Credit Rating of Banks as Its Impact on Their Profitability

7/30/2019 Credit Rating of Banks as Its Impact on Their Profitability

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Dedication

I dedicate my work to my Honorable parents

And my Family and Respectable Teacher Sir Syed Atif Ali

Whose efficient & Magnificent Devotion to my studies

Encourages me to achieve this.


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Acknowledgement

I would like to thank the following persons without whose guidance this dissertation could not

have been completed.

First of all I would like to thank my ALLAH who always guides me in every walk of my life.Secondly, I would like to express my sincere appreciation and gratitude to my supervisor

Prof.Sayed Atif Ali for his guidance and insight throughout in making my dissertation and

especially, his valuable suggestions and comments that really guided my research and also

helped me to structure my dissertation.

Thirdly, I am also very indebted to my parents and family and my friends Ashfaq Ahmad,

Haseeb Ahmad, Hafiz Abdul Manan, for their continuous support. I owe lot of their

unconditional love and understanding. Well, their suggestions allowed me to think in many

different ways. Most importantly, they continually helped me to improve my confidence. There

were certain times, when I used to say that I just did not think I could go on with my studies, butthey always knew just what to say to get me back in the race. They really very special entities of

my life. What a journey!! I will never stop admiring them.


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Table of Contents

Dedication 1

Acknowledgement 2

Abstract 4

Introduction 5-11

Research Question/Data Method/Data Collection/Sample 11

Literature Review 12-21

Frame Work 21-24

Pakistani banks rating last 5 years 25-33

Banking Sector of Pakistan 33

Financial/Historical/Current situation 34

Empirical findings 35-39

Analysis & Discussion 40-43

Conclusion/Recommendation 44

References 45


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Abstract:

Financial sector of an economy plays an important role in its economic development and

prosperity of the country. Banking industry serves as the backbone of the financial sector that

accumulates savings from surplus economic units in the form of deposits and provides it to

deficit economics units in the form of advances, banking industry provides support to economyand industries in specific in the time of recessions and economic crisis. But when banks are the

heart of economics recession or banks are the cause of financial crisis like the recent past

financial crisis 2007- 2009, it makes the situation worst for economic recovery. So it is of great

importance to kneely observe the performance of the banks and their compliance with the

regulatory requirements. Performance of banks is measured at two levels, one is at the

management and regulatory level of the banks and another is at external rating agencies, purpose

of regulatory and supervisory rating system is to measure the bank performance at internal level

and its compliance with regulatory requirements to keep the bank on right track. These ratings

are highly confidential and are only available to the bank management. External credit rating

agencies examine and evaluate the banks and issue ratings for the general public and investors in

particulars. It is great importance that both these ratings present the same results about the

condition of banks to provide clear information to investors and management. In past several

banks suffer from bankruptcy that was the failure of both internal ratings system and credit rating

agencies.

CAMELS is the supervisory and regulatory rating system implemented by State Bank of

Pakistan. It takes into account six important components of a bank when it evaluates

performance of the bank. These components are Capital assets, Management, Earning, Liquidity,

and sensitivity to market risk. Rating is assigned to these components on the scale of 1 to 5 and

that is a base for composite rating that also ranged from 1 to 5. PACRA rating agency is the

dominant credit rating agency of Pakistan that performs ratings for most banks and industries in

the country.

In my study I examine credit ratings of 5 Pakistani banks, ALLIED BANK LIMITED, ASKARI

BANK LIMITED, BANK Al-HABIB, BANK al FALAH, and MUSLIM COMMERCIAL

BANK. First of all I collected the credit ratings of these banks mention above of last five years

from 2007 to 2011. And the credit rating agency of these banks is PACRA, this research of last

five year credit ratings of banks PACRA show both long term and short term credit rating of

these 5 banks for last 5 years. In this study I calculated the ROA of 5 banks also to see what the

return on assets of banks is at last 5 years. And provided some financial data regarding these

banks.


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Introduction:

A credit rating evaluates the credit worthiness of a debtor, especially a business or a government.

It is an evaluation made by a credit rating agency of the debtors ability to pay back the debt andthe likelihood of default.

Credit ratings are determined by credit rating agencies. The credit rating represents the credit

rating agencys evaluation of qualitative and quantitative information for a company or

government; including non-public information obtained by the credit rating agencies analysts.

Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their

judgment and experience in determining what public and private information should be

considered in giving a rating to a particular company or government. the credit rating is used by

determine the likelihood that the government will pay its bond obligations.

A poor credit rating indicates a credit rating agencys option that the company or government has

a risk of defaulting, based on the agencys analysis of the entitys history and analysis of long

term economic prospects.

First of all I will discuss credit rating institutions in general and their role in subprime financial

crisis:

Credit rating agencies and financial market stability:

Credit rating agencies (CRAs) issue credit worthiness estimation that assist triumph theinformation asymmetry flanked by those who are issuing debt instruments such as bonds, andthose who are investing their money in these instruments. Credit rating agencies have a foremostimpact on the financial markets. Rating issued by CRAs are closely tracked by investors,borrowers, issuers and governments, it is indispensable that they time and again provide topquality, sorveign and objective credit ratings. Credit rating market is dominated by three outsizedagencies operating globally:They are Standards and Poors, Moodys investors service and Fitch ratings.These three markets leading CRAs have a collective market share over 90 % globally. In Europe

a small no of CRAs operate with an obvious focus on specific industry segments e.g. insurance

industry sector or financial market sector e.g. municipal bonds, thus reacts to specialized market

needs. In total, around 50 credit rating agencies are established all over the Europe (Balz, p6,2010)

Credit rating agencies have very considerable impact on the operation of the financial markets,

as the credit ratings are used by investors, borrowers, issuers and government as part of making

informed investment and financing decisions. It is therefore essential to ensure that the

regulatory and supervisory framework in which CRAS operates is sufficiently robust and


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effective to satisfy the general objective of, contributing to the stability of financial markets,

enhancing investor protection, facilitating a sustainable development of fair and transparent

financial markets (Balz, p11, 2010). Rating agencies basically provide assistance to the dispersed

investors in managing issuers in the debt capital market. By allocating prices measure of credit

quality to debt issues, depend on the analysis issuer information based on financial performance.

CRAs can remove the information asymmetries between investors and borrowers (Deb. P et al,

201, p3) rating is formally used for the forward looking and subjective, beside this there are

many quantitative and qualitative indicators come across during CRAs assessment. Therefore

rating is different from the accounting ratios which mainly provide information about the back

looking indicators, provide information about the financial stability based on standard measures

and principles. Rating agencies play the role to mitigate the adverse selection problem arises

between debt issuers and investors. In such situation, capital market freeze there functions. A

risk adverse investor may stay out of the market or invest in securities which return is very high

risk premium (Deb. P et al, 2011, p.3).

CRAs and current financial crisis:

In USA and Europe flawed credit ratings and faulty rating procedures and methodologies are

broadly perceived as being amongst the major contributors to the worldwide financial crisis.

Those allegations bring them under severe scrutiny and led to suggestions for drastic reforms.

Credit rating agencies have been widely condemned for their part in fueling the untenable

development of the asset backed controlled finance debt market that is considered as a major

means for the global financial crisis (Smith,p1, 2009).

In the US banking industry, they are use 6 banks assets, profitability, and size and leverage data

collected from the Federal Deposit Insurance Corporation, Call reports and Bloomberg from theperiod of 1989 to 2008. They show credit rating Upgrades and Downgrades. And the result

shown that downgrades has a lasting and relatively more severe impact on banks and upgrades.

Each bank has his own credit rating, and they use three criterias in order to properly function as

candidates controls for the treated banks:

1- The untreated bank must have the same rating as the treated bank at t.2- Its rating remained unchanged for one year after unit t+13- For each treated commercial bank or bank holding company, a commercial bank or bank

holding company, respectively, that satisfies the criteria 1 and 2 is distinguished as

candidate control. (US banking Industry).

The banks rating system differ significantly from agencies ratings. Banks in different lines of

business or using internal ratings for purpose design and operate different systems that meet their

needs. In few cases banks scale uses ratings in computing the relatively few grades is adequate,

whereas a bank using in computing the relative probability of different loans may require a scale

with many grades in order to achieve one distinction of credit risk. The most banks internal


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rating system introduced to support loan approval and loan monitoring process and to support is

best for all banks. (William F. Theary)

The downgrading and upgrading are different types of process. Downgrading is memory less

process, whereas, upgrading is not the longer a rating has not changed, the higher the probability

that it will be upgraded. The rating express the creditworthiness of obligors with rating in letterform .AAA is the highest rating whereas CCC is the lowest. (N. Jonker)

Two types of credit rating systems are used one is internal rating system and another is external

rating system. Internal credit ratings do not contain all the information about borrowers that is in

incorporated in the credit bureau ratings, even though the credit bureau ratings are available to

the bank loan officers. (Leond l Nakamura).

Banking Sector of Pakistan:

Economic prosperity is a symbol of success of a country. Soundness of an economy is achieved

through positive macroeconomic indicators that become possible via bringing together and

proper utilization of country resources such as financial, informational, physical and human

resources etc. banking sector of a n economy is an important constituent of financial sector of a

country that facilitates proper utilization of financial resources. Since independence of Islamic

Republic of Pakistan in 1947, banking industry of the country has undergone through several

fundamental changes. Central bank of a country that is named as State bank of Pakistan was

established 1st July 1948. SBP act 1956 encouraged private sector investments in the banking

industry to establish banks and financial institutions. In the 1974 government decided to take

control of all of the existing banks in the economy and they were nationalized. This decision was

the bad consequence of bad economic conditions that emerged after separation of Bangladeshthat was part of Pakistan since 1947 to 1971. After nationalization of all these banks, their

performance was very much affected. Their performance was deteriorated to the alarming point

in last years of 80s decade, this cause privatization of banking sector in early 1990s. In 2002

first Islamic commercial bank that is named Meezan Bank was found and started its operations.

(Ahmed, et al 2010)

PACRA Rating Agency:

Pakistan credit rating agency is the first national rating agency that was founded in the year 1994

as a joint venture of international financial corporation (IFC), Lahore Stock Exchange (LSE) and

International Bank Credit Analysis (IBCA). It is usually known as PACRA. The main objective

of PACRA is to assess the capability and eagerness of a business entity to honor its financial

commitments. Ratings published by PACRA reflect sovereign, proficient and unbiased

evaluation of the credit risk that is coupled with a debt certificate /instruments or an overall

position of a corporate entity. Analysis and rating of banks is based upon several qualitative and

quantitative factors and all these factors have same weight age and importance in the rating

process. Factors that are taken under consideration in PACRA rating 5 methodology and risk


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management, funding and liquidity, capitalization, earning and performance, diversification of

business and franchise and corporate governance. Under the risk management, PACRA analyzes

the risk management process implemented by the banks, there adherence to polices implemented

and its focus on all risks that stick to the banks such as credit risk, and operational risk. To

analyze composition of the banks funding diversification of its funding base, source of its

funding and liquidity. PACRA use its own set of standards to analyze the capitalization that is

applied to all banks. One of the important measures is pure common equity to a proportion of

total banking assets. While analyzing the quality of the earnings, PACRA takes into account the

chronological inclination in banks earning, quality and stability in the banks earning and its

future competence to produce earnings. Under this section of analysis diversification of the

business activities commenced by the bank in different geographical and industrial segment and

diversification in business products and services are analyze by PACRA. PACRA assess the

quality of banks corporate governance data on several qualitative and quantitative measures

(PACRA, 2005)

Know here I am showing the last 5 years financial analysis of:

Allied Bank Limited Askari Bank Limited Bank Al- Habib Bank Alfalah Limited Muslim Commercial Bank

ALLIED BANK LIMITED:

(PKR MILL)

2007 2008 2009 2010 2011

Total assets 320,109.7 366,680.2 418,374 449.932 515,888

Equity 18,408.4 20,805.1 25,891 31,167 37,761

Net income 4,076.1 4,156.7 7,122 8,225 10,256

ROA% 1.27 1.13 1.71 1.84 1.98

ROE% 23.54 21.2 30.5 28.8 27.16

Equity/assets% 5.75 5.67 6.2 6.9 6.9

Sbp CAR% 9.29 10.9 13.5 13.8 13.43


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ASKARI BANK LIMITED:

(PKR MILL)

2007 2008 2009 2010 2011

Total assets 182,171 206,191 524,327 314,745 343,865

Equity 12,099 12,034 13,142 14,821 16,585

Net income 2,681 386 1,108 943 1,705,207

ROA% 1.47 0.19 0.42 0.29 0.49

ROE% 22.16 3.21 8.12 6.20 10.28

Equity/assets% 6.6 5.8 5.2 4.7 4.8

Sbp CAR% 9.35 9.22 11.75 10.3 11.34

BANK Al-HABIB LIMITED:

(PKR MILL)

2007 2008 2009 2010 2011

Total assets 141,234 177,324 249,806 301,533 384,525

Equity 8,014 9,967 12,286 14,706 17,837

Net income 22,11 2,425 2,856 3,602 4,537

ROA% 1.57 1.37 1.14 1.22 1.17

ROE% 31.2 27.0 25.6 26.7 25.37

Equity/assets% 5.7 5.6 4.9 4.9 4.6

Sbp CAR% 10.4 11.1 14.9 12.8 16.86

BANK ALFALAH LIMITED:

(PKR MILL)

2007 2008 2009 2010 2011

Total assets 328,895 348,999 389,070 411,483 468,345

Equity 13,766 14,608 19,770 19,726 23,126,022

Net income 3,130 1,301 897 968 432,588

ROA% 0.95 0.37 0.23 0.24 0.92

ROE% 25.7 9.2 5.2 4.9 18.70Equity/assets% 3.8 4.1 5.1 4.8 4.9

Sbp CAR% 9.8 8.0 12.5 10.5 11.6


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MUSLIM COMMERCIL BANK:

(PKR MILL)

2007 2008 2009 2010 2011

Total assets 410,485 443,615 509,223 567,553 656,324

Equity 45,414 52,244 61,075 69,180 81,034

Net income 152,65 15,374 15,495 16,873 19,302

ROA% 3.72 3.47 3.06 2.96 2.94

ROE% 37.6 31.4 27.3 26.8 23.82

Equity/assets% 11.0 11.7 11.9 12.1 12.1

Sbp CAR% 17.8 20.7 19.0 22.1 21.8

(PACRA and ANNUAL REPORTS)

Problem background:

The financial sector play an important role in the economy of the country and banks are the

major players in this field. Know there are two big companies Bear Stearns Inc and Lehman

Brothers Holding Inc, these companies considered a big players in the market in US from last

100 years. These bankruptcies were not anticipated or tracked by regular system or external

rating agencies. (lal 2010)

Growth of Pakistani banking industry is mention above of last few years. In the present political

and economical conditions in the country it is of great significance to analyze and evaluate the

banking sector position.

Research Question:

My study is on credit rating of banks so my resesrch question is:

Q. Does credit rating of banks effect on banks performance?

Key term defined:

Credit Rating:

An estimate of the amount of credit that can be extended to a company or person without unduerisk.

A credit rating evaluates the credit worthiness of a debtor, especially a business or a government.

It is an evaluation made by a credit rating agency of the debtors ability to pay back the debt and

the likelihood of default.


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Credit ratings are determined by credit rating agencies. The credit rating represents the credit

rating agencys evaluation of qualitative and quantitative information for a company or

government; including non-public information obtained by the credit rating agencies analysts.

Return on assets measures the operating performance of an institution. It is the widely used

Indicator of earning and is calculated as net profit as percentage of average assets.

Return on equity is a measure that indicates the earning power of equity and is calculated as netIncome available for common stockholders to average equity

DATA Method:

Selection of the Topic:

As for my educational background I am MBA finance student. And I studied several coursesabout finance. So I develop my interest in Banking. And I choose my topic regarding this as my

research focusing on Credit rating of banks and its impact on performance.

Data collection:

Data collection is an important aspect in any research. There are two types of sources are use for

data collection, one is primary source and another is secondary source. In primary source data is

collected at first time. Or we can say that data collected for the first time particularly for this

research. In primary source data is collected from questionnaires, observations, social survey,

interviews. On the other hand secondary data is collected from some published stuff and

someone else in the past. In this study I am using secondary data, research papers, articles

websites, etc. I read the articles and research papers that were published for public information

and visiting several websites to find my target.

Sample:

Regarding my study of credit rating of banks. I selected 5 Pakistani banks are ABL, ASKBL,

Bank Al-Habib, Bank Alfalah, and MCB. Collected data from their Annual Reports and PACRA

Pakistan credit rating agency. And also show the Total Assets, Equity, Net Income, ROE, ROA,

Equity/Assets and CAR for understand the credit ratings of banks mention above.


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Literature Review:

In this study I read the 17 research papers regarding the my study topic Credit ratings of banks

and its impact on their performance there are different research papers on credit ratings, credit

rating agencies, current rating system of different countries. And the overview of these papers is

given below:

In the US banking Industry they use the six different banks assets, profitability size and leverage.

Collect data from Federal Deposit Insurance Corporation, call reports and Bloomberg for the

period of 1989 to 2008. They show credit rating upgrades and downgrade. And the result of the

study suggests that a downgrade has a lasting and relatively more severe impact on banks and

upgrade. And the downgrade banks do not seem to effectively reduce their appetite for risk over

a long horizon. The role of credit rating agencies are same that integral part of banks prudential

supervision through part of banks prudential supervision through market discipline is in a long

horizon. The main objective of banks is processing of risk and information (Greenbarum and

Thakor 2007). The data is used for 370 financial entries for the period of 1987- 2009.and thetotal observation of the firm year is 4,043. Convert the letter long term issuer credit rating at the

end of each year to a numerical scale as AAA=1, AA+=2.D=22, thus the higher number

correspond to lower ratings.

Each bank has his own credit rating, and they use three criterias in order to properly function as

candidates controls for the treated banks:

4- The untreated bank must have the same rating as the treated bank at t.5- Its rating remained unchanged for one year after unit t+16- For each treated commercial bank or bank holding company, a commercial bank or bank

holding company, respectively, that satisfies the criteria 1 and 2 is distinguished ascandidate control.

The result of this study indicates that in the one year horizon after the rating change upgrades

results in an increase in net loans and profitability. Turning to the two year horizon after a rating

change, upgraded banks continue to increase their loss provisions, while they improve their

liquidity position. The finding of this study suggest that a downgrade has a lasting and relative


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more severe impact on banks than an upgrade; yet downgrade banks seem to not effectively

reduce their appetite for risk in a longer horizon. The role of credit rating agencies as an integral

part of banks prudential supervision through market discipline is in a longer horizon, overstated.

And this paper finding point to increased supervisions responsibility for deterring banks risk

taking behavior especially for downgraded banks and evaluating its performance towards

authorities roles in the context of an improved regulation and supervision scheme remains an

open question.

(Credit Rating Changes Impact on Banks Evidence from the US Banking Industry)

The internal rating system is in use 50 largest banks of US banking organizations. They use the

illuminate relationships between uses of ratings, different options for rating system make an

understanding of such relationships important for both banks and regulators. The banks rating

system differ significantly from agencies ratings. Banks in different lines of business or using

internal ratings for purpose design and operate different systems that meet their needs. In few

cases banks scale uses ratings in computing the relatively few grades is adequate, whereas a bank

using in computing the relative probability of different loans may require a scale with manygrades in order to achieve one distinction of credit risk. Changes in banks business and its uses

of ratings can cause form and function to diverge, placing stress on its rating systems that are

neither anticipated nor immediately recognized. Failure to relive severe stress can compromise

the effectiveness of a banks credit risk management. The most banks internal rating system

introduced to support loan approval and loan monitoring process and to support is best for all

banks. Banks system vary widely largely because of differences in business mix and in the uses

to which ratings are put. Among variations in business mix the share of large corporate or

institutions loans in a banks portfolio has the largest implications for its internal rating system,

because they give bank staff with a personal interest in transactions and incentive to rate too

favorably.

(Credit Risk Rating System at the largest US Banks William F. Theary, Markcarey)

Credit and interest rate risk are two of the most important sources of risk for commercial banks.

Credit and interest rate risk reflect the possibility, respectively, of a borrower failing to repay her

or his debt and of a fall in a banks profitability due to a change in interest rates. While banks

and regulators are aware of the importance of both risks, they tend to manage these risks

separately. However, credit risk and interest rate risk are intrinsically related to each other and

not separable. And ignoring this interdependence may potentially have relevant implications for

banks stability, especially during severe downturns. A general framework to measure thecombined impact of interest rate and credit shocks on banks economic value and profitability.

And this framework incorporates the integrated impact of credit and interest rate risk on banks

assets. But liabilities and off balance sheet items also need to the taken into account to obtain a

complete picture of the risks off balance sheet items also need to be taken into account to obtain

a complete picture of the risks faced by a bank. There framework also capture other forms of

interaction between credit and interest rate risk. For example, they do not capture the direct


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impact of changes in macroeconomics variables, such as unemployment, on the profitability of

borrowers defaulting, but also their indirect via potential changes in default free interest rates.

The stability of bank is not threatened in this streets sanerio as both the economic value and

capital adequacy conditions hold. But the simulation confirms that interest rate and credit risk

have to be assessed simultaneously as well as jointly for the whole portfolio. In this stress

sanerio, the bank experiences not only an increase in bad loans, but also a fall in net interest

income.

(The Integrated impact of credit and interest rate risk on banks: Mathias Drehmann,

Steffen Sorensen and Marco Stringa)

N Jonker analysis credit rating transactions of banks in Europe, US and Japan by using a

competing risk model. They distinguished two types of rating transitions:

Upgrading and Downgrading

They used some bank characteristics, like country of domicile, type of bank, initial rating, as

explanatory variables in their model. They found that downgrading and upgrading are differenttypes of process. Downgrading is memory less process, whereas, upgrading is not the longer a

rating has not changed, the higher the probability that it will be upgraded. Furthermore the type

of bank and country (Japan) matters in the downgrading process but not in the upgrading

process. Banks which have a speculative rating show much more volatility in both upgrading and

downgrading intensities than banks with an investment rating. They use of data from Bloomberg

covering the period January 1990 to June 2002. The credit rating that they use is from standard &

poors. a firms credit rating reflect the assessment of the firms capacity to pay interest and to

repay the debt according to the terms of issue. The rating express the creditworthiness of

obligors with rating in letter form .AAA is the highest rating whereas CCC is the lowest in this

data. On top of the standard and poors can ddd- signs to the ratings indicating the probabledirection of the next change in rating. They collected data from 625 total banks, 320 banks in

US, 230 in Western union, and 75 are Japanese. In 1990 114 banks got a credit rating of which

107 were in US and only 7 in Europe. At last they found some interesting results. There are some

signs that are upgrading process and the downgrading process may differ. Some types o banks

seem to be downgraded more often than the reference type of banks commercial banks, whereas

this does not occur with regard to upgrading.

(Credit Rating of the Banking Sector: N. Jonker Research Memorandum WO no 714)

Nachane, DM and Ghosh, investigate the impact of credit rating on capital adequacy ratios of

Indian state owned banks using quarterly data for the period of 1997 to 2002. The variables that

can impinge upon capital adequacy ratio have been used as explanatory variables. Two separate

models, one for long term credit rating and another is for short term ratings, in this capital

adequacy ratios are an important impinging on credit rating of Indian banks. This study employs

quarterly off site monitoring and surveillance (OSMOS) data for selected Indian owned state

banks which have obtained long/short term rating over the period of 1997 to 2002, and several


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points about the data are in order. In order to conclude this study claims on banks would overall

attract higher risk weights, irrespective of whether they continue to remain unrated or obtain

ratings, internal or external, since the present ceiling of 20 per cent would then become a floor.

With most corporate being unrated, there would be no major change in the overall risk weight on

good quality assets, and there could even be lower risk weights for premium borrowers. However

non performing loans would attract the 150 per cent risk weight up from the 100 per cent at

present and hence require more capital support them. Overall the conclusion is instable that the

new Accord would require net additional capital for the Indian banking system as a whole.

(Credit Rating and bank behavior in India: Nachane, DM and Ghosh, Saibal Reseve Bank

of India)

Leond l Nakamura, the basket of straight forward techniques are purposed enable both financial

institution and regulators to assess the performance of banks credit rating systems. They using

both internal bank credit ratings and external credit bureau ratings of corporate borrowers, they

investigate if bank credit ratings are able to forecast the ratings of a public monitor, like a creditbureau. And the techniques are also being applied to bond ratings for longer commercial loans.

They using data from two major Swedish banks, they find the stronger evidence that these banks

relative to a credit bureau that produces ratings using public information only, obtain private

information about their clients and incorporate this into their internal credit ratings. However

they also show that these banks internal credit ratings do not contain all the information about

borrowers that is in incorporated in the credit bureau ratings, even though the credit bureau

ratings are available to the bank loan officers. There finding can be interpreted in two ways one

is that banks fail to incorporate publicity available information optimally. The other is the banks

lose information in the process of generating credit ratings. Irrespective of the interpretation,

there finding imply that it is not optimal for either banks. Risk managers or for their regulators toaccept the banks own private ratings as the single measure by which to evaluate of portfolio

credit risk. Instead it would be beneficial for both of them to incorporate more information into a

risk review in particular, credit bureau ratings could be used to improve overall portfolio risk

evaluation. It is possible that through use of this test banks may improve on the credit ratings that

they employ to evaluate borrowers.

(Credit Ratings and Bank Monitoring Ability: Leond l Nakamura, federal Reserve Bank of

Philadelphia Kasper Roszbach Sveriges Riksbank May 28, 2010)

Harald Hau, Sam Langfield, and David Marques- Ibanez)

2007 to 2009 financial and banking crises have shifted rating agencies and the quality of their

opinions into the centre of the policy debate. The issue of rating is closely connected to a largest

debate about bank regulation, which is founded on rating contingent bank capital requirements.

To inform this debate, the current paper contributes a number of stylized empirical facts about

the quality of banks ratings. They ground their analysis on the premise that it is inherently

difficult to predict the timing and intensity of a systemic banking crisis this insight informs our


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strictly ordinal definition of rating quality. In this analysis it is not the absolute cardinal level of

default risk among all banks. Then they apply this ordinal approach to a large database on bank

ratings issued by the three major ratings agencies over the period 1990 to 2011. The

corresponding measure of bank distress is the expected default frequency (EDF) measured by the

widely used Merton model of corporate default. They draw their EDF measures directly from

Moodys in order to avoid any parameter choices which might bias the rating quality metric

against a finding high rating quality. Their first concerns the overall quality of ratings. They

show the banks ratings in upper investment grade range bear no ordinal relationship to expected

default probabilities two years later. The Spearman rank correlation between the credit rating

rank and the EDF rank is even slightly negative when EDFs are measured outside of crisis

periods. This findings runs contrary to the risk weights applied in the standardized approach to

credit risk under the first pillar of the Basel II accord. Under the recommendations of this accord,

exposures of financial institution are signed a 20% risk weight if the external credit rating is

between AAA to AA-; a 50% risk weight if the external ratings is between A+ to A-; and a

100% risk weight for the lowest investment grades rating from BBB+ to BBB_. There riskweights are used by national bank regulators to determine whether banks meet minimum

regulatory capital requirements. But such a large step change in risk weights cannot be

reconciled with our evidence that the AAA to AA- bucket is satisfactory indistinguishable from

the A+ to A-. Bucket in term of ratings of EFDs. This discrepancy is likely to generate

important market distortions. To the extent that minimum regulatory capital requirements bind,

they expect banks to other rated AAA to AA- compared with banks rated A+ to A-. These Basel

II weights thus distort the market for interbank lending and entrenches the market position rated

AA- and above.

(Bank Credit Ratings what determines their quality? Harald Hau, Sam Langfield, and

David Marques- Ibanez)

Credit rating agencies in the business of rating banks claims s one of their main function the

assessment of a banks financial strength as measured by its capacity to meets its obligations

(without the support of the government bailouts) and its effectiveness to manage risk. To a large

extent, these functions are shared by domestic banking supervisors and, therefore, there is a

common interest in identifying the best indicators of banks, financial performance. The rating

agencies record of prompt identification of banking problems in emerging markets has not been

satisfactory, and neither has been that of banking supervisors. This paper suggests that such

defiances could be explained by the use of financial indicators that, while appropriate for

industrial countries, do not work in emerging markets. Indeed, the results from the empirical

analysis conducted in this paper support the view that the particular features markets in emerging

markets limit the effectiveness of traditional indicators of bank performance and then alternative

system needs to be in place at least in the short run, while these countries improve their legal and

regulatory framework and capital markets develop. This paper showed that the most commonly

used indicator of banking problems in Latin America East Asia. This is because of two reasons:


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17

First because of severe deficiencies in the accounting and regulatory framework, the meaning of

traditional ratios is extremely limited.

Second , bank ratios become less effective when liquid markets for banks shares, subordinated

debt and other liabilities and assets are not available to validate the real worth of a bank as

opposed to its accounting value. In spite of these problems, an appropriate set of indicators for

banking problems in emerging markets can be constructed. But such a system should be based

not on the quality of banks loans or on levels of capitalization, but on the general principle that

good indicators of banking problems are those that revels the true riskiness of individual banks

because they are based on markets that work rather than just relying on accounting figures. Of

the alternative indicators proposed in this paper interest rate paid on deposits and interest rate

spreads have proven to be strong performers by showing a high degree of accuracy in predicting

banking problems. In this paper the first methodology implies that the appropriate of banks

performance evolve over time as markets develop. Second, because emerging markets differ

significantly among themselves in their degree of financial depth and development, a single set

of indicators will not fit all the basic principle that indicators work where markets work is theleading guide to the selection of effective indicators.

(Rating Banks in Emerging Markets: Liliana Rojas-Suarez)

Bo Becker Todd Milbourn, credit rating performs a function of critical importance to the

financial system. They find that the entry of a third major rating agency coincides with lower

overall quality, as measured by both the levels and informational content of incumbents, ratings.

The negative link between competition and quality is economically robust and unlikely to be

explained by the sources of reverse causality and omitted variables bias they examine. It also

appears unlikely that ratings shopping or growth in overall market share can explain these

patterns. The effect of competition on incumbent quality is of substantial economic magnitude. A

one standard deviation increase in Fitchs market share is predicated to increase the average firmand bond rating by between a tenth and half of a step (and increases it significantly more for

more highly levered firms). Moving from the 25th to the 75th percent of their competition

measure reduces the conditional correclation between ratings and bond yields by about a third

and reduces the conditional predictive power for default events at a three horizons by two thirds.

Calls for more competition in the ratings industry, such as by the US department of justice (1998,

2009), may deserve a caveat. For regulators and policymakers, it is worth considering that

increasing competition in the ratings industry involves the risk of impairing the reputational

mechanism that seemingly underlies the provision of good quality ratings. There may obviously

be benefits of competition in other areas, including reducing the level of rents in rating agencies

and the additional information provided to financial markets by the additional ratings.

(Who did increased competition affect credit ratings: Bo Becker Todd Milbourn)

Lawrence J. White, The Basel proposal will only exacerbate the demand for ratings but not solve

the problem of how credit rating firms should be certified. There is a better way. It would make

more extensive use of market information. It would use market spreads directly as indicators of

the riskiness of assets, and it would use market value accounting, forward looking stress tests,


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18

and subordinated debt as vital components of the process of determining adequate capital for

banks. These suggestions do not mean that the credit rating firms should be prevented from

playing a continuing role in helping issuers and investors pierce the fog of asymmetric

information. But that role should be determined by the market participants themselves, not by

additional regulation that artificially increases demand and restricts supply. The latter is a recipe

for shortage and rents. This is not a welcome prospect.

(The credit rating industry: An industrial organization analysis Lawrence J. White)

Arturo Estrella, Show the twelve BCBS members countries only Germany does not use credit

rating agencies, ratings in its banking supervision. Of the remaining eleven, seven use them only

for the market risk amendment (or CAD). On average, BCBS members currently recognize six

agencies. Given the relatively recent adoption of the market risk amendment (or CAD), there has

not been such change to the list of eligible agencies over time. Most of eleven supervisors use

objectivity as one of their recognition criteria. Their use of the other five criteria is more

patchily, with two transparency and international access being used rarely, if at all. Only theBCBS members undertake ongoing monitoring of agencies. Split ratings are generally dealt with

using the conditions under the market risk amendment for a qualifying item. There does not

appear to be a distinction between the treatment of solicited and unsolicited ratings.

(Credit ratings and complementary sources of credit quality information by Arturo

Estrella)

Chung-Hua Shen- Yu-Li Haung- Iftekhar Hasan, presents an information asymmetry hypothesis

to examine why banks with similar financial ratios receive different ratings. They use economic

development level and institutional environment quality to classify countries into low and high

information symmetry groups. The low information asymmetry countries are high incomecountries, industrial countries and countries fare strongly on institution environment quality.

Banks in these countries are expected to have high quality financial statements. In contrast,

serious information asymmetry countries are middle income countries, countries in emerging

market economies or countries with poor institutional environment quality. Banks in these

countries are expected to have a low quality financial statement. The financial ratios are then

classified into two groups: positive and negative financial ratios, for which largest and smaller

values indicate better performance, respectively. The former comprise profitability. Liquidity

and capital and the latter include efficiency and quality. The information asymmetry hypothesis

considered here posits that the influence of financial ratios is higher in countries with lower

information asymmetry, for both positive and negative ratios, thus strengthening the positive

influence of positive financial ratios and then negative influence of negative ones. In contrast,

both influences are mitigated in countries with severe information asymmetry. The study results

demonstrate that first, without considering the effect of the asymmetric information variable, the

five financial ratios shows the expected positive and negative influences on ratings. Second,

when employing income as the measure of information asymmetry, for example, by dividing


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19

countries into industrial, emerging, high and middle income countries, the hypothesis is

supported. In industrial or high income countries, financial ratios have high quality, reflecting the

intrinsic value of banks. Ratings agencies, thus assign greater weight to financial ratios in such

countries. in contrast , in middle income countries and emerging market countries, the influences

of financial ratios are reduced. Negative and positive coefficients of interaction terms are found

using positive and negative financial ratios, respectively, reducing the influence of financial

ratios. Accordingly even if the quality of capital is opaque or substantially underestimated in

these countries, rating agencies cannot help but assign better ratings to banks with greater capital.

(Asymmetric benchmarking in bank credit rating: Chung-Hua Shen- Yu-Li Haung-

Iftekhar Hasan)

Steinar Holden- Gisle Jaames Natviky Adrien Vigierz ,Finding that reputation concerns on the

part of credit rating agencies far from constitute a panacea to the industrys shortcoming first,

reputation concerns motivate CRAs to give ratings that push outcomes in one direction, with a

view to vindicate ratings ex post, in equilibrium, when investors realize this effect. CRAs areonly able to provide very coarse information, simply indicating whether rated objects are above

some minimum standard. Second, reputation concerns induce CRAs to exacerbate underlying

market conditions. In situations where investors have limited need for liquidity and it therefore is

relatively unproblematic to refinance projects. CRAs further reduce coordination risk. On the

other hand, in liquidity squeeze where coordination is a severe problems. CRAs only make

matters worse. Furthermore, our analysis reveals that while it is explicitly desirable that CRAs

stimulate investment, it need not be desirable that they are favorably inclined to issuers. On the

contrary, when CRAs effect is purely informational, their incentive structure should be

conservative, since otherwise investors will just ignore positive ratings as reacting CRAs biased

incentives. While in practice, this implication must be balanced against other concerns, itforcefully, shows that a discussion of the appropriate incentive structure of CRAs cannot treat

their impact on real outcomes as given. Their analysis focuses solely on the information

providing role of CRA, and ignores their potential effects through regulation, combining the two

channels seems a fruitful avenue for further research.

(An Equilibrium Model Of credit rating agencies: Steinar Holden- Gisle Jaames Natviky

Adrien Vigierz December 18,2012)

Richard cantor and Frank Packer, are testing whether the tendency of third rating agencies to

assign higher ratings than Moodys and Standards and Poors results from more lenient standards

or sample selection bias. More lenient standards might result from incentives to satisfy issuers

who are in fact, the purchasers of the ratings. Analysis of a board sample of corporate bond

rating at year end 1993 reveals that although sample selection bias appears important, it explain

less than half the observed difference in a average ratings. They also investigate why bond

issuers seek ratings in addition to those of Moodys and Standard and Poors. Main thing is that

they do not find that the profitability of obtaining a third rating is related to levels of ex ante


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20

uncertain over firm default probabilities. The most important determinants of the decision are a

firms age and size.

(Multiple Ratings and Credit Standards: Differences of option in credit rating industry)

By Richard cantor and Frank Packer:

Federal Reserve Bank of New York December 1995:

Pamela Nickell William Perraudin and Siamone Varotto Quantify the dependence of ratings

transition probabilities on the industry and domicile of the obligor, and on the stage of the

business cycle. Employing ordered probate models, they indentify the incremental impact of

these factors. Credit rating published by agencies such as Moodys or Standard and poors

played an increasingly important role in financial markets. The significance of agency ratings

will be even greater if they are used as a basis for calculating banks regulatory capital as

suggested in proposals recently issued by the Basel committee. An important question is to what

extent ratings correctly summarize that risks involved in holding a particular exposure. I

allocating obligors or bond issues to different ratings categories, rating agencies endeavor to

ensure that similar ratings imply similar credit quality in some broad general sense. And the twoapproaches are used to estimating rating change profitabilitys are implemented. The first is a

simple non parametric approach which consists of simply estimating probabilities based on

relative frequencies for separate data sets corresponding to obligors of different type sets or

observed at different stages of the business cycle. The second approach employs a parametric

ordered probate model. This has the advantage that one may estimate the impact on rating

change probabilities of a altering a single characteristic of an obligor, holding other

characteristics and the stage of the business cycle constant. Japanese ratings transition

probabilities were consistent with less volatile ratings than of the US and UK. These cross-

differences are especially important for higher credit quality obligors. Business cycle effects are

important particularly for low rated borrowers.

(Stability of Banking Transactions by Pamela Nickell William Perraudin and Siamone

Varotto) Bank of England:

Sam Hakim and Simon Neaime, investigate the performance and risk in two prominent countries

in the MENA region, Egypt and Lebanon, the study covers the 1990s a period that witnessed

banking sector reforms towards a more efficient financial system. They investigate the impact of

liquidity, credit and capital on banks profitability in each countrys banking sector.

(Performance & Credit risk in Banking: A compressive study for Egypt and Lebanon bySam Hakim and Simon Neaime)

Haseeb Zaman Babar, CAMELS is the supervisory and regulatory rating system implemented by

State Bank of Pakistan. It takes into account six important components of a bank when it

evaluates performance of the bank. These components are Capital assets, Management, Earning,

Liquidity, and sensitivity to market risk. Rating is assigned to these components on the scale of 1


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to 5 and that is a base for composite rating that also ranged from 1 to 5. PACRA rating agency is

the dominant credit rating agency of Pakistan that performs ratings for most banks and industries

in the country. In their results they examine the similarities in the results generated by the

Camels rating system and Pacra rating agency.

(Camels rating system for banking industry in Pakistan by Haseeb Zaman Babar)

Credit rating agencies supply debtors and investors essential concerning the creditworthiness of

companies, an individual or even an independent government. The credit ratings agencies assist

evaluate the quantitative and qualitative risks of these bodies and individuals and let investors to

formulate wiser conclusions by benefiting from the abilities of specialized risk assessment

conceded by the agencies. Quantitive risk analysis conceded by CRAs comprises evaluation of

financial ratios with selected levels whereas qualitative analysis spotlight legal, managerial,

political and economic situation in a jurisdiction (Sandler)

Credit rating agencies assist with risk measures for a variety of entities and make it simple to

financial market participant to evaluate and comprehend with the risk implicated in the investing

process. Organizations can borrow funds effortlessly from banks without having to go through

prolonged assessment from each individual lender individually. Government and corporations

can issue debt in variety of corporate bonds and treasuries to magnetize financiers and investors

based up on the credit rating (Turrner 2006)

Credit rating provided by the most famous and popular rating agencies including Standard &

Poors, Moodys and Fitch, have turn out to be a standard for regulation and parameters of

financial markets.

Framework:

Why performance measurement of banking sector?

If I talk about financial sector of any country then banking sector play a vital role in the

economic development of the country. And as it directs the flow of the funds from surplus

economic units of the economy towards deficit economic units (khan 2006) banking industry

being a important pillar of financial sector of an economy, its performance measurement cannot

be neglected. And the role of the financial institutions and banks in particular in economic

development of a country is accepted and acknowledged by Joseph Schumpeter way back in

1911. He argued that functions performance by financial institutions such as mobilizing saving

of the surplus units of an economy, risk measuring and management activities, complicatedtransactions being performed by these institutions and evaluation of the business projects all

together increase the pace of economic growth (King & Levine 1993)

Goldsmith also argued that size of a financial system plays a vital role in economic development

and proved it through his research on a sample of 35 different countries that they positive

correlation among each other. Organizations that build a financial sector are run mostly by the

public money, so it is very important to measure their performance (Purohit & Mazumder)


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22

performance evaluation and measurement of the banks take place at to levels. First management

of the bank internally measure and evaluate their banks performance and in the second phase

central banks that are usually regulatory controller of all commercial banks in a country critically

measure and evaluate performance of the banks.

Individual investors and investment institutions are also interested in information regarding

performance of individual banks. These investors are also important for the banks as well

because they bring money into the organization. For this specific purpose banks avail service of

international external credit rating agencies such as S&P Moodys, Fitch or a local credit rating

agency such as a PACRA in Pakistan for which they get extensively.(Pyle 1997)

CAMEL Rating System:

This system was adopted by national Credit union Administration NCUA in October 1987.Camels methodology adopted by North American Bank to know the financial and managerialreliability of commercial lending institutions. To examine the Camels system, information isrequired from different sources such as financial statements, funding sources, macroeconomicinformation, budget and cash flow projection, staffing/ operation. This model is perfect to assess

the overall condition of the bank, its strengths and weakness (Sarker 2005) Camels stand forcapital adequacy represent the relationship between quality and risk weighted assets, how torise equity and measure the ability to which the organization observe the loan and losses. Assetquality, the quality of a potfolio, assesses the portfolio risk and shows the productivity of longterm assets. Management, to know the base of directors functions whether they are performingwell or not and its decision making ability. It also evaluates the Human Resource managementweather they give support and clear guidance to staff, all the facilities which staff need.Earnings, quantifies the performance of the institution to increase and maintain the total worththrough earnings from operations. It also assess the interest rate policy, management examineand adjust the interest rate on micro finance loans and evaluate that adjusted return on assets thathow well the assets are utilized. Liquidity Management, securitizes institution liabilities like

interest rate, payment terms tenor, etc. it also evaluate the fund meet its credit demand and cashflow requirements. Sensitivity, to assess the risk of the market primarily based on adversechanges in commodity price, interest rate, foreign exchange rate, fixed assets and the ability ofmanagement to identify and control these risks. (Trautmann 2006)There are 5 credit rating:

Rating 1:

It shows safe and sound operations through strong performance and risk management.

Rating 2:It shows safe and sound operations through satisfactory performance and risk managementpractices.

Rating 3:In this the performance is marginal, unsatisfactory practices and flawed to some degree, meansthat weak performance but limited concern for failure.

Rating 4;

It show below average, poor performance and requires closer supervisory attention andimmediate action.

RATING 5:


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23

It reflects unsatisfactory performance; there is a great chance of failure and very difficult for themanagement to control.

PACRA bank Analysis Frame Work:

Analysis of banks rating is based upon different qualitative and quantitative factors and all these

factors have same weight age and importance in the rating process. These factors are discussedas under:

Risk management:

PACRA is focused on all the risks such as credit risk, market risk and operational risk. And for

last few years SBP implemented Basel II accord on the banking industry of Pakistan to

strengthen the risk management procedures and policies of the commercial banks (PACRA

2005)

Credit risk is analyzed on the basis of on-balance sheet activities, on balance sheet activities

include loans, fixed income securities and interbank deposits and loans whereas off balance sheet

activities include derivatives, guarantees and later of credit (LC). Loans make up the large

proportion of banks assets; special attention is given of the portion. Analysis such as size of the

loan type of the loans, its currency and the economic sector in which loan is provided. They also

consider large exposure of loans to an individual such as more than 10% of the equity, bad debts

and non performing loans. PACRA takes into consideration structural and trading risk in

analyzing market risk of a bank. To analyze the structure risk PACRA inspect assets and liability

management strategies of the banks and the hedging instruments used to offset the fluction in

price or interest to cover the unwanted risk

Funding and liquidity:

Composition of the banks funding diversification of its funding base, source of its funding and

liquidity of the banks is analyzed. If a bank is not able to renew its maturing liabilities, this is a

great threat and risk for banks funding. This risk can be reduced by diversifying the fund base

extend the source of suppliers. The measure the liquidity of a bank, PACRA analyzes liquidity at

both internal and external sources. Internal sources include marketable securities and maturing

source whereas external sources include capital markets, rediscount of the bills and securities. It

is important to measure the liquidity to their portfolio whether they are liquid enough to be sold

in market in case of any financial crisis.

Earning and performance:

Analyzing the quality of the earnings, PACRA takes into account the chronological inclination

in banks earning, quality and stability in the banks earnings and its future competence to

produce earnings. PACRA analyze earnings of each business line of a bank where they look at

the net interest revenue, non interest income, noninterest expenses, provision level and

exceptional income and expenditure items. In some cases PACRA make some minor change in

the income statement provided by the banks to make it comparable with the other banks in the


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24

industry. It also evaluates the management previous record in supply of trustworthy budgets and

forecasts.

Diversification of Business and Franchise:

PACRA also observe diversification in business products and services that are delivered to theircustomers and their ability to develop new products and services. PACRA also take into account

network of the banks franchise spread throughout the country and internationally and their

ability to retain their customers on hand and ability to make new customers.

Corporate Governance:

Banks corporate governance has an impact on creditworthiness. PACRA assess the quality of

banks corporate governance data on several qualitative and quantitative measures.

PACRA Standard Rating Scale and Definitions:

Long Term Ratings Short Term Ratings

AAA denotes highest credit quality of a bankunder examination and lowest expectation of abank to go into credit risk. This rating is givento the banks very rarely and only those eligiblefor it who maintains very timely repaymenthistory of financial obligations.

A+ indicates that all financial obligations arebacked by the highest capacity of the bank torepay them when they become due.

AA represents very high credit quality of abank that is under examination and has verylow prospect of credit risk. This rating isassigned to a bank who maintains very goodcapacity to repay their financial obligation ontime.

A1 denotes that financial obligations arebacked by a strong capacity of the bank torepay them when they are mature.

A represents high credit quality of a bank and

indicates low expectation of banks credit risk.

Bank has a strong capacity to repay its allfinancial obligations on time.

A2 indicates that all financial obligations aresupported by the satisfactory capacity of thebank to repay them when they become due.

BBB rating represents good credit quality of abank and signifies that there is less probabilityof the bank credit risk. Ability of the bank torepay all of its financial obligations is good butchanges in economic conditions andcircumstances can affect its capacity.

A3 indicates that financial obligations arebacked by a good level of capital capacity forthe timely repayment of these obligations butchanges in economic conditions andcircumstances can affect its capacity to repaythem.

BB represents speculative position of a bank B indicates that the capacity of the bank to


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25

under examination and denotes likelihood of a

banks credit risk in development especially if

there is any unfavorable economic change.

repay their financial obligations is highlysuspected to positive business activities andeconomic conditions.

B rating scale represents highly speculative

position of a bank and indicates presence ofconsiderable credit risk with the bank.

C denotes that bank have less capacity to repay

their financial obligations in timely manner.

CCC, CC & C: These ratings represent highdefault risk. Financial position of the bank isvery weak and is totally dependent on positivebusiness outcomes or economic changes. CCindicates that bankruptcy is somehow apparentwhere are C rating indicates forthcoming bankdefault.

D indicates that financial obligations are inhigh risk of default or already in the default.

Pakistani Banks Rating:

Regarding my study here I am showing the credit rating of 5 Pakistani Banks from 2007 to 2011:

Allied Bank Limited Askari Bank lImited

Bank Al-Habib Bank Alfalah Muslim Commercial Bank

Credit ratings of banks update as January 01, 2011:

Sr.No Name of Bank Rating

Agency

Short

term

Long

term

Date of

rating

Remarks

1 Allied BankLimited

PACRA A1+ AA Dec-10

2 Askari BankLimited PACRA A1+ AA June-10

3 Bank AlfalahLimited

PACRA A1+ AA June-10

4 Bank Al -HabibLimited

PACRA A1+ AA+ May-10

5 MCB A1+ AA+ June-10


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PACRA

Credit ratings of banks update as May 01, 2011:



2 Askari Bank

Limited






5 MCBPACRA

A1+ AA+ June-10

Credit ratings of banks update as July 20, 2011:


PACRA A1+ AA July-11

2 Askari BankLimited





PACRA A1+ AA+ June-11

5 MCB PACRA A1+ AA+ July-11

Credit ratings of banks update as February 01, 2010:Sr.No Name of Bank Rating

Agency

Short

term

Long

term

Date of

rating

Remarks




PACRA A1+ AA June-09 Plaoed on ratingwatho



4 Bank Al -Habib

Limited


5 MCB PACRA A1+ AA+ June-09

Credit ratings of banks update as June 01, 2010:




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27


PACRA A1+ AA June-09 Plaoed on ratingwatho



4 Bank Al -HabibLimited PACRA A1+ AA+ May-10







3 Bank Alfalah

Limited





Credit ratings of banks update as August 02, 2010:










Credit ratings of banks update as October 01, 2010:











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28

Credit ratings of banks update as Jan 01, 2009:

Sr.No Name of

Bank

Rating

Agency

Short term Long term Date of

rating

Remarks

1 AlliedBank

Limited


2 AskariBankLimited


3 BankAlfalahLimited





Credit ratings of banks update as Feb 02, 2009:

1 AlliedBankLimited


2 AskariBankLimited


3 Bank

AlfalahLimited





Credit ratings of banks update as March 02, 2009:

1 AlliedBankLimited


2 AskariBankLimited




4 Bank Al - PACRA A1+ AA June-08


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29

HabibLimited



1 AlliedBankLimited


2 AskariBankLimited




4 Bank Al -

HabibLimited




1 AlliedBankLimited


2 AskariBankLimited








Sr.No Name of

Bank

Rating

Agency


rating

Remarks

1 AlliedBankLimited

PACRAJCR-VIS

A1+A-1+

AAAA-

June-07June-07

2 AskariBankLimited



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30



4 Bank Al -Habib

Limited



Credit ratings of banks update as June 05, 2008:

1 AlliedBankLimited

PACRAJCR-VIS

A1+A-1+

AAAA-

June-07June-07

2 AskariBankLimited







Credit ratings of banks update as Aug 15, 2008:

1 AlliedBank

Limited


2 AskariBankLimited







Credit ratings of banks update as Dec 20, 2008:

1 AlliedBankLimited


2 AskariBank



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31

Limited






Credit ratings of banks update as March 31, 2007:

Sr.No Name of

Bank

Rating

Agency


rating

Remarks

1 AlliedBankLimited

JCR-VIS A-1+ A+ Aug-06

2 AskariBankLimited






5 MCB PACRA A1+ AA+ May-06

Credit ratings of banks update as Apr 16, 2007:

1 AlliedBankLimited

JCR-VIS A-1+ A+ Aug-06

2 AskariBankLimited


3 BankAlfalah

Limited






1 Allied JCR-VIS A-1+ A+ Aug-06


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BankLimited

2 AskariBankLimited








1 Allied

BankLimited

JCR-VIS A1+ AA June-07

2 AskariBankLimited




4 Bank Al -Habib

Limited



Credit ratings of banks update as Aug 09, 2007:

1 AlliedBankLimited

JCR-VIS A1+ AA June-07

2 AskariBankLimited








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Credit ratings of banks update as Oct 19, 2007:

1 AlliedBankLimited

PACRAJCR-VIS

A1+A-1+

AAAA-

June-07June-07

2 AskariBankLimited







(PARA)

BANKING SECTOR OF PAKISTAN:

Economy of Pakistan:

Since the independence of Pakistan, economy of the country is primarily agrain. Pakistan is a

developing country, having total estimated population of 177 million in 2011. The total labor

force is 58.41 million out of which 55.17 million is employed. At the time of independence in

1947, Pakistan was an agrarian economy where the contribution of agriculture toward GDP wad

53% during the year 1950. However, major shifts in the sectoral shares have occurred since then

as the shares of agriculture, industry and services towards GDP during year 2011 were 20.9

percent, 25.8 percent, and 53.3 percent respectively.

Growth has been slow during a year 1947, the growth rate has been better than the global

average during the subsequent five decades, but showed a bit late 1990s. however, Pakistans

economy gained its momentum again and grew at an average rate of 7 percent between 2003to

2007 which enables the government to rise development spending. As a result the poverty

headcount was reduced by more than 10 percent from 34.5 percent in 2001 to 22.3 percent in

2006.

Since the beginning of 2008 Pakistan face security issues stemming from the nations role in the

War on Terror have create great instability and led to a decline in FDI from a height of

appproimanetly US $5410.2 in 2008 to US $2205.7 Million for the fiscal year 2010. Due to


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current situation foreign investment transfer to Gulf countries. The dual impact has shocked

Pakistans economy with gaping trade deficits, high inflation.

In 2008 inflation reached as high as 21% and Pakistan had to depend on an aggressive fiscal

policy backed by the international monetary fund to avoid possible bankruptcy. The inflation rate

of fiscal year 2011 was 14.1%. The average inflation rate between 2007 and 2011 stood at14.6%.

And the GDP growth for 2011-12 has been estimated at 3.7 percent as compared to 3.0 percentin the previous fiscal year 2011.

Financial Sector of Pakistan:

Financial institutions play a vital function of intermediations between providers of investable

funds (depositors, securities holders etc) and the users of such funds (namely businesses). No

economy can progress unless its financial sector of facilitates its business activity consistently,

and in the case of a developing country like Pakistan, these FIS act as a necessary catalyst foreconomic growth as well.

The State Bank of Pakistan is the central bank of the country, has played two very critical roles

with respects to the financial sector. Firstly it ensures soundness of banks and DFIs through

prudential oversight with a view to maintain financial stability; secondly it pursues a

development objective under which it facilitates financial markets developments and

enhancement of access to finance.

The banking system of Pakistan has an 88 percent share of the total financial sector, in this

banking structure of 38 commercial banks and 4 specialized banks, 24 local private banks, 4nationalized public sector banks, 6 foreign banks, out 24 private commercial banks 5 are Islamic

banks (Pakistan & Golf economist 2010). The share of Non Banking institutions is 12 percent

and includes leasing companies, Mudarabas, Insurance companies, investments banks, housing

finance companies, and mutual funds.

Historical perspective:

The current structure of the financial sector in Pakistan is the result of several policy shifts anddevelopments. The eras of financial sector developments in Pakistan can broadly be segregated

into 194770, 1971 90 and 1991 to date period. Prior to 1971, the primary focus was on

developing commercial banks in the private sector and creating development finance institutionsbacked by the government. The private sector development, however, almost clogged during the

period 19711990, owing to the nationalization policy of the government. During this period, thebanking sector came under the governments control.

Current Situation:

Know here i m discussing key performance figures of the current banking sector. Total assets ofthe banks is amount Rs.7.7 trillion as end of June 2011. The deposits RS 6.0 trillion, while


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advances and investments of the sector are 3.8 trillion and Rs 2.6 trillion respectively. Profit ofthe banking sector of year 2010 was Rs 105 billion and for the first six months of 2011 it was RS77 billion. The banks have a healthy Capital Adequacy Ratio of over 14 percent and have shownsteady increase in capital even in absolute terms and equity of the banks is RS 722 billion June2011. The gross none performing loans which were low in 2007 (7.6%) are now at 15.3% as of

June 2011. (Role of financial institution and capital markets in Pakistan economy December2011)

Empirical Findings:

In this section of my theses I will present empirical finding which are based upon financial toolssuch as ratios implemented on the annual statements of the banks for the year ended 31December 2011. Sample of my search include 5 local banks of Pakistan. I calculated total eightfinancial ratios for all 5 banks of my sample that represent six components of CAMELS rating

system.

Bank Name Branches Total

Assets

Total

Capital

Deposits Advances Profit

Allied BankLimited

837 515,888,612 40,710,370 399,560,790 244,439,837 10,256,173

Askari BankLimited

245 343,865,720 20,411,442 291,499,395 150,712,556 1,705,207

Bank alHabib

289 384,525,614 26,652,267 302.097,187 114,863,132 4,537,104

Bank AlFalah 820 468,345,788 29,117,254 401,245,675 198,468,512 4,325,888

MCB 860 656,324,807 82,014 491,146,798 225,794,738 19,302,483

Camel rating Base:

There are 6 components of CAMEL rating model. And these are rated on the basis of followingcriteria on the scale of 1 to 5. Rating 1 shows strong position while rating 5 indicates worstposition of the bank in the particular component. And each component has a well throughoutscale of rating based on the prevailing financial and economic conditions (Saltzman & Salinger,1998). Key ratios of CAMELS rating system to evaluate the rating of different banks are:

Components Rating 1 Rating 2 Rating 3 Rating 4 Rating 5Capital Adequacy Ratio 15% 12%-14.99% 8%-11.99% 7-7.99% 6.99%

Asset Quality Ratio 1.25% 2.5%-1.26% 3.5%-2.6% 5.5%-3.6% 5.6%

Management 25% 30%-26% 38%-31% 45%-39% 46%

ROA 1% 0.9%-0.8% 0.35%-7% 0.25%-0.34% 0.24%

ROE 22% 17%-21.99% 10%-16.99% 7%-9.9% 6.99%

Liquidity Ratio 1.1 0.55 0.62-0.56 0.68-0.63 0.80-0.69 0.81

Liquidity Ratio 1.2 50% 45%-49.99% 38%-44.99% 33%-37.99% 32%


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Sensitivity Ratio 25% 30%-26% 37%-31% 42%-38% 43%

Capital Adequacy:

The Capital Adequacy shows the financial strength of a bank, and in this financial strengthusually show by bank CAR= TIER1 +TIER2/Risk Weighted Assets. This ratio determines theability of banks to meet with obligation on time and other risks such as operational risk, credit

risk, etc. Tire 1 is a type of capital, in simple words we can say own capital which consistsprimarily of common stock, preferred stock, retain earnings. Tier II is a supplementary form ofcapital of banks. In this include undisclosed reserves, subordinate term debt, general provision,and resolution reserves (Christopoulous 2011). In Risk weighted assets, according to the creditrisk assets are weighted.

Bank

Name

Tier I Tier II Total

Regulatory

Capital

Base

(a)

Total Risk

Weighted

Assets

(b)

CAR

a/b*100

Ratings

AlliedBank 34,818,473 5,891,897 40,710,370 303,082,586 13.43% 2

AskariBank

149,290,74 5.482,368 20,411,442 17,984,0957 11.34% 3

BankalFalah

21,639,777 7,474,477 29,117,254 250,932,783 11.60% 3

BankalHabib

17,803,517 8,848,750 26,652,267 158,102,911 16.86% 1

MCB 77,030 4,984 82,014 376,442 21.78% 1

Assets Quality:Quality of banks assets is related to the left side of the balance sheet. Usually top

management of the bank is concerned mostly with quality of the loans they provided to theircustomers as it provides earnings to their banks. Quality of the assets as its affects both costto the banks and economies of scale for the bank (Bernstein 1996) assets that have lowquality usually have higher possibility to become a non performing loan. Nonperformingloans are usually bad debts that are in default or they are near to be in default. In Pakistan


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those which are in default for more than three months are included in nonperforming loans(Chang 2006)

Below is the list of banks in alphabetical order that shows total advances of the banks, theirtotal non-performing assets and provision provided by the banks to cover theses non-

performing loans. Lower asset quality ratio shows higher performance of the bank. (Figuresin Rs 000)

Bank

Name

Advances

1

Provision

Non

Performing

Assets2

Total Non

Performing

Assets

3

Asset

Quality

Ratio%

3-2/1*100

Rating

AlliedBank

244,439,837 17,703,717 20,452,465 1.12% 1

AskariBank

150,712,556 16,668,690 23,645,541 4.62% 4

BankalFalah

198,468,512 12,925,864 19,096,614 3.1% 3

Bank alHabib

114,863,132 5,131,178 3,203,630 - 1

MCB 656,324,807 22,333,442 26,664,873 0.65% 1

Management :Below is a table of banks shows the ratio of Management expenses to total earnings, placed inalphabetical order. (Figures in Rs 000)

Management Quality Ratio:

Banks Name Mgt Exp

1

Total

Earnings

2

MER%

*100

Rating

Allied Bank 13,289,101 51,828,897 25.6% 1

Askari Bank 8,787,381 32,768,950 26.8% 2

Bank alFalah 13,880,361 44,166,897 31.4% 3Bank al Habib 7,621,965 36,529,237 20.8% 1

MCB 15,860,242 68,215,902 23.2% 1

Earning:


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It is necessary for the banks to generate sufficient earning to stay in the market for a longerperiod of time. To measure earnings the ratio used are Return on assets and Return on equityROA= Net Profit/Total Assets, this ratio avoids the volatility of earnings linked with usualitems, and measures the profitability of the banks. ROE= Net Profit/Own Capital, this ratioshows the efficiency of the bank that how the bank uses its own capital.

BankName TotalAssets

1

TotalEquity

2

ProfitAfter Tax

3

ROA%3/1*100 ROE%3/2*100 RatingROA RATINGROE

AlliedBank

515,888,612 37,761,572 10,256,173 1.98% 27.16% 1 1

AskariBank

343,865,720 16,585,997 1,705,207 0.49% 10.28% 3 3

BankalFalah

468,345,788 23,126,022 4,325,888 0.92% 18.70% 3 2

Bankal

Habib

384,525,614 17,878,659 4,537,104 1.17% 25.37% 1 1

MCB 656,324,807 81,034,402 19,302,483 2.94% 23.82% 1 1

Liquidity Management:

Liquidity is a ability of a firm to convert its financial assets into cash most rapidly or in aquick succession or we can say availability of the funds to pay off all its financial obligationswhen they become due. Here I am using two ratios: one is Loan to Total Deposits L-1, secondis Circulating assets to Total assets L-2.

Advances to Deposits:

Bank Name Advances

1

Deposits

2

Ratio

=

Rating

Allied Bank 244,439,837 399,560790 0.611 2

Askari Bank 150,712,556 291,499,395 0.051 1

Bank alFalah 198,468,512 401,245,675 0.494 1

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Credit Rating of Banks as Its Impact on Their Profitability

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