Banking

Performance evaluation of HDFC Bank using CAMEL model

BANK

The word bank means an organization where people and business can invest or

borrow money; change it to foreign currency etc. According to Halsbury “A Banker is an

individual, Partnership or Corporation whose sole pre-dominant business is banking, that is

the receipt of money on current or deposit account, and the payment of cheque drawn and the

collection of cheque paid in by a customer.’’

The Origin and Use of Banks

The Word ‘Bank’ is derived from the Italian word ‘Banko’ signifying a bench, which

was erected in the market-place, where it was customary to exchange money. The Lombard

Jews were the first to practice this exchange business, the first bench having been established

in Italy A.D. 808. Some authorities assert that the Lombard merchants commenced the

business of money-dealing, employing bills of exchange as remittances, about the beginning

of the thirteenth century.

About the middle of the twelfth century it became evident, as the advantage of coined

money was gradually acknowledged, that there must be some controlling power, some

corporation which would undertake to keep the coins that were to bear the royal stamp up to a

certain standard of value; as, independently of the ‘sweating’ which invention may place to

the credit of the ingenuity of the Lombard merchants- all coins will, by wear or abrasion,

become thinner, and consequently less valuable; and it is of the last importance, not only for

the credit of a country, but for the easier regulation of commercial transactions, that the

metallic currency be kept as nearly as possible up to the legal standard. Much unnecessary

trouble and annoyance has been caused formerly by negligence in this respect. The gradual

merging of the business of a goldsmith into a bank appears to have been the way in which

banking, as we now understand the term, was introduced into England; and it was not until

long after the establishment of banks in other countries-for state purposes, the regulation of

the coinage, etc. that any large or similar institution was introduced into England. It is only

within the last twenty years that printed cheques have been in use in that establishment. First

commercial bank was Bank of Venice which was established in 1157 in Italy.

The banking sector has been undergoing a complex, but comprehensive phase of

restructuring since 1991, with a view to make it sound, efficient, and at the same time it is

forging its links firmly with the real sector for promotion of savings, investment and growth.

Although a complete turnaround in banking sector performance is not expected till the

completion of reforms, signs of improvement are visible in some indicators under the

CAMELS framework. Under this bank is required to enhance capital adequacy, strengthen

asset quality, improve management, increase earnings and reduce sensitivity to various

financial risks. The almost simultaneous nature of these developments makes it difficult to

disentangle the positive impact of reform measures.

In 1994, the RBI established the Board of Financial Supervision, which operates as a

unit of the RBI. The entire supervisory mechanism was realigned to suit the changing needs

of a strong and stable financial system. The supervisory jurisdiction of the BFS was slowly

extended to the entire financial system barring the capital market institutions and the

insurance sector. Its mandate is to strengthen supervision of the financial system by

integrating oversight of the activities of financial services firms. The BFS has also established

a sub-committee to routinely examine auditing practices, quality, and coverage. In 1995, RBI

had set up a working group under the chairmanship of Shri S. Padmanabhan to review the

banking supervision system. The Committee gave certain recommendations and based on

such suggestions a rating system for domestic and foreign banks based on the international

CAMELS model combining financial management and sensitivity to market risks element

was introduced for the inspection cycle commencing from July 1998. It recommended that

the banks should be rated on a five point scale (A to E) based on the lines of international

CAMELS rating model. CAMELS rating model measures the relative soundness of a bank.

BASEL - II ACCORD

Bank capital framework sponsored by the world's central banks designed to promote

uniformity, make regulatory capital more risk sensitive, and promote enhanced risk

management among large, internationally active banking organizations. The International

Capital Accord, as it is called, will be fully effective by January 2008 for banks active in

international markets. Other banks can choose to "opt in," or they can continue to follow the

minimum capital guidelines in the original Basel Accord, finalized in 1988. The revised

accord (Basel II) completely overhauls the 1988 Basel Accord and is based on three mutually

supporting concepts, or "pillars," of capital adequacy. The first of these pillars is an explicitly

defined regulatory capital requirement, a minimum capital-to-asset ratio equal to at least 8%

of risk-weighted assets. Second, bank supervisory agencies, such as the Comptroller of the

Currency, have authority to adjust capital levels for individual banks above the 9% minimum

when necessary. The third supporting pillar calls upon market discipline to supplement

reviews by banking agencies.

Basel II is the second of the Basel Accords, which are recommendations on banking

laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of

Basel II, which was initially published in June 2004, is to create an international standard that

banking regulators can use when creating regulations about how much capital banks need to

put aside to guard against the types of financial and operational risks banks face. Advocates

of Basel II believe that such an international standard can help protect the international

financial system from the types of problems that might arise should a major bank or a series

of banks collapse. In practice, Basel II attempts to accomplish this by setting up rigorous risk

and capital management requirements designed to ensure that a bank holds capital reserves

appropriate to the risk the bank exposes itself to through its lending and investment practices.

The final version aims at:

1. Ensuring that capital allocation is more risk sensitive;

2. Separating operational risk from credit risk, and quantifying both;

3. Attempting to align economic and regulatory capital more closely to reduce the scope

for regulatory arbitrage.

While the final accord has largely addressed the regulatory arbitrage issue, there are

still areas where regulatory capital requirements will diverge from the economic.

Basel II has largely left unchanged the question of how to actually define bank capital, which

diverges from accounting equity in important respects. The Basel I definition, as modified up

to the present, remains in place.

The Accord in operation

Basel II uses a "three pillars" concept

minimum capital requirements (addressing risk),

supervisory review and

market discipline – to promote greater stability in the financial system.

The Basel I accord dealt with only parts of each of these pillars. For example: with

respect to the first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner

while market risk was an afterthought; operational risk was not dealt with at all.

The First Pillar

The first pillar deals with maintenance of regulatory capital calculated for three major

components of risk that a bank faces: credit risk, operational risk and market risk. Other risks

are not considered fully quantifiable at this stage.

The credit risk component can be calculated in three different ways of varying degree of

sophistication, namely standardized approach, Foundation IRB and Advanced IRB. IRB

stands for "Internal Rating-Based Approach".

For operational risk, there are three different approaches - basic indicator approach,

standardized approach and advanced measurement approach. For market risk the preferred

approach is VaR (value at risk).

As the Basel II recommendations are phased in by the banking industry it will move

from standardized requirements to more refined and specific requirements that have been

developed for each risk category by each individual bank. The upside for banks that do

develop their own bespoke risk measurement systems is that they will be rewarded with

potentially lower risk capital requirements. In future there will be closer links between the

concepts of economic profit and regulatory capital.

Credit Risk can be calculated by using one of three approaches:

1. Standardized Approach

2. Foundation IRB (Internal Ratings Based) Approach

3. Advanced IRB Approach

The standardized approach sets out specific risk weights for certain types of credit

risk. The standard risk weight categories are used under Basel 1 and are 0% for short term

government bonds, 20% for exposures to OECD Banks, 50% for residential mortgages and

100% weighting on commercial loans. A new 150% rating comes in for borrowers with poor

credit ratings. The minimum capital requirement (the percentage of risk weighted assets to be

held as capital) has remains at 8%.

For those Banks that decide to adopt the standardized ratings approach they will be

forced to rely on the ratings generated by external agencies. Certain Banks are developing the

IRB approach as a result.

The Second Pillar

The second pillar deals with the regulatory response to the first pillar, giving

regulators much improved 'tools' over those available to them under Basel I. It also provides a

framework for dealing with all the other risks a bank may face, such as systemic risk, pension

risk, concentration risk, strategic risk, reputation risk, liquidity risk and legal risk, which the

accord combines under the title of residual risk. It gives banks a power to review their risk

management system.

The Third Pillar

The third pillar greatly increases the disclosures that the bank must make. This is

designed to allow the market to have a better picture of the overall risk position of the bank

and to allow the counterparties of the bank to price and deal appropriately. The new Basel

Accord has its foundation on three mutually reinforcing pillars that allow banks and bank

supervisors to evaluate properly the various risks that banks face and realign regulatory

capital more closely with underlying risks. The first pillar is compatible with the credit risk,

market risk and operational risk. The regulatory capital will be focused on these three risks.

The second pillar gives the bank responsibility to exercise the best ways to manage the risk

specific to that bank. Concurrently, it also casts responsibility on the supervisors to review

and validate banks’ risk measurement models. The third pillar on market discipline is used to

leverage the influence that other market players can bring. This is aimed at improving the

transparency in banks and improves reporting.

HDFC BANK:

HDFC Bank was incorporated in the year of 1994 by Housing Development Finance

Corporation Limited (HDFC), India's premier housing finance company. It was among the

first companies to receive an 'in principle' approval from the Reserve Bank of India (RBI) to

set up a bank in the private sector. The Bank commenced its operations as a Scheduled

Commercial Bank in January 1995 with the help of RBI's liberalization policies.

In a milestone transaction in the Indian banking industry, Times Bank Limited

(promoted by Bennett, Coleman & Co. / Times Group) was merged with HDFC Bank Ltd., in

2000. This was the first merger of two private banks in India. As per the scheme of

amalgamation approved by the shareholders of both banks and the Reserve Bank of India,

shareholders of Times Bank received 1 share of HDFC Bank for every 5.75 shares of Times

Bank.

In 2008 HDFC Bank acquired Centurion Bank of Punjab taking its total branches to

more than 1,000. The amalgamated bank emerged with a strong deposit base of around Rs.

1,22,000 crore and net advances of around Rs. 89,000 crore. The balance sheet size of the

combined entity is over Rs. 1,63,000 crore. The amalgamation added significant value to

HDFC Bank in terms of increased branch network, geographic reach, and customer base, and

a bigger pool of skilled manpower

HDFC Bank Ltd. is a major Indian financial services company based in Mumbai,

incorporated in August 1994, after the Reserve Bank of India allowed establishing private

sector banks. The Bank was promoted by the Housing Development Finance Corporation, a

premier housing finance company (set up in 1977) of India. HDFC Bank has 1,412 branches

and over 3,295 ATMs, in 528 cities in India, and all branches of the bank are linked on an

online real-time basis. The Bank posted total income and net profit of Rs. 19,980.5 crores and

Rs. 2,948.7 crores respectively for the financial year ended March 31, 2010 as against Rs.

19,622.9 crores and Rs. 2,245.0 crores respectively in the previous year.

HIGHLIGHTS OF HDFC BANK:

Net profit: 5,167 crore. An increase of 31.6% compared to the previous year.

• Balance sheet size: 337,909 crore as at 31st March 2012

• Total deposits: 246,706 crore. An increase of 18.3% compared to the previous year

• Total advances: 195,420 crore. An increase of 22.2% compared to the previous year

• Capital Adequacy Ratio: 16.5%. Regulatory minimum requirement is 9%

• Tier I capital ratio: 11.6%

• Non Performing Assets: 1,999 crore (gross); 1.0% of Gross Advances

• Network:

Branches: 2544 • ATMs: 8913 • Cities: 1399

CAMELS FRAMEWORK

CAMELS evaluate banks on the following six parameters:-

• Capital Adequacy (CRAR)

• Asset Quality (GNPA)

• Management Soundness (MGNT)

• Earnings & profitability (ROA)

• Liquidity (LQD)

• Sensitivity to Market Risks (β)

CAMELS is basically a ratio-based model for evaluating the performance of banks.

CAPITAL ADEQUACY

Capital Adequacy highlights entire financial condition of a bank. It also shows the ability

of the management to meet the need for additional capital. It is an indicator of additional strength

of a bank. Capital Adequacy put impact on overall performance of the bank in terms of opening

of new branches and subsidiaries, diversification.

Capital Adequacy of HDFC Bank

Capital Adequacy Ratio (CAR): -Capital Adequacy Ratio constitutes the most important

indicator for evaluating the soundness and solvency of the banks. This indicates ratio of capital

funds in relation to bank’s assets. It measures the strength and stability of banks. Capital

Adequacy ratio as per Basel I and Basel II has been given. Higher value of this ratio indicates

better solvency and financial strength of the banks and lower value indicates poor solvency and

financial strength of the banks. In 2006-2008, CAR was 13.08 percent in 2006-07 which

increased to 13.60 percent in 2007-08. In the base period that is year of amalgamation of HDFC

Bank with Centurion Bank of Punjab it was 15.09 percent as per Basel I. In 2009-11, CAR was

16.45 percent in 2009-10 and it decreased to 15.32 percent in 2010-11. Average of CAR as per

Basel I for 5 years is 14.08 percent which is higher than RBI norm of 9 percent for capital

adequacy ratio. As per Basel II, no CAR is available. In the base period, CAR as per Basel II was

15.69 percent. In post-merger period it was highest in 2009- 10 that is 17.44 percent as compared

to 16.22 percent in 2010-11. Average of CAR as per Basel II is 16.45 percent. There is fair level

of consistency in CAR as per Basel I as compared to CAR as per Basel II.

Advances to Asset Ratio: - This is the ratio of total advances to total assets. Total advances also

includes receivables. The value of total assets excludes the revaluation of all the assets.

In 2006-2008, advances to asset ratio was Rs. 0.515 Cr. in 2006-07 which declined to 0.476 in

2007-08. In base period it increased to Rs. 0.539 Cr. In 2009-11, it increased to Rs.0.566 Cr.

which further increased to Rs.0.577 Cr. Average of Advances to Asset ratio is Rs. 0.535 Cr. This

ratio indicates fair level of consistency over period of time.

ASSET QUALITY

Asset Quality is another important aspect of the evaluation of bank’s performance. The

main motive in measuring asset quality is to ascertain the proportion of non-performing assets as

a percentage of the total assets.

Asset Quality of HDFC Bank

Following ratios are calculated in order to ascertain asset quality of the bank:

Net NPAs as percentage of Net Advances: - The Net NPA levels help us to know the efficiency

of Credit Risk Management system of the bank. The ratio of Net NPAs to Net Advances is a

measure of quality of assets of the banks. Hence, the lower the Net NPA level, the better is the

quality of the assets of the bank. Net NPAs as percent of Net Advances increased from 0.43

percent in 2006-07 to 0.47 percent in 2007-08. It further increased to 0.63 percent in base period.

It declined to 0.31 percent in 2009-10 to 0.19 percent in 2010-11.

This indicates favourable sign of improvement in asset quality. Average of Net NPAs as percent

of Net Advances is 0.41 percent. High coefficient of variation indicates high variability in the

ratio.

Priority Sector Advances as a percentage of Total Advance: -The formal definition of

‘Priority Sector’ came into existence in 1972 when retail trade, small business,

professional and self employed persons and education loans were also declared as priority sector

in addition to Small Scale Industries, agriculture and allied agricultural activities and transport

operators. Now housing has also been brought under the priority sector. Priority sector Advances

as percentage of Total Advances represents the bank’s credit pattern in the priority sector against

the given target by RBI i.e. 40 percent of the total advances. The bank has been all along making

sincere efforts to achieve the benchmark for priority sector advances.

MANAGEMENT CAPABILITY

The measurement of management capability is a qualitative and subjective concept. It can

be measured through subjective evaluation of management systems, organization culture, control

mechanisms etc. The capability of management can be best measured through deployment of

resources, maximization of income reduction of costs, productive utilization of facilities of the

bank etc.

Management Capacity of HDFC Bank

The management capability is measured with ratios given below:

Credit Deposit Ratio: - This ratio indicates the total advances as a proportion of total deposits. It

shows the management’s aggressiveness to improve income by higher lending operations. It

indicates the deployment of bank resources by way of loans and advances. The ratio of 60 percent

is considered as a norm for banks. If CD ratio is higher a larger percentage of deposits mobilized

is lent to different sectors and it will lead to an improvement in profitability of banks. Credit-

deposit ratio was 68.74 percent in 2006-07 which declined to 62.94 percent in 2007-08. Credit

Deposit Ratio increased to 69.24 percent in base period. Credit deposit ratio increased to 75.17

percent in 2009-10 which further increased to 76.69 percent in 2010-11.

Credit deposit ratio is able to achieve norm of 60 percent. Average of credit deposit ratio is 70.56

percent. Credit deposit ratio indicates fair level of consistency over period of study.

Profit per Employee: -Net Profit implies the balance of profit as per profit and loss account.

This ratio shows net profits earned per employee. Higher value of this ratio indicates better

productivity per employee of a bank and lower value of this ratio indicates lower productivity per

employee of a bank.

Profit per employee = Net Profit/No. of employees

Profit per employee is Rs. 6.13 lacs in 2006-07 which declined to Rs. 4.97 lacs in 2007-08. In

base period profit per employee was Rs. 4.18 lacs. It increased to Rs. 5.98 lacs in 2009-10 and

and which further increased to Rs.7.37 lacs in 2010-11.

Average of profit per employee is Rs. 5.726 lacs.

EARNING QUALITY

Earning is one of the conventional indicators of measuring financial performance of bank.

This parameter is being increasingly used as indicator to measure performance of the bank due to

fact that bank’s are earning much of their income through core activities like investments,

treasury operation and corporate advisory services etc. Following ratios are used to ascertain

earning quality of the bank:

Earning Quality of HDFC Bank

Operating Income as a percentage of Working Funds: -This is arrived at by dividing the

operating profit by average working funds. Working Funds is the daily average of the total assets

during the year which indicate how much operating income is generated from average working

funds. Higher ratio indicates good performance of bank.

This ratio increased from 2.98 percent in 2006-07 to 3.13 percent in 2007-08. It declined to 2.94

in the base period. It further increased to 3.33 percent in 2009-10 and declined to 3.12 percent.

Performance of HDFC Bank in terms of operating profit as percent of working funds is to some

extent same in pre-merger and post-merger period. Average of this ratio is 3.1 percent. This ratio

indicates fair level of consistency over period of time.

Return on Assets: -Return on Assets is defined as net income divided by total assets. It measures

the bank profits per currency units of assets. It is an indicator of assets management’s efficiency

of an organization.

ROA= Net Income/Total Assets

This is the main indicator of profitability used in international comparisons and it is one among

the guidelines of RBI for balance sheet analysis of bank. Higher value of this ratio indicates,

better financial productivity and profitability of banks and lower value indicates lower

productivity of banks.

ROA was 1.33 in 2006-07 which declined slightly to 1.32 in 2007-08. In base period, it further

declined to 1.28 percent.

LIQUIDITY ANALYSIS

Liquidity is one of the important parameters through which the performance of a bank is

assessed. These parameters of CAMEL Model assess the ability of Bank to pay its short term

liabilities towards its deposit holders in a particular span of time.

Liquidity Analysis of HDFC Bank

It can be measured with the help of the following ratios:

Liquid Assets/Total Assets: -This ratio shows the degree of liquidity preference adopted by the

bank. Ratio of Liquid Assets to Total Assets indicates that what percent of total assets are held as

liquid assets. This liquidity can be considered to be adequate enough to meet the immediate

liabilities of the banks. Higher value of this ratio indicates higher liquidity of banks and lower

value indicates lower liquidity of banks.

The liquid assets include cash in hand, cash at bank and short-term deposits. The total assets

include cash balances, balances with banks, investments, advances, fixed assets and other assets.

Liquid assets/total assets is 0.099 in 2006-07 which further increased to 0.111 in 2007-08. In base

period it declined to 0.096. In post-merger period, it increased to 0.135 in 2009-10 and which

declined to 0.107 in 2010-11. This indicates that ratio of liquid assets/total assets improved.

Average of this ratio is 0.109. This ratio indicates fair level of consistency over a period of time.

Liquid Assets/Total Deposits: -This ratio indicates that what percent of total deposits are held

as liquid Assets. This liquidity can be considered adequate enough to meet the immediate

liabilities of the banks. Higher value of this ratio indicates higher liquidity of bank and lower

value of the ratio indicates lower liquidity of bank.

Liquid assets/total deposits were 0.132 in 2006-07 which increased to 0.147 in 2007-08. In base

period it declined to 0.123. It increased to 0.179 in 2009-10 which declined to 0.142 in 2010-11.

Liquidity of HDFC Bank has improved . Average of liquid assets/total deposits is 0.145. This

ratio also indicates fair level of consistency over a period of time.

RECOMMENDATIONS FOR HDFC BANK:

Following recommendations are being made to improve the financial performance of HDFC

Bank:

In order to reduce NPAs of bank, employees should be well trained to monitor the

creditworthiness of borrowers and the final usage of the loans to avoid defaults in later

stage. Moreover, projects with outdated and obsolete technology should not be financed.

Loan policy of bank should be made transparent and unnecessary formalities and

procedures should be eliminated

Credit limits of agriculture and small-scale industries should be increased for promoting

priority sector advances.

HDFC Bank should work at grass root level by paying more attention to common

masses. It should introduce diversified and innovative financial products which are best

suited to common man.

Financial inclusion and micro finance should be the slogan of success. Bank should

build up buffer of capital base in good times to be drawn upon in period of stress and

crisis.

REFERENCES:

1. http://www.rbi.org

2. http://www.hdfcbank.com

3. http://www.moneycontrol.com

4. http://www.rbidocs.rbi.org

5. http://www.stock-picks-focus.com/hdfc-bank.html

6. http://www.allbankingsolutions.com/camels.htm

7. http://www.shkfd.com.hk/glossary/eng/RA.htm

8. http://www.wikinvest.com/wiki/CAPITAL_ADEQUACY_RATIO

9. Annual Reports of HDFC Bank, Various Issues, www.hdfcbank.com

10. Gupta Sumeet & Verma Renu, “Comparative Analysis of Financial Performance of

Private Sector Banks in India: Application of CAMEL Model”, Journal of Global

Economy, Vol. 4, No.2, April-June, 2008,

11. Jain Paras Mal, “Consolidation in Banking Sector Through Mergers and Acquisitions”,

“Banking Reforms and Globalisation”

12. Prajapati Sadhana, “Mergers & Acquisitions in the Indian Banking system- An

Overview”, International Referred Research Journal Issue 19, August 2010.