Evaluation of Bank Performance, CAMEL Rating-

Balance Score Card, Asset Liability Management,

NPA, BASEL
SESSIONS 6 & 7: 25 JUN 2019
ROE Model : Value of the Bank’s Stock
Po= Expected stream of future stockholder dividends  Discount
factor (based on the minimum required market rate of return on
equity capital given each bank perceived level of risk)

E(Dt)
P0  
t  0 (1  r)
t

E(Dt)= expected dividend stream

r = cost of capital ~ risk free return + equity risk premium

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Value of a Bank’s Stock Rises When:
Expected Dividends Increase

Risk to the Bank Falls

Combination of Expected Dividend Increase and Risk

Decline

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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 M argin 
Total Assets
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Profitability Ratios in Banking
Net Noninterest Income
Net Noninterest Margin 
Total Assets
Total Operating Revenues -
Total Operating Expenses
Net Bank Operating M argin 
Total Assets

Net Income After Taxes

Earnings Per Share (EPS) 
Common Equity Shares Outstanding

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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.

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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.
ROE is strongly influenced by the capital structure of a financial
institution, in particular, how much use it makes of equity
financing.

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Profitability Ratios in Banking
Management may be able to boost ROE simply by greater use of
financial leverage- that is, increasing the ratio of debt to equity
capital. This can be seen clearly if we note that
ROE = ROA x (total assets/total equity capital)
or equivalently,
ROE=ROA x ((total equity + total debt) / total equity)

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CAMELS
Capital: The risk capital of the bank should be above the prescribed minimum level.
Asset Quality: Lending portfolio of the bank should be well performing.
Management Quality: compliance with set norms, ability to plan and react to changing
circumstances, technical competence, leadership and administrative ability.
Earnings Ability: The single best indicator used to gauge earning is the Return on Assets (ROA),
which is net income after taxes to total asset ratio.
Liquidity: Ability to obtain sufficient funds, either by increasing liabilities or by converting its
assets quickly at a reasonable cost.
Sensitivity: Sensitivity is mostly evaluated in terms of management’s ability to monitor and
control market risk.

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CMELS Rating Scale
Rating Scale in India
A - Sound in every respect
B - Fundamentally sound, but with moderate weaknesses
C - Financial, operational and/or compliance weaknesses that give cause for supervisory
concern
D - Serious or moderate financial, operational and/or managerial weaknesses that could impair
future viability
E - Critical financial weaknesses that render the possibility of failure in the near term

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Balanced scorecard
…performance measures that look
beyond just financial measures
Attempts to measure the performance of a bank based on:
◦ financial measures
◦ relationships with its customers
◦ effectiveness of support processes in designing and delivering products and services
Performance is measured using indicators such as:
◦ market share,
◦ customer retention and attrition,
◦ customer profitability, and
◦ service quality to evaluate performance
Internally, they also track productivity and employee satisfaction
Such nonfinancial indicators provide information regarding whether a bank is truly
customer-focused and whether its systems are appropriate
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 Components of a
Bank Balance sheet
Liabilities Assets
1. Capital 1. Cash & Balances with
2. Reserve & Surplus RBI
3. Deposits 2. Bal. With Banks &
4. Borrowings Money at Call and
Short Notices
5. Other Liabilities
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
Contingent Liabilities
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Banks Profit & Loss Account
A bank’s profit & Loss Account has the following components:
I. Income: This includes Interest Income and Other Income.
II. Expenses: This includes Interest Expended, Operating Expenses
and Provisions & contingencies.

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Asset Liability Management
It is a dynamic process of Planning, Organizing & Controlling of
Assets & Liabilities- their volumes, mixes, maturities, yields and costs
in order to maintain liquidity and NII.

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Significance of ALM
Controls volatility in income and stock prices
Facilitates product innovations
Satisfies regulatory requirement
Reflects management efficiency

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Tools for ALM
Liquidity Management
Management of interest rate sensitivity

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 Liquidity Management
Bank’s liquidity management is the process of generating funds to
meet contractual or relationship obligations at reasonable prices at
all times.
New loan demands, existing commitments, and deposit withdrawals
are the basic contractual or relationship obligations that a bank must
meet.

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 Adequacy of liquidity position
for a bank
Analysis of following factors throw light on a bank’s adequacy of
liquidity position:
a. Historical Funding requirement
b. Current liquidity position
c. Anticipated future funding needs
d. Sources of funds
e. Options for reducing funding needs
f. Present and anticipated asset quality
g. Present and future earning capacity and
h. Present and planned capital position
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Funding Avenues

To satisfy funding needs, a bank must perform one or a combination

of the following:
a. Dispose off liquid assets
b. Increase short term borrowings
c. Decrease holding of less liquid assets
d. Increase liability of a term nature
e. Increase Capital funds

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Statement of Structural Liquidity
All Assets & Liabilities to be reported as per
their maturity profile into 8 maturity Buckets:
i. 1 to 14 days
ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years

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STATEMENT OF STRUCTURAL LIQUIDITY
Places all cash inflows and outflows in the maturity ladder as per
residual maturity
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 8 time buckets
Mismatches in the first two buckets not to exceed 20% of
outflows
Shows the structure as of a particular date
Banks can fix higher tolerance level for other maturity buckets.

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Example: Statement of Structural
Liquidity
15-28 30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5
1-14Days Days 3 Month 6 Mths 1Year Years 5 Years Years Total

Capital 200 200

Liab-fixed Int 300 200 200 600 600 300 200 200 2600
Liab-floating Int 350 400 350 450 500 450 450 450 3400
Others 50 50 0 200 300
Total outflow 700 650 550 1050 1100 750 650 1050 6500
Investments 200 150 250 250 300 100 350 900 2500
Loans-fixed Int 50 50 0 100 150 50 100 100 600
Loans - floating 200 150 200 150 150 150 50 50 1100
Loans BPLR Linked 100 150 200 500 350 500 100 100 2000
Others 50 50 0 0 0 0 0 200 300
Total Inflow 600 550 650 1000 950 800 600 1350 6500
Gap -100 -100 100 -50 -150 50 -50 300 0
Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0
Gap % to Total Outflow
-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57

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STRATEGIES…
To meet the mismatch in any maturity bucket, the bank has to
look into taking deposit of a time bucket with positive mismatch
and invest it suitably so as to mature in time bucket with
negative mismatch.
The bank can raise fresh deposits of Rs 300 crore over 5
years maturities and invest it in securities of 1-29 days of Rs
200 crores and rest matching with other out flows.

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 STATEMENT OF INTEREST RATE
SENSITIVITY
Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time
buckets.
RSA:
MONEY AT CALL
ADVANCES ( BPLR LINKED )
INVESTMENT
RSL
DEPOSITS EXCLUDING CD
BORROWINGS
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 MATURITY GAP METHOD
THREE Possibilities:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap
If a negative gap occurs (RSA<RSL) in given time band,
an increase in market interest rates could cause a decline in NII.

conversely, a positive gap (RSA>RSL) in a given time band,

a decrease in market interest rates could cause a decline in NII.

Interest Rate Swaps (IRS) help manage negative gap.

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Non-Performing Assets
Beginning Allowance for Loan Losses
+ This Year’s Provision for Loan Loss
= Adjusted Allowance for Loan Losses
- Actual Charge-Offs of Worthless Loans
+ Recoveries from Previous Charge-Offs
= Ending Allowance for Loan Losses

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
• The Basel Agreement
▫ An international agreement on new capital standards
▫ Designed to keep their capital positions strong
▫ Reduce inequalities in capital requirements among different
countries
▫ Promote fair competition
▫ Catch up with recent changes in financial services and financial
innovation
▫ In particular, the expansion of off-balance-sheet commitments
▫ Formally approved in July 1988
▫ Included countries such as:
▫ The United States, Belgium, Canada, France, Germany, Italy,
Japan, the Netherlands, Spain, Sweden, Switzerland, the United
Kingdom, and Luxembourg

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)
• Basel I
▫ The original Basel capital standards are known today as
Basel I
▫ Various sources of capital were divided into two tiers:
▫ Tier 1 (core) capital
▫ Common stock and surplus, undivided profits (retained
earnings), qualifying noncumulative perpetual preferred stock,
minority interest in the equity accounts of consolidated
subsidiaries, and selected identifiable intangible assets less
goodwill and other intangible assets
▫ Tier 2 (supplemental) capital
▫ Allowance (reserves) for loan and lease losses, subordinated debt
capital instruments, mandatory convertible debt, intermediate-
term preferred stock, cumulative perpetual preferred stock with
unpaid dividends, and equity notes and other long-term capital
instruments that combine both debt and equity features

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Basel I
▫ In order for a bank to qualify as adequately capitalized, it
must have:
1. A ratio of core capital (Tier 1) to total risk-weighted assets
of at least 4 percent
2. A ratio of total capital (the sum of Tier 1 and Tier 2 capital)
to total risk-weighted assets of at least 8 percent, with the
amount of Tier 2 capital limited to 100 percent of Tier 1
capital

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Basel II
▫ Bankers found ways around many of Basel I’s restrictions
▫ Capital arbitrage
▫ Instead of making banks less risky, parts of Basel I seemed to
encourage banks to become more risky
▫ Basel I represented a “one size fits all” approach to capital
regulation
▫ It failed to recognize that no two banks are alike in terms of their
risk profiles
▫ Basel II set up a system in which capital requirements would
be more sensitive to risk and protect against more types of
risk than Basel I
▫ Basel II would be gradually phased in for the largest
international banks

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Pillars of Basel II
1. Minimum capital requirements for each bank based on
its own estimated risk exposure from credit, market,
and operational risks
2. Supervisory review of each bank’s risk-assessment
procedures and the adequacy of its capital to ensure
they are “reasonable”
3. Greater public disclosure of each bank’s true financial
condition so that market discipline could become a more
powerful force compelling excessively risky banks to
lower their risk exposure

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Problems Accompanying the Implementation of Basel II

▫ Basel II was not perfect
▫ Some forms of risk had no generally accepted measurement
scale
▫ Operational Risk
▫ How do we add up the different forms of risk exposure in order
to get an accurate picture of a bank’s total risk exposure?
▫ What should we do about the business cycle?
▫ Most banks are more likely to face risk exposure in the middle of
an economic recession than they will in a period of economic
expansion
▫ For example, the Global credit crisis of 2007-2009
▫ Some have expressed concern about improving regulator
competence

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Basel III: Another Major Regulatory Step Underway,

Born in Global Crisis
▫ Basel II was never fully implemented
▫ Had to move toward Basel III in order to prevent future crises
▫ Key issue in Basel III
▫ Determining the volume and mix of capital the world’s leading
banks should maintain if their troubled assets generate massive
losses
▫ Capital requirements laid down in Basel I and II apparently
were inadequate in the face of the latest credit crash
▫ Bankers found ways to hold both less capital in total and a
weaker mix of kinds of capital

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The Basel Agreement on International Capital Standards:
A Continuing Historic Contract Among Leading Nations
(continued)

• Basel III: Another Major Regulatory Step Underway,

Born in Global Crisis
▫ Proponents of Basel III called for greater total
capitalization, stronger definition of what belongs in banks’
capital accounts
▫ Volcker Rule was proposed in the U.S.
▫ Implementation of Basel III could take many years
▫ Implementation would be phased in slowly, beginning in 2012
and possibly be completed close to 2019
▫ Basel III covers the capital, liquidity, and debt positions of
individual international banks and also broader issues
associated with global business cycles and systemic risks

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