CHAPTER 1

INTRODUCTION

1.1. Background of the study

Financial Performance analysis is a study or relationship among the various financial factor in
business a disclosed by a single set of statement and a study of the trend of these fact as shown in
a series of statements. By establishing a strategic relationship between the item of a balance sheet
and income statements and other operative data, the financial analysis unveils the meaning and
signification of such items.

According to R.W. Metcalf and P.H. Tatar (1996), “Financial Performance analysis is a process
of evaluating the relationship between components parts of a financial statement to obtain a
better understanding of a firm’s position and performance.”

Similarly, Khan and Jain have defined that (1990) “The ratio analysis is defined as the systematic
use of ratio to interpret the financial performance so that the strength and weakness of firm as
well as its historical performance and current financial condition can be determined.”

Various ratios are used to compute the financial performance of a banking institution. Usually, a
firms employs a financial ratio method as it provides a simple explanation about the company's
performance compared to the previous years (Lin, 2005). Financial ratios based on CAMEL
framework are considered as an efficient measure for the purpose of evaluation and monitoring.
With the evaluation of the CAMEL - Capital adequacy, Asset quality, Management quality,
Earnings and Liquidity - rating criterion, the performance and financial soundness of the
activities of the bank can be assessed and evaluated. Wachira states that the key purpose of
CAMEL rating is to determine the overall condition of the bank and to recognize its strength and
weaknesses not only in financial terms but also in operational and managerial terms. (Wachira,
2010)

Performance evaluation is a critical approach for organizations as it provides both incentive and
restraint for the company’s workers. Also, this serves as a significant channel for the
organizational stakeholders in order to attain information (Yang, 2008). Since, performance
evaluation is important for all the stakeholders including depositors, investors, bank managers
and regulators, it is vital that performance is assessed time and again.

Therefore, the aim of this study is to measure the best performance between the two recognized
commercial banks and to find out the relationship between bank specific factors on the banks
performance using CAMEL.

1.2. Organization Profile

1.2.1. About Nepal Investment Bank Limited

Nepal Investment Bank Limited (NIBL), previously known as Nepal Indosuez Bank Ltd, was
established in 1986 as a joint venture between Nepalese and French partners. The French partner
(holding 50% of the capital of NIBL) was Credit Agricole Indosuez, a subsidiary of one of the
largest banking group in the world.

Later, in 2002 a group of Nepalese companies comprising of bankers, professionals,

industrialists and businessmen acquired the 50% shareholding of Credit Agricole Indosuez in
Nepal Indosuez Bank Ltd., and accordingly the name of the Bank also changed to Nepal
Investment Bank Ltd. (Nepal Investment Bank, 2017)

NIBL is considered as a pioneer with an impeccable track record in the Nepalese banking
industry.

At present, NIBL has 61 branches and 98 ATMs across Nepal also 4 extension counter and
Information Office. The company employs more than 1187 people that provide premium product
and service to its customers. Since its inception, NIBL has been a customer centric bank that
unites customers with opportunities and enables the business to thrive and the economies to
prosper.

Nepal Investment Bank has been able to maintain a lead in the primary banking activities. The
company has a solid portfolio delivering world class service through the blending of state-of-the-
art technology and visionary management in partnership with competent and committed staff, to
achieve sound financial health with sustainable value addition to all our stakeholders. The bank
is committed to do this mission while ensuring the highest levels of ethical standards,
professional integrity, corporate governance and regulatory compliance.

NIBL today stands as one of the leading, secure and dependable bank in the country that
provides quality services to the general public with the creative initiative of the management,
support of the shareholders and trust of the customers (Nepal Investment Bank Limited, 2017).

1.2.2. About Nabil Bank Limited

Nabil Bank Limited (NABIL) embarked its operations since July 1984 as the nation’s first
private sector bank. The bank was founded with the technical collaboration of the then Dubai
Bank Limited along with the institutions like Nepal Industrial Development Bank, Rastriya
Beema Sansthan and Nepal Stock Exchange.

With an aim to be renowned for its international standard services, NABIL has been serving
various sectors of the country through its 55 branches and over 100 ATMs. The company staffs
848 people who partake in the day-to-day operations of the bank.

Similar to every commercial bank, NABIL activities are basically associated with deposit
mobilization, advancement of various credits, international banking including trade financing,
inward and outward remittances and fund & portfolio management. NABIL is also known for its
expertise in project financing and having a reputed and ‘A’ rated business experience.

NABIL is committed to delivering highest possible standards that suit the customer requirements
as well as the market needs. Thus, in order to extend better services to its customers, NABIL has
been adopting latest and innovative banking technologies and modern banking tools.

The team stands by the C.R.I.S.P values that represent the banks foresight to be celebrated as
Customer focused, Result oriented, Innovative, Synergistic and Professional. The bank thus, laid
a foundation and established itself as the pioneer in the commercial banking industry. (Nabil
Bank Limited, 2017)

1.3. Statement of the problem

The financial system, the bank in particular, is exposed to a variety of risks that are growing
more complex nowadays. Since, the financial institutions have the most relation with the
country’s macroeconomics; any form of volatility can shake the system as a whole.

Likewise, the Nepalese commercial banking sector has become highly competitive and is being
exposed to various increased risks that are not just confined to the bank’s internal but external
factors also. Hence, there is a need to identify the overall conditions, strengths, weakness,
opportunity and threats of the banks as only the financial statements cannot reflect the overall
performance of the banks. This so urges the need of more frequent examination between and
among the banks.

The financial statement of an institution is not a complete reflection of the overall performance
of the same. Thus, institutions around the world depend upon financial ratios as a measure of
performance evaluation. Despite the constant use of ratios analysis as a means of performance
appraisal by regulators, opponents to it still exist. Financial ratios are somewhat limited in scope,
for instance, the simple gap analysis are one dimensional views of a service, product, or process
that ignore any interactions, substitutions or trade-offs between key variables. (Siems & Barr,
1998)

The financial ratio method is an appropriate method when firms use a single input or generate a
single output. However, as the banking industry uses multiple inputs to produce multiple outputs,
a consistent aggregation is difficult to achieve. Also, this classical approach proves to be a
relative performance measure (Grigorian & Manole, 2002). Thus, CAMEL is one such approach
that incorporates the qualitative aspects as well formulating the analysis as an overall measure of
performance evaluation.

Myriad researches have been conducted to examine the financial soundness of the commercial
banks. However, no significant research is carried out by utilizing the CAMEL model for the
comparative performance evaluation of NIBL and NABIL that are the leading banks of the
country. Therefore, this study is an attempt to answer the following research question:

A. What are the individual financial factors that are associated to the CAMEL components?

B. Which bank has been performing better with regard to the CAMEL rating?
1.4. Objective of the study

The principle objective of this study is to examine the financial performance of NIBL and
NABIL through CAMEL test. The specific objectives of the study are:

i) To investigate the individual financial factors that is predominantly associated to the

respective CAMEL components of both NIBL and NABIL

ii) To conduct a comparative study about the performance of NIBL and NABIL using the
CAMEL model

iii) To suggest and recommend measures to improve the CAMEL factors of the selected
banks

1.5. Significance of the study

The significance of the research is:

i) Protecting individual against risk running banks due to speculative motives

related with capital market.

ii) Essential for administrate finance of company.

iii) Recognition of management problems on time can help in protection of citizen

and whole system as banks are central of any economy.

1.6. Review of Literatures

1.6.1. Concept of CAMEL Framework

One of the very popular and accepted methods for the analysis of the soundness of a banking
sector is represented by the CAMEL framework. This framework was created in the early 1970s
in USA by the bank regulatory agencies after subsequent realization that stemmed from the
advantages provided by a standardized framework of the examination process. This mechanism
was developed as part of the “Uniform Financial Institutions Rating System” and was considered
as a useful tool for the superior authorities whereby the most critical parameters of a financial
institutions‟ overall soundness could be identified, measured and quantified (Roman & Sargu,
2013).

CAMEL rating system is a mean to classify a financial institution based on the overall health,
financial status, managerial and operational performance. (Kumar, Harsha, Anand, & Dhruva,
2012) CAMEL rating is an acronym used for its five dimensions - Capital adequacy, Asset
quality, Management efficiency, Earnings ability and Liquidity- and is considered as a concise
and an indispensable tool for examiners and regulators. In 1997, Sensitivity to market risk was
added as the sixth dimension thereby changing the acronym to CAMELS (Lopez, 1999).

Capital adequacy (C) is considered to be a significant parameter to measure the financial strength
of the financial sector as it assures the capacity to absorb the eventual losses generated by the
manifestation of certain risks or certain significant macroeconomic imbalances (Roman & Sargu,
2013). The capital maintains the balance with the risks exposures such as credit risk, market risk
and operational risk that protect a financial institutions debt holder (Uniform Financial
Institutions Rating System, 1997).

Likewise, Asset quality (A) is another important indicator to assess the financial soundness of
the sector as a whole. The asset quality of the bank is evaluated based on its capacity to recover
the outstanding loans and advances (Kabir & Dey, 2012). This dimension reveals the existent as
well as potential risk connected to the investment portfolios, loan and off-balance sheet
transactions (Uniform Financial Institutions Rating System, 1997).

Management efficiency (M) is the ability of the Management as well as the Board of Directors to
recognize, determine, inspect and control the activities of an organization in order to guarantee
safety, security and efficiency in compliance to the existing rules and regulations (Uniform
Financial Institutions Rating System, 1997). This dimension is dependent upon a wide array of
issues that range from the educational level to the expertise of the management. Also, the
management efficiency means the capability of to respond to the dynamically volatile
environment and to sustain the leadership and administrative competence of an institution (Aspal
& Misra, 2013).
The Earning ability (E) is yet another significant criterion that represents the profitability of a
financial institution. Also, the ability to maintain quality and consistent earnings is demonstrated
with the help of this dimension. It moreover, determines the sustainability and growth of an
institution along with its future earnings (2013). Thus, it determines the capacity to absorb the
losses by forming a substantial capital base, finance its expansion so as to pay adequate
dividends to its shareholders. (Uniform Financial Institutions Rating System, 1997)

Liquidity (L) serves to be the most critical component of a financial institution as it constitutes
the elements of operational performance. It demonstrates the ability of a bank to pay its short-
term debt and face unforeseen withdrawals from depositors (Roman & Sargu, 2013).

Consequently, these component parts are used to reflect the performance and operational
soundness along with regulatory compliance of the banking institutions. Also, the CAMEL rating
guarantees a bank financial soundness by appraising different informational sources such as
financial statement, funding sources, macroeconomic data budget and cash flow (Barr, Killgo,
Siems, & Zimmel, 1999).

In the recent years, CAMEL model deems to be amongst the most used methods for the
estimation of a bank performance and solidity (Baral, 2005). With an aim to supervise and
evaluate the financial institutions, CAMEL model is thus used by the regulatory authorities as a
means of surveillance (Glibert, Meyer, & Vaughan, 2000). The CAMEL supervisory criterion in
the banking sector is an imperative and a considerable upgrade over the previous criterions with
respect to frequency, check, spread over and concentration (Aspal & Misra, 2013).

1.6.2. Relevant Studies

In the light of the banking crisis in recent years throughout the world, CAMEL is an efficacious
tool to scrutinize the safety of the banks, and help alleviate the probable risks associated with
bankruptcy. Dang (2011) highlights that the CAMEL framework plays a dynamic role in the
banking supervision. Also, the findings conclude that the framework is a globally acclaimed and
a standardized rating method that delivers flexibility amid the on-site and off-site examination.
Therefore, CAMEL is the foremost model that is used to appraise a bank performance.
The development of financial soundness indicators responds to the need for better tools to assess
the strengths and weaknesses of the financial systems. As an outcome to this maxim, efforts have
been made time and again to measure the financial position of each bank and manage it
efficiently and effectively (Sundararajan, 2010). Thus, CAMELS framework is used by bank
supervisors to evaluate individual performance and soundness of financial institutions.

CAMEL is a rating system that is generally adopted by the principal regulators all around the
world (Kabir & Dey, 2012). This research examined the comparative performance of the two
leading private sector commercial banks. Likewise, Chen (2014) empirically investigated the
relationship between CAMEL and bank performance by allowing supervisors to give a careful
consideration to the parameters so as to enhance the competitiveness of the bank.

A study by Majumder and Rehman (2016) was carried out to assess the performance of fifteen
selected banks in Bangladesh by adopting the CAMEL model. The study examined the financial
strength of the selected banks to analyze whether any significant difference occurred in the
performance of the banks. Various statistical tools were applied to analyze the data and the
outcomes from the research showcase that there is a positive relation between the indicators of
Capital adequacy, Assets quality, Management and Earning ability with the financial execution.

Evans and Nurazi (2005) used 13 variables that represent the CAMEL ratio. They concluded that
the CAMEL parameters are statistically significant in explaining the bank failure and thus,
stakeholders should focus on these variables to detect and solve banking problems.

Olweny and Shipho (2011) scrutinized the effects of banks-specific factors and market focus on
the profitability of commercial banks in Kenya. The outcome of this result was that all the bank
specific factors had a statistically significant impact on profitability while the market factors did
not have a significant impact. Also, the study shed light on to the factors that result into bank
collapse. They concluded that Liquidity and Asset quality were responsible for bank failures and
thus, recommended policies that would encourage revenue diversification, minimize liquidity
holdings and minimize credit risk.

Likewise, a study on the Determinants of the financial performance of Commercial banks in

Kenya reveals that bank-specific factors except liquidity significantly contribute to the
performance of the banks. Thus, the financial performance of the commercial banks in Kenya is
propelled mainly by the executive and managerial decisions with a minor contribution from the
macroeconomic factors (Ogore & Kusa, 2013).

According to a study carried out by Muhmad and Hashim (2015), the performance of the
domestic and foreign banking institutions functioning in Malaysia is utilized with the help of a
CAMEL framework. The outcome of the research demonstrates that capital, asset quality and
liquidity played a significant effect on the execution of Malaysian banks starting from 2008 to
2012.

Jha and Hui (2012) compared the financial performance of various ownership structured
commercial banks in Nepal based on their economic characteristics and identified factors that
determine the results shown by financial ratios. The findings of the study revealed that public
sector banks were less competent than their counterparts while domestic private banks were
equally competent as the foreign-owned (joint venture) banks.

Rostami (2015) examined the performance while taking into account various financial ratios so
as to find out the strong point and vulnerabilities of the Iranian banks. Using Q-Tobin's ratio as a
performance indicator, the research focuses on means to manage and control some possible
crisis.

According to Dincer, Gencer, Orhan, & Sahinbas (2011), the crisis of November 2000 and
February 2001 led to a structural change in the financial sector in Turkey. The Global Economic
Crisis further fueled the need for an imperative regulatory system. Thus, this research examines
the need for performance assessment through CAMELS ratio which is the most important
parameter to measure the performance of the banking sector.

A study was conducted to analyze the soundness of the Indian Banking System in which 12
public and private sector banks were assessed over a period of eleven years based on the
CAMEL approach. The findings of the research revealed that private sector banks were sound
compared to the public sector banks that failed to exhibit efficiency (Kumar, Harsha, Anand, &
Dhruva, 2012).
CAMELS rating is one of the most established methods that is used to scrutinize and assess the
Iranian banking strength. The six dimensions have myriad components under each of them and
these variables thus represent a complex economic and monetary system. This study uses the
qualitative system dynamics approach and a systematic.

1.7. Theoretical / Conceptual Framework

In the due course of this study, two categories of variables are employed in order to examine the
performance of NIBL and NABIL. These categories can be classified as independent variables
and dependent variables. The five independent variables - CAMEL- and their respective
financial factors are computed and evaluated. These independent variables are used to evaluate
the effect on NIBL and NABIL performance which is the dependent variable.

Dependent Variable:

A. Financial Performance

The overall performance of banks is the outputs that will be determine using CAMEL analysis.
Thus, CAMEL ratios will impact on the total financial performance of the banks.

Independent Variables:

CAMEL:

CAMEL rating system is a mean to classify a financial institution based on the overall health,
financial status, managerial and operational performance. (Kumar, Harsha, Anand, & Dhruva,
2012) Wachira states that the key purpose of CAMEL rating is to determine the overall condition
of the bank and to recognize its strength and weaknesses not only in financial terms but also in
operational and managerial terms. (Wachira, 2010)

Acronyms of CAMEL is used for its five Dimensions

C stands for Capital Adequacy

Capital adequacy of financial institutions is the key indicator for financial managers to maintain
satisfactory levels of capital base. Moreover, besides absorbing unanticipated shocks, it
maintains a depositors’ confidence and prevents the bank from going bankrupt. Ratios that are
used under capital adequacy are:

a. Capital Adequacy Ratio (CAR): It is a measure of bank’s capital that ensures the bank’s
ability to absorb a reasonable level of loss and determine the capacity of the bank in meeting
those losses.

b. Core Capital Ratio (CCR): This ratio is the measure of a bank’s financial strength that is
based on the sum of its equity capital and disclosed reserves along with non-cumulative and non-
redeemable preferred stock.

A stands for Assets Quality

Asset quality is an indicator that governs the robustness of financial institutions by assessing the
credit risks and the loss of value associated with a particular asset. Generally, the deteriorating
value of assets is deemed to be the prime source of the banking problems that directly spreads
into other areas which ultimately affects an institution’s earning capability. Ratios used here are:

a. Non- Performing Loans to Total Loans (NPLL): This ratio is calculated by using the NPL
to the total value of loan portfolio. It is intended to identify problems with asset quality in the
loan portfolio.

b. Non- Performing Loans to Shareholders’ Equity (NPLE): This ratio is computed through
the use of NPL with the total shareholders’ equity. A smaller NPL to Equity ratio indicates
smaller losses while a larger ratio indicates larger losses for the bank.

M stands for Management Efficiency

The performance of Management capacity is usually qualitative and subjective evaluations are
ways to comprehend this dimension. Management systems, organization culture, and control
mechanisms are amongst the few factors that determine the management efficiency. Ratios used
here are:

a. Profit per Employee (PPE): this ratio is used to compute the surplus earned per employee. It
is obtained by dividing the net income by the total number of employees.
b. Net Income to Total Branches (NITB): This ratio computes the net income by the total
number of branches. Also, this ratio reflects the managerial competency and flexibility of a
particular branch.

E stands for Earning Quality

Earnings and profitability plays a crucial role in the increase in the capital base. It is examined
with regards to interest rate policies and adequacy of provisioning. Moreover, a good earning
quality provides support to maintain present as well as future operations of an organization.
Ratios used here are:

a. Return on Assets (ROA): This ratio computes the net income of a company with respect to
its total assets. It gives an impression as to how efficiently a company uses its assets to generate
its earnings.

b. Return on Equity (ROE): This ratio computes the net income of a company with respect to
its shareholders’ equity. It gives an impression as to how efficiently a company uses its
shareholders’ equity to generate its earnings.

L stands for Liquidity

An abundant liquidity position refers to a condition when an institution can obtain sufficient
funds by converting its assets quickly at a reasonable cost without any loss in its value. When a
mismatch against overall assets and liability management undertakes, liquidity risk is deemed to
occur. Ratios used here are:

a. Cash Reserve Ratio (CRR): This ratio measures the percentage of the total deposit that a
particular bank has to hold as reserve in the form of either cash or deposit with the Central Bank.

b. Credit Deposit Ratio (CDR): This ratio computes the proportion of loan created by banks
from the deposit it receives. In other words, it is the capacity of the bank to lend. A high CD ratio
indicates that a bank is generating more credit from its deposits.
The conceptual framework can be presented in diagram as:

CAPITAL
CAPITAL ADEQUACY
ADEQUACY
Capital
Capital Adequacy
Adequacy Ratio
Ratio
Core
Core Capital
Capital Ratio
Ratio

ASSETS
ASSETS QUALITY
QUALITY
Non-Performing
Non-Performing loans
loans to
to Total
Total Assets
Assets
Non-Performing
Non-Performing Loans to
Loans to
Shareholder’s
Shareholder’s Equity
Equity
Performance
Performance

MANAGEMENT OF
OF
MANAGEMENT EFFICIENCY
EFFICIENCY
Profit
Profit per
per employees
employees
Net NIBL
NIBL
Net profit
profit to
to total
total branches
branches
vs.
vs.

EARNING
EARNING ABILITY
ABILITY NABIL
NABIL
Return
Return on
on Assets
Assets
Return
Return on
on Equity
Equity

LIQUIDITY
LIQUIDITY
Cash
Cash Reserve
Reserve Ratio
Ratio
Credit
Credit Deposit
Deposit Ratio
Ratio
 INDEPENDENT VARIABLE DEPENDENT VARIABLE

Figure 1: Conceptual Framework of CAMEL Analysis

1.7. Research Methodology

This study has been based on a very simplified approach that uses internationally accepted
CAMEL rating parameters. This is mainly a descriptive and analytical research in which a
5-year (FY 2012/13- FY 2016/17) time horizon is taken to assess the data.

1.7.1. Population

The total population of the research is 28 commercial bank in Nepal.

S.N. Name of Commercial Banks Short Name
1 Nepal Bank Ltd. NBL
2 Rastriya Banijya Bank Ltd. RBB
3 Nabil Bank Ltd. NABIL
4 Nepal Investment Bank Ltd. NIBL
5 Standard Chartered Bank Nepal Ltd. SCBNL
6 Himalayan Bank Ltd. HBL
7 Nepal SBI Bank Ltd. NSBI
8 Nepal Bangladesh Bank Ltd. NBB
9 Everest Bank Ltd. EBL
10 Bank of Kathmandu Lumbini Ltd. BOK
11 Nepal Credit and Commerce Bank Ltd. NCC
12 NIC ASIA Bank Ltd. NIC
13 Machhapuchhre Bank Ltd. MBL
14 Kumari Bank Ltd. Kumari
 15 Laxmi Bank Ltd. Laxmi
16 Siddhartha Bank Ltd. SBL
17 Agriculture Development Bank Ltd. ADBNL
18 Global IME Bank Ltd. Global
19 Citizens Bank International Ltd. Citizens
20 Prime Commercial Bank Ltd. Prime
21 Sunrise Bank Ltd. Sunrise
22 NMB Bank Ltd. NMB
23 Prabhu Bank Ltd. PRABHU
24 Janata Bank Nepal Ltd. Janata
25 Mega Bank Nepal Ltd. Mega
26 Civil Bank Ltd. Civil
27 Century Commercial Bank Ltd. Century
28 Sanima Bank Ltd. Sanima
Source: Nepal Rastra Bank,2017

1.7.2. Sample

Financial Statement of Nepal Investment Bank Limited (NIBL) and Nabil Bank Limited
(NABIL) from fiscal year 2012/13 to fiscal year 2016/17 are the sample for the research.

1.7.3. Methods of Data collection

The proposed topic relates to Banking Sector. For this purpose, secondary data is used to assess a
comparative performance of NIBL and NABIL. The vital information is gathered from the
financial statements of the banks for the abovementioned period. This data is used to calculate
the key financial ratios of the banks as well as to assess the execution of the bank. Moreover,
data is assembled from articles, papers, the World Wide Web (Internet), International Journals,
and relevant previous studies.

1.7.4. Methods of Data Analysis

The study is based on the quantitative research which requires precise numerical and
mathematical analysis. The numerical data gathered as part of this research is processed through
Microsoft excel. Financial Ratios and statistical tools are applied to compare the performance of
the banks.

Financial Tool: the following financial tools have been used and they are:
A. CAR : Total Capital Fund/ Total Risk Weighted Assets

B. CCR : Total Core Capital/ Total Risk Weighted Assets

C. NPLL : Total Non-Performing Loans / Total Loans

D. NPLE : Total Non-Performing Loans / Total Equity

E. PPE : Net Income/ Number of Employees

F. NITB : Net Income/ Total Number of Branches

G. ROA : Net Income/ Total Assets

H. ROE : Net Income/ Total Equity

I. CRR : A portion of the depositors balance that the bank has to hold as reserves with
the Central Bank

J. CDR : Total Loans/ Total Deposits

Statistical Tool: The following statistical tools have been used for the fulfillment of the
research:

 Descriptive Analysis reviews and compares the performance of banks with respect to
the bank’s operating efficiency and banking operation

 Descriptive Statistical Analysis such as measure of Central Tendency (Mean) and

Standard Deviation are used to describe the data set.

1.8. Limitation of Study

The study has some limitations despite holding with the best methodology and analysis

 This study is mainly based on the financial report i.e. secondary data.
 This study covers only the period of first five years i.e. 2012/13-2016/17
 This study does not consider the factors that affect the company’s financial positions such
as technical condition, social condition, political condition, personal advertisement etc.
 Only limited financial tools and technique are used for analysis, so this study may not be
sufficient for analysis