due from Banks/Total Assets
• Cash assets and Government Securities/Total Assets
LCR & NSFR (Basel III Norms)
• The Basel Committee has designed two liquidity ratios to ensure that
financial institutions have sufficient liquidity to meet their short-term
and long-term obligations:

• LCR and NSFR.

• These two requirements are intended to reduce risks in case of

episodes of financial turbulence.
Liquidity coverage ratio
• The LCR measures a bank’s liquidity risk profile, banks have an adequate stock of unencumbered high-quality
liquid assets that can be easily and immediately converted in financial markets, at no or little loss of value. This
category would include, for example, central bank deposits, corporate promissory notes or guaranteed bonds. The
goal is to ensure that the institution can meet its liquidity needs for a 30 day hypothetical financial stress scenario.

• The LCR is the percentage resulting from dividing the bank’s stock of high-quality assets by the estimated total net
cash outflows over a 30 calendar day stress scenario. Total net cash outflows is defined as the total expected cash
outflows minus total expected cash inflows (up to an aggregate cap of 75% of total expected cash outflows).

• Total expected cash outflows are calculated by multiplying the current balance of liability products (such as
accounts and deposits) and off-balance sheet commitments (such as credit and liquidity lines to customers) by the
rates at which they are expected to run off or be drawn down in accordance with the aforementioned stress scenario.

• As of January 1, 2019, the minimum liquidity coverage ratio required for internationally active banks is 100%. In
other words, the stock of high-quality assets must be at least as large as the expected total net cash outflows over the
30-day stress period.
NSFR
• The NSFR requires banks to maintain a stable funding profile in relation to their off-balance sheet assets
and activities. The goal is to reduce the probability that shocks affecting a bank's usual funding sources
might erode its liquidity position, increasing its risk of bankruptcy. The NSFR standard seeks that banks
diversify their funding sources and reduce their dependency on short-term wholesale markets.

• The NSFR is defined as the ratio between the amount of stable funding available and the amount of stable
funding required. Available stable funding means the proportion of own and third-party resources that are
expected to be reliable over the one-year horizon (includes customer deposits and long-term wholesale
financing). Therefore, unlike the LCR, which is short term, this ratio measures a bank’s medium and long
term resilience. The stable funding requirements for each institution are set based on the liquidity and
maturity characteristics of its balance sheet asset’s and off-balance sheet exposures.

• Basel III requires the NSFR to be equal to at least 100% on an ongoing basis. In other words, the amounts
of available stable funding and required stable funding must be equal.
Market Risk
• Probability of the Market Value of the Bank’s Investment Portfolio
Declining in Value Due to a Rise in Interest Rates

• Market risk measures

• Book-Value of Assets/ Estimated Market Value of Assets
• Book-Value of Equity/ Market Value of Equity
• Market Value of Bonds/Book-Value of Bonds
• Market Value of Preferred Stock and Common Stock
Interest Rate Risk
• The Danger that Shifting Interest Rates May Adversely Affect a
Bank’s Net Income, the Value of its Assets or Equity

• Interest rate risk measures

• Interest Sensitive Assets/Interest Sensitive Liabilities
• Uninsured Deposits/Total Deposits
Earnings Risk
• The Risk to the Bank’s Bottom Line – Its Net Income After All
Expenses

• Earning risk measures

• Standard Deviation of Net Income
• Standard Deviation of ROE
• Standard Deviation of ROA
Solvency or Default Risk
• Probability of the Value of the Bank’s Assets Declining Below the
Level of its Total Liabilities. The Probability of the Bank’s Long Run
Survival

• Solvency risk measures

• Stock Price/Earnings Per Share
• Equity Capital/Total Assets
• Purchased Funds/Total Liabilities
• Equity Capital/Risk Assets
Performance Indicators among Banking’s Key
Competitors
Among the key bank performance indicators that often are equally applicable to
privately owned, profit-making nonbank financial firms are
• Prices on common and preferred stock • Interest-sensitive assets to interest sensitive
• Return on equity capital (ROE) liabilities
• Return on assets (ROA) • Book-value assets to market-value assets
• Net operating margin • Equity capital to risk-exposed assets
• Net interest margin • Interest-rate spread between yields on the
• Equity multiplier financial firm’s debt and market yields on
government securities
• Asset utilization ratio
• Earnings per share of stock
• Cash accounts to total assets
• Nonperforming assets to equity capital ratio
 Efficiency and Expense control
ratios
These ratios describe how well the financial institution control expenses
relative to producing revenues and how productive employees are in
terms of generating income, managing assets and handling accounts
Description Numerator Denominator Interpretation/ Remarks
Operating Efficiency Total Operating Total Assets The lower this ratio, the more efficient the bank
Expenses
Cost of funds Total interest Total deposit and non The lower this ratio, the lower the variable cost for the
expenses deposit borrowings bank
Efficiency (cost-income) ratio Non interest Net total income Net total income will be NII+ other income. Shows the
income share of non interest income in total income. Though
some school of thought seem to think that the higher the
ratio, the more profitable the bank, since most of this
income comprises fee-based services, such services are
not without risk to banks
Overhead efficiency (burden) Non interest Non interest expenses A variant of this ratio would be non interest income
ratio income LESS non interest expenses in the numerator. (typically,
non interest income will be less than non interest
expenses overheads)
Income productivity per Cost per Net-interest margin
employee employee (NIM)
Break even volume of Cost per Net interest margin NIM = Net interest income total earnings assets
incremental cost per employee employee (NIM)
Tax Ratio Total income tax Income before taxes
payments
Tax Ratio (2) Provisions for Total Equity
tax
Tax Ratio (3) Taxes paid Total assets
 Liquidity Ratios
• It is mandatory that banks meet investors demands for liquidity.
However, there is a trade-off since more liquid assets generally yield
lower returns.

• The following ratios describe the institutions liquidity position.

Description Numerator Denominator Interpretation/ Remarks
Demand to time deposits Total demand deposits Total time deposits The higher this ratio, the more the need for liquidity for the
bank
Demand deposits ratio Total demand deposits Total assets The higher the ratio, the more the need to invest in liquid
assets for the bank
Non deposit borrowing Non deposit borrowings Total assets The higher the ratio, the higher the probability of default
ratio risk or reputation risk for the bank.
Credit asset ratio Total credit extended Total assets The more this ratio for the bank, the higher the risk of
counter party default
Net loans – asset ratio Total credit LESS Total assets When comparting the preceding ratio with this, the larger
provisions made the difference between the two ratios, the less healthy the
Banks's credit portfolio
Short term investments – Investment in money Total assets The higher this ratio, the more liquid is the banks asset
total assets ratio market instrument and portfolio. However, it is likely that a very liquid portfolio
other short term assets may be at the cost of profitability.
SLR investment – total SLR investments Total Investments SLR investments are essentially liquid. Hence, the higher
investment ratio the ratio, the higher the liquidity in the bank.
Cash to demand deposits Cash and bank balances Demand deposits The higher the ratio, the higher the liquidity of the bank.
ratio including callmoney Hence, the probability that the bank defaults on its payment
obligations is low.
Cash to total deposits Cash and bank balances Total deposits Akin to the CRR. A variant to this ratio is including call
money to cash in the numerator
Cash to total assets Cash and bank balances Total assets The higher the ratio, the higher the liquidity of the asset
including call money portfolio; however, this may lead to low profitability
 Risk
• Financial institutions face many risks including losses on loans and
losses on investments. Financial institution managers must limit these
risks in order to avoid failure of the institution (bankruptcy)

• The following ratios provide some information concerning the risk of

the institution
Description Numerator Denominator Interpretation/ Remarks
Equity Multiplier Total Assets Equity
Equity Ratio Equity Total Asses Inverse of the Equity multiplier. Shows how
many assets can default before the equity is
eroded. The higher the ratio, the less risky the
bank.
Capital adequacy ratio Total capital Risk – weighted assets
Adjusted capital Total capital LESS net Risk weighted assets
adequacy NPAs LESS net NPAs
Provision ratio Loan loss provisions Total assets
Net NPA to assets ratio Net NPAs Total asset
Net NPAs to equity ratio Net NPAs Equity
Average risk weighted Risk weighted assets Total assets
assets
Incremental risk of asset Incremental risk Incremental total assets A trend would indicate the banks propensity to
portfolio weighted asses take risk
Description Numerator Denominator Interpretation/ Remarks
ROE Net Profit Equity Measures the return to shareholders
ROA Net profit Total assets ROA measures efficiency or how well the institution
is using its assets to generate income
Profit Margin Net Profit Total Income
Asset utilization Total income Total asses ROE can be decomposed into profit margin and asset
utilization and EM
Yield on assets Interest income earned Total earning assets
Interest cost to asset ratio Interest expenses Total assets
Cost of funds Interest expenses Interest bearing deposits
+ borrowings
Earnings per share Net profit Number of equity
shares
P/E ratio Share price Earnings per share
(EPS)
Net operating margin Total operating income LESS total Represents bank’s operational efficiency. What
operating expenses portion of the bank’s revenues flow through to net
income
Yield spread Percent yield on interest earning This is comparable to contribution margin and
assets less percent cost on interest provides insight into profitability of banking
bearing funds operations
Net interest margin (NIM) Total interest income LESS total Total assets
interest expenses
CAMEL Model/CAMELS model
• Capital adequacy
• Ratio of capital to risk weighted asses (CRAR)
• A sound capital base strengthens confidence of depositors
• Asset quality
• Ratio of non performing loans
• An indicative of the quality of credit decisions made by bankers
• Higher GNPA is indicative of poor credit decision making
• Management
• Ratio of non interest expenditure to total assets (MGNT)
• This variable which includes a variety of expenses such as payroll, workers
compensation and training investment, reflects the management policy stance
CAMEL Model/CAMELS Model
• Earnings
• Measured as the return on assets ratio
• Liquidity
• Cash maintained by the banks and balances with central bank, to total assets ratio (LQD)
• Banks with a larger volume of liquid assets are perceived safe, since these assets would
allow banks to meet unexpected withdrawals
• Sensitivity
• Sensitivity is the last category and measures an institution’s sensitivity to market risks.
For example, assessment can be made on energy sector lending, medical lending, and
agricultural lending. Sensitivity reflects the degree to which earnings are affected by
interest rates, exchange rates, and commodity prices, all of which can be expressed by
Beta.
CAMEL Contd…..
Rating Symbol Rating symbol indicates
A or 1 Bank is sound in every aspect
B or 2 Bank is fundamentally sound but with moderate weakness
C or 3 Financial, operational or compliance weaknesses that give cause
for supervisory concern
D or 4 Serious or immoderate finance, operational and managerial
weaknesses that could impair future viability
E or 5 Critical financial weaknesses and there is high possibility of failure
in the near future
A Risk based index approach
• ROA used as most widely accepted measure but the ROA is not a static measure –
it varies with credit risk, interest rate risk, liquidity risk and other risks inherent in
banking business.
• The variability or volatility in the ROA is typically measured by the standard
deviation – either over time for an individual bank or across various banks at any
point in time.
• A combination of the three important factors – ROA, EM and the standard
deviation of the ROA (the risk measure) – is called the risk index (RI).
• Method proposed by Hannan and Hanweck (1988) where
• RI = (expected value of ROA + capital to asset ratio)/ standard deviation of ROA
Economic Value Added (EVA)
• EVA measures the extent to which the firm has increased shareholder value in a
given year.

• EVA represents the residual value that remains after the cost of all capital,
including equity capital has been deducted.

• Increase Economic Value Added (EVA)

• Increase operating efficiency
• Commit new resources that promise a high return
• Redirect resources to more productive uses
• Make prudent use of tax benefits of debt financing
• Some analysts criticize traditional earnings measures such as ROE,
ROA, and EPS because they provide no information about how a
bank’s management is adding to shareholder value.

• If the objective of the firm is to maximize stockholders’ wealth, such measures

do not indicate whether stockholder wealth has increased over time, let alone
whether it has been maximized.

• Stern, Stewart & Company has introduced the concepts of market value added
(MVA) and its associated economic value added (EVA) in an attempt to directly
link performance to shareholder wealth creation.
Market and economic value added
• MVA represents the increment to market value and is determined by
the present value of current and expected economic profit:
MVA = Market Value of Capital - Hist. Amount of Invested Capital

• Stern Stewart and Company measures economic profit with EVA,

which is equal to a firm's operating profit minus the charge for the cost
of capital:

where the capital charge equals the product of the firm’s value of
capital and the associated cost of capital.
EVA = Net Operating Profit After Tax (NOPAT) - Capital Charge
Difficulties in measuring EVA for the entire bank
• It is often difficult to obtain an accurate measure of a firm's cost of capital.

• The amount of bank capital includes not just stockholders' equity, but also
includes loan loss reserves, deferred (net) tax credits, non-recurring items such
as restructuring charges and unamortized securities gains.

• NOPAT should reflect operating profit associated with the current economics of
the firm. Thus, traditional GAAP-based accounting data, which distort true
profits, must be modified to obtain estimates of economic profit.
EVA calculation
RAROC/RORAC analysis
• RAROC refers to risk adjusted return on capital and is represented as (Risk
adjusted income/ Capital)
• RORAC refers to return on risk adjusted capital and is calculated as (Income / Risk
adjusted capital)
• Though the above are the theoretical definitions, these terms are often used
interchangeably
• Risk adjusted income implies that net revenues have been arrived at after deducting
expenses and expected losses.
• Some banks also deduct a capital charge from the return to assess the economic
capital
• Risk adjusted capital represents capital necessary to compensate earnings volatility
Benefits of the EVA’s implementation
• It may be summarized in “the four M’s : Management system, motivation, mind-set,
measurement (Marusak 2007)
• Management System
• Simply measuring EVA can give managers a better focus on performance
• Provides a foundation for a comprehensive financial management system
• Motivation
• Incentive plan to make managers think like owners because they are paid like owners
• EVA bonus plan
• Mind-set
• Changes corporate culture
• EVA system provides a common language for employees across all corporate functions
• Facilitates decentralized decision making
• Measurement
• Most accurate measure of corporate performance over any given period
• Translates accounting profits into economic reality
A Risk based index approach
• The capital to asset ratio is the inverse of the EM and is a measure of book value of solvency of a bank, RI
therefore can be interpreted as a measure of the extend to which a banks accounting earnings can fall till its
book value turns negative.

• It follows that higher values of RI indicate lower risk of insolvency – implying a higher level of book value of
equity – relative to the potential shocks to the earnings of a bank. Thus, banks with risky asset portfolios can
remain solvent as long as they are well capitalized.

• Hannan and Hanweck also derive a probability of book value insolvency (PI) expressed in terms of the RI as:
PI = ½(RI)2

• The RI measure derives its appeal from the use of ROA, the most widely accepted and undertook accounting
measure of banks overall performance, the standard deviation of ROA, which is an accepted measure of risk,
and book capital adequacy that approximates a banks solvency
Banking Stability Map (RBI)
The banking stability map and indicator (BSI) present an overall assessment of changes in underlying conditions and
Risk factors that have a bearing on stability of the banking sector during a period. The following ratios are used for
Construction of each composite index. https://m.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1183
Dimension Ratios
Soundness CRAR Tier – I capital to Tier- Leverage ratio as total assets to capital and
II capital reserves
Asset quality Net NPAs to total Gross NPAs to total Sub standard Restructured
advances advances advances to gross standard advances to
NPAs standard advances
Profitability Return on assets Net interest margin Growth in profit
Liquidity Liquid assets to total Customer deposits to Non bank advances to Deposits maturing
assets total assets customer deposits within 1 year to total
deposits
Efficiency Cost to income Business (credit + Deposits) to staff expenses Staff expenses to total
expenses
Indradhanush – performance evaluation of Public
sector banks
• Separate the position of Chairman & MD - CEO will be getting the position of MD & CEO -
Another person to be appointed as Non Executive Chairman of PSBs
• Current Private sector candidates are also allowed to apply for the above mentioned positions in
PSBs.

• The GOI will delegate all its responsibilities as owners of PSBs to Bank Board Bureau
• Perform functions of appointment at senior level in PSBs
• Watchdog for PSBs performance Structure of BBB
• To be headed by RBI governor
• BBB will comprise of a Chairman and six more members of which three will be officials and three
experts (of which two would necessarily be from the banking sector)

• https://financialservices.gov.in/sites/default/files/PressnoteIndardhanush_1.pdf
Key performance Indicators
(KPI) for banks
Indian Context
• KPIs are essentially financial ratios.
• To be computed in consistent manner and compared with past trends
or benchmarked with industry peers.
• Magnitude of ratios depends on the value of the numerator and
denominator, and if either of them is not correctly represented, the
interpretation could be misleading.
• While calculating ratios the following aspects should be considered:
• Are we comparing a balance sheet figure with an income statement
figure? The balance sheet figure is a ‘stock’ figure and income statement
figure is a ‘flow’ figure and to make them comparable, the balance sheet
figure should be taken as an average figure. The average can be computed
as the average of year end figures or quarterly figures if available

• A single ratio cannot be interpreted meaningfully. Trends in ratios should

be traced and interpreted. What has caused the changes in the ratio? Is it
the numerator or the denominator? What are the implications of these
changes?
• If only a single ratio is available, then benchmarking against industry
average, or peer comparison would yield meaningful insights.
Choosing the peer group for comparison should be done carefully.

• Accounting figure may camouflage details, and computing ratios

mechanically might not lead to proper interpretation. Notes to
accounts would provide more detailed information on the financial
statement figures and would help in improved understanding of the
implications of the ratios.
• External factors that affect the performance of financial institutions
include:
• Technology changes
• Regulation
• Competition
• Government policies (fiscal and monetary policy)

• Bank management cannot control these factors. The best they can do is
to try to anticipate future changes and position the institution to best
take advantage of these changes.
• Managers of banks, can however, control many internal factors. The
KPIs will, therefore, focus on these controllable factors, some of
which are
• Operating efficiency
• Expense control
• Tax management
• Liquidity
• risk
Other performance evaluation parameters
based on qualitative and quantitative
parameters
DEA (Data Envelopment Analysis)
• DEA is a method for measuring the relative efficiencies of a set of
comparable units such as banks, bank branches, schools, hospitals and
similar institutions whose common feature is the ability for their activities to
be described as the conversion of certain inputs into various form of output
• On the basis of relation between output and input ratio
• Inputs
• Operation Expenses
• No. of employees (measured in man/hour per annum)
• Outputs
• The total deposits
• Total loans and total guarantees
• End product of this method application
• Separation of banks (branches) into the efficient ones (the level of their
efficiency is 1) and the inefficient ones (whose efficiency is less than 1)

• The DEA analysis results

• What needs to be done in order for an inefficient bank to increase its
efficiency, or
• To what extent and with what expenses this goal is obtainable
• These results are directly followed by the useful bank management
information
AHP (Analytical Hierarchy Process)
• This method is based on the problem
• Decomposition into a hierarchy structure which consists of the element such
as:
• The goal
• The criteria (sub – criteria)
• And the alternatives

• Very useful in solving complex problems

Quality related criteria
Quality related criteria
AHP method application
• This method application can be explained in four steps
• The hierarchy model of the decision problem is developed in such a way that the
goal is positioned at the top, with criteria and sub – criteria on lower levels and
finally alternatives at the bottom of the model
• On each hierarchy structure level of the pairwise comparisons should be done by
all possible pairs of the elements of this level. The decision makers preference
are expressed by verbally described intensities and the corresponding numerical
values on 1-3-5-7-9 scale (Satty, 1980)
• On the basis of pairwise comparisons relative significance (weights) of elements
of the hierarchy structure (criteria, sub-criteria and alternatives) are calculated
which are eventually synthesised into an overall alternatives priority list
• The sensitivity analysis in carried out.
Balance score card – Kaplan & Nortorn
Using Financial Ratios and Other Analytical Tools to Track Financial-
Firm Performance – The UBPR and BHCPR - US Banks

• Compared to other financial institutions, more information is available about

banks than any other type of financial firm
• Through the cooperative effort of four federal banking agencies – the Federal
Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift
Supervision, and the Office of the Comptroller of the Currency – the Uniform
Bank Performance Report (UBPR) and the Bank Holding Company Performance
Report (BHCPR) provide key information for financial analysts
• The UBPR, which is sent quarterly to all federally supervised banks, reports each
bank’s assets, liabilities, capital, revenues, and expenses, and the BHCPR is
similar for BHCs
• Web link for UBPR and BHCPR: www.ffiec.gov