A Case Study of Joint Venture Banks in Nepal Essay

Using the selective nurture set published by correlative jeopardise banks in their annual reports, and NRB in its supervision annual reports, this paper examines the pecuniary wellness of joint casualty banks in the CAMEL framework. The wellness check up conducted on the basis of publically available fiscal data concludes that the wellness of joint casualty banks is better than that of the other technical banks. In addition, the poring over of indicators of different divisions of CAMEL indicates that the fiscal health of joint gauge banks ar not so strong to manage the possible large scale raps to their balance wheel sheet and their health is mediocre.THE HISTORY OF MODERN commercialized banking industry dates sustain to 1937 A.D in which year Nepal entrust Ltd. was incorporated. Till 1984, fiscal vault of heaven was close to semi personal celestial sphere and distant investors. HMG/Nepal started to liberalize the pecuniary sector in the first half(a) of t he 1980s. solely it speeded up this process just now in early 1990s. Private sector rushed into the finance industries especi onlyy by and by the resto symmetryn of democracy in 1990. Most of the commercial banks came into ope symmetryn during the ten-spot of 1990s. Government of any(prenominal) countries highly monitors and controls the finance industry even in the liberalized foodstuff economy. Government does so due to its high gravity in the national economy, and to build up the confidence of private sector in its financial trunk.Nepal Rastra jargon (NRB) as an apex mo meshworkary authority of the demesne started to monitor and control the finance industry especially at the conclusion of the 1990s by issuing the directives to the financial institutions (FIs). It initiated the killsite and onsite supervision of FIs to maintain their strong financial health and to build upthe confidence of private sector in the liberalized financial dodge and protect the recreate o f the investors. It has adopted the CAEL ( outstanding sufficiency, plus prize, earning and runniness) governance to check up the health of FIs. It has yet to use the CAMELS to rate the financial procedure and check up the financial health. Independent outsiders in like manner displace not use all agents of CAMELS to check up the financial health of FIs in Nepal due to the full disclosures of withdrawd financial knowledge to outsiders. NRB dictated FIs to snitch the financial information in uniform focusing only in the fiscal year (FY) 2001/02. In this paper, attempt has been do to check up the financial health of joint chance banks in the framework of CAMEL.1. Rationale of Regular wellness Check up of mer advisetile BanksNot only the commercial banks but also any FIs require unfluctuating health check up to maintain the confidence of private sector in financial system of the country and protect the interest of defineors, fetchers, sh beholders and other stake holders. The gravity of the importance of reasoning(a) financial sector has change magnitude tremendously after the worldwide financial turmoil of the second half of the 1990s. International monetary authorities much(prenominal)(prenominal) as International monetary Fund and international FI like the founding Bank withdraw belowpinned the call for of healthy financial sector to build up the confidence of private sector in the liber41The Journal of Nepalese trade Studiesalized financial system. in that locationfore, they allow direct their member countries to reform the financial sector and conduct the regular health check up of FIs through onsite and offsite supervision. International FIs like the land Bank and Asian Development Bank (ADB) ar supporting the projects lay out in the vein of reforming process of the financial sector of different countries. For example, the World Bank is constantly providing the technical and financial support to reengineer NRB and restru cture Nepal Bank Ltd. and Rastriya Banijya Bank (NRB 2005).Health of financial sector depends on the health of case-by-case FIs. In addition, one-on-one FIs health counts on the myriad large and microfactors. Among the macro factors, semipolitical stability and the real sector addition are vital. The financial health of FIs open fire not sustain without the political stability and sustainable real sector growth with unplumbed health. However, the effectiveness of contagious effect of these macro variables may vary from one individual FI to another. Therefore, health of individual FI should be checked up regularly to agnise the intensity of much(prenominal) effect.Health of an individual FI is a function of duplex factors such as quality of its additions, semi liquid state position, nifty tie-up, circumspection quality, merc clearise sensitiveness and earnings. All these factors instill the different typesetters cases of pretend to an individual FI. polar types o f stakes credit try, interest rate happen, fluidity hazard, commercialise risk, off-balance sheet risk, hostile permutation risk, sovereign risk, technology, operational risk, insolvency risk, affect the health of an individual FI adversely if they are not managed in sustainable manner (Saunders and Cornett 2004).A human action of factors such as quality of assets, financial market condition, foreign rallying market, composition of assets, financial health of its clients, gainfulness, seat of government enough, affect the degree of these risks. monetary health check-up of an individual institution should be made regularly to unwrap the adverse effect of these risks on its health. Micro-prudential indicators such as bang-up adequacy, asset quality, centering soundness, earning and profitability, liquidity, sensitivity to market risk, and market based indicators like market price of financial instruments, credit ratings are utilize as indicators of the sound health of an individual FI (Evan and others 2000). These indicators are explained at length in the ensue section of this paper.2. Theoretical Prescription of CAMELS FrameworkThe Basle Committee on Banking inadvertence of the Bank of International Settlements (BIS) has recommended using seat of government letter adequacy, assets quality, management quality, earnings and liquidity (CAMEL) as criteria for assessing a FI in 1988 (ADB 2002). The sixth member, market risk (S) was added to CAMEL in 1997 (Gilbert, Meyer and Vaughan 2000). However, most of the developing countries are using CAMEL instead of CAMELS in the act evaluation of the FIs. The central banks in some of the countries likeNepal, Kenya use CAEL instead of CAMELS.CAMELS framework is a common method for evaluating the soundness of FIs. This system was veritable by regulatory authorities of the U.S banks. The Federal Reserve Bank, the Comptroller of the specie and the Federal Deposit Insurance Corporation all use this syste m (McNally 1996). fiscal authorities in the most of the countries are using this system to check up the health of an individual FI. In addition, International Monetary Fund also is using the aggregated indicators of individual FIs to assess the financial system 42Health Check-up of commercial-grade Bankssoundness of its member countries as part of its surveillance work (Hilbers, Krueger and Moretti 2000).2.1 pileus AdequacyCAMELS framework system looks at six major aspects of an FI corking adequacy, asset quality, management soundness, earnings, liquidity, and sensitivity to market risk (Hilbers, Krueger and Moretti 2000). The first component, jacket adequacy ultimately determines how fountainhead FIs can manage with shocks to their balance sheets. Thus, it tracks uppercase adequacy ratios that take into report card the most important financial risksforeign exchange, credit, and interest rate risksby assigning risk weightings to the institutions assets. For the purpose of cap ital adequacy measurement, bank capital is divided into horizontal surface I and Tier II. Tier I capital is primary capital and Tier II capital is supplementary capital.In Nepalese context, Tier I (core/primary) capital let ins paid-up capital, share premium, non-redeemable preference share, widely distributed stand-in fund, accumulated profit, capital buyback reserve, capital adjustment fund, and other free reserve. Amount of the goodwill, fictitious assets, enthronement in the financial instruments issued by an organized organization in unornamented to the limit specified by NRB, and investment in the financial instruments issued by the organizations having the own financial interest is deducted from the sum of all elements of the primary capital to arrive at the core capital. Similarly, Tier II (supplementary) capital comprises of customary impart red provision, assets revaluation reserve, hybrid capital instruments,subordinated term impart, exchange come toization re serve, excess giveword loss provision, and investment adjustment reserve. Thus, the come in capital of commercial banks is the sum of core capital and supplementary capital (NRB 2005).Leverage ratio can be utilize to measure the capital adequacy of a bank. This is the ratio of banks book regard as of core capital to the book value of its assets. The higher(prenominal) ratio shows the higher level of capital adequacy. The U.S.A. Federal Deposit Insurance Corporation return Act (FDICIA) of 1991 has fixed the five target zones i. 5 portion and higher up ii. 4 part and above iii. under 4 per centum, iv. under 3 per centum, v. 2 part and less, of supplement ratio. The leverage ratio falling in the first zone implies that bank is well capitalized.Similarly, the leverage falling in the second zone shows that bank is adequately capitalized. The leverage falling in the last three zones indicates that bank is inadequately capitalized and regulators should take prompt tonic actio n to bring the capital to the desirable level (Saunders and Cornett 2004). The leverage ratio utter in the foregoing discussion is dewy-eyed capital to assets ratio. In other words, assets are not risk adjusted. The 1993 Basel Accord enforced the capital ratio to risk adjusted assets of commercial banks. According to this accord, core capital must equal to or exit 4 percent of the risk weighted assets of the commercial banks. Similarly, the measuring of the supplementary capital should not exceed the amount of the core capital and the fit capital must equal or exceed 8 percent of risk weighted assets (Saunders and Cornett 2004).NRB initially fixed the core capital at the level of 4.5 percent of the risk weighted assets and tally capital at the level of 9 percent of risk weighted assets of the commercial banks (NRB 2058). For the current FY2005/06, the mandatory levels of core capital and entirety capital are 6 percent and 12 percent of risk weighted assets of commercial banks . But NRB has strictly directed all commercial banks that the amount of the supplementary capital should not be in excess to the amount of the core capital (NRB 2005). 43The Journal of Nepalese Business Studies2.2 Asset QualityCredit risk is one of the factors that affect the health of an individual FI. The extent of the credit risk depends on the quality of assets held by an individual FI. The quality of assets held by an FI depends on exposure to circumstantial risks, leanings in non-performing loans, and the health and profitability of bank borrowersespecially the corporate sector. We can use a number of measures to indicate the quality of assets held by FIs. ADB suggests these measuresloan concentration by industry, region, borrower and portfolio quality related party policies and exposure on outstanding loan, approval process of loan, check and balance of loans loan loss provision ratio portfolio in arrear loan loss ratio and reserve ratioof checking the quality of assets of an FI (ADB 2002).NRB uses composition of assets, nonperforming loan to sum up loan ratio, net nonperforming loan to total loan ratio as the indicators of the quality of assets of commercial banks (NRB 2005. NRB has directed the commercial banks in regards to the concentration of the loan. Any licensed FI can grant the fund base loan to a single borrower or borrowers related to the same business group up to the 25 percent of its primary capital. In the same vein, it can provide the non-fund base loan up to 50 percent of its core capital (NRB 2005). Similarly, it has directed FIs to single out the loans into performing loan and nonperforming loans.The loans that are not due and 3 months recent due fall in the class of performing loans/performing assets and others do in the non-performing loans. Further, non-performing loans are classified into three groups sub amount, doubtful, and bad debt/ loss (for expound classification see NRB directive 2/061/62). Commercial banks have to sh uffling 1 percent provision for pass loan/performing loan, 25 percent for substandard loan, 50 percent for doubtful loan and snow percent for bad loan (NRB 2005). Non-performing assets in the total assets of commercial banks was 22.77 percent in the FY 2003/04. But the percentage of non-performing assets of an individual commercial bank varies from 0.76 percent to 57.64 in the same fiscal year. But the normal international standard of the percentage of non-performing assets is 5-8 percent of the total assets.2.3 Management QualitySound management is key to bank performance but is difficult to measure. Itis primarily a qualitative factor applicable to individual institutions. Several indicators, however, can conjointly serve as an indicator of management soundness. Expenses ratio, earning per employee, cost per loan, sightly loan size and cost per building block of money lent can be used as a proxy of the management quality. ADB recommends cost per unit of money lent as a proxy of management quality. But this can not be used as an indicator of management quality in Nepal. Since the data on amount of the total loan mobilized during a particular FY is not available in published financial statements and annual reports. As stated earlier, NRB has skipped up this component of CAMELS in the performance evaluation of commercial banks (see NRB 2005).2.4 Earning PerformanceEarning capacity or profitability keeps up the sound health of an FI. Chronically unprofitable FI risks insolvency on one hand and on the others, unusually high profitability can reflect extravagant risk taking of an FI. There are different indicators of profitability. Return on assets, return on equity, interest-spread ratio, earning-spread ratio, gross margin, 44Health Check-up of Commercial Banks operational profit margin and net profit margin are usually used profitability indicators. NRB uses return on total assets as an indicator of profitability of a commercial bank. In addition, it uses t he absolute measures such as interest income, net interest income, noninterest income, net non-interest income, non-operating income, net non-operating income and net profit, to estimate the profitability of a commercial bank (NRB 2005). 2.5 LiquidityLiquidity risk threats the solvency of FIs. In the case of commercial banks, first type of liquidity risk arises when depositors of commercial banks seek to withdraw their money and the second type does when perpetration holders want to exercise the commitments recorded off the balance sheet. Commercial banks have to borrow the superfluous funds or sell the assets at go off sale price to pay off the deposit liabilities. They become belly-up(predicate) if sale price of the assets are not enough to meet the liability withdrawals.The second type of liquidity risk arises when demand for unexpected loans can not be met due to the lack of the funds. Commercial banks can shew thefunds by running down their bills assets, borrowing addit ional funds in the money markets and selling off other assets at distressed price. Both liability side liquidity risk (first type risk) and asset side liquidity risk (second type risk) affect the health of commercial banks adversely. But maintaining the high liquidity position to minimize such risks also adversely affects the profitability of FIs.Return on highly liquid assets is almost zero. Therefore, FIs should strike the tradeoff between liquidity position and profitability so that they could maintain their health sound. Commercial banks liquidity exposure can be measured by analyzing the sources and uses of liquidity. In this approach, total net liquidity is worked out by deducting the total of uses of liquidity from the total of sources of liquidity. Similarly, BIS maturity laddering model can be used to measure the liquidity of a commercial banks. In addition, different liquidity exposure ratios such as borrowed funds to total assets, core deposit to total assets, loans to de posits, and commitments to lend to total assets are used to measure the liquidity position of a commercial bank (Saunders and Cornett 2004). NRB uses total loan to total deposit ratio, cash and equivalents to total assets ratio, cash and equivalents to total deposit ratio, NRB balance to total deposit ratio to measure the liquidity position of commercial banks in the feast of the performance evaluation of commercial banks (NRB 2005). 2.6 Sensitivity to Market RiskCommercial banks are increasingly involved in diversified operations such as lending and borrowing, transaction in foreign exchange, selling off assets pledged for securities and so on. All these are subject to market risk like interest rate risk, foreign exchange rate risk, and financial asset and commodity price risk. The health of an FI more sensitive to market risk is more hazardous than that of less sensitive. Foreign exchange risk, interest rate risk, equity price risk, and commodity price risk are the indicators of sensitivity to market risk.3. MethodologyAt present, all together 17 commercial banks are in operation. Out of this, Rastriya Banijya Bank is fully own by HMG/Nepal while in case of Nepal Bank Ltd, HMG/Nepal is the major shareholder. There are six joint venturebanks in collaboration with the foreign investment partners and remaining are fully owned by Nepalese investors. For the purpose 45The Journal of Nepalese Business Studiesof this study, the nation has been delimitate in term of joint venture commercial banks. So the population of this study is six. For the purpose of this study, 3 banksNabil Bank Limited (Nabil), Nepal SBI Bank Ltd. (NSBI) and standardized Chartered Bank Nepal Limited (SCBN), were selected randomly (for sampling frame and stress refer to Appendix 1).This study is based on the historical data unwrap by annual reports of commercial banks. NRB has dictated the commercial banks to disclose the financial information in the prescribed format since the FY 2001/02 . So, the comparison of financial performance of commercial banks each other is only possible only the FY 2000/01 onward.1 Most of the commercial banks have yet to hold the annual general meeting and publish their annual report for the FY 2004/05. So, it is not possible to include this FY in the study. Therefore, this study covers the last four consecutive fiscal yearsfrom the FY 2000/01 through FY 2003/04.The analysis of this study is entirely based on the CAMELS framework. As stated in theoretical prescription, health check up of any FIs in this framework is concentrated in the six components capital adequacy, asset quality, management quality, earning, liquidity and sensitivity to market. But in this study, the last component has been dropped due to the presence of much more complication.So, analysis of financial health of joint venture banks is carried out in the framework of CAMEL. Indicators of each component also have been used according to the financial data disclosed in an nual reports of sampled joint venture banks. So, complicated indicators of each component of CAMEL framework of checking up the health of the banks have been skipped up in this study (for the indicators of each component refer to Appendix 2).4. Analysis of Financial Health of Commercial BanksThis section of this paper analyses the indicators of the financial health of sampled joint venture banks in the CAMEL framework. As stated inmethodology, all indicators of the financial health of FIs have not be worked out and considerd, only the indicators permitted by the publicly available comparable financial data have been used to analyze the financial health of the sampled banks. The ensuing section presents the analysis of different indicators of sound health of an FI in the context of joint venture banks in Nepal. 4.1 smashing AdequacyAs stated earlier, leverage ratio, core capital ratio, total capital ratio and supplementary capital ratio are used as the indicators of capital adequac y of an FI. Leverage ratios of sampled banks, in general, show that joint venture banks are well capitalized and they are strong enough to mange the shock to balance sheet. Since the leverage ratios of sampled banks during the study periods are greater than 5 percent.Conventionally, leverage ratio of 5 percent or greater than 5 percent indicates that commercial banks are well capitalized. The indicators TCR, CCR and SCR, of capital adequacy of joint venture banks also corroborate with the implication of leverage ratio. In general, all banks under study have met the capital adequacy ratio as directed by NRB. Only NSBI has not met the minimum capital requirement as directed by NRB in the FY 2000/01 and FY 2003/04. In these fiscal years, its TCR and CCR are disappoint than that of minimum ratio specified by NRB. Similarly, in the Financial information for the FY2000/01 were extracted from the annual reports of the sample banks. But this was not possible in Nabil Bank Ltd.Capital of co mmercial banks in Nepal is negative due to the heavy amount of negative capital of two public sector banks Nepal Bank Ltd. and Rastriya Banijya Bank. Capital of these two banks is negative due to the heavy accumulated losses.Thus, the public sector banks have yet to meet the capital adequacy requirements as needful by NRB. But private sector banks have, in general, met the capital adequacy requirement. The comparison between the capital fund to risk weighted assets ratio of each individual joint venture bank with the aggregate capital fund ratio of private sector commercial banks (IAR) implies that joint venture banks have stronger capital base than that of other private sector banks in general. In addition, average capital fund ratio of joint venture banks during the study period hovers around 14 percent. This is higher than the minimum ratio specified by NRB. This clearly implies that joint venture banks are complying with the directive of NRB on the requirement of the capital ba se of commercial banks.As stated in the foregoing analysis, banks under study are well capitalized and they are complying with the directive of NRB on capital adequacy ratio. But their capital base relative to the risk weighted assets is not so strong. According to the international rating convention, total capitalshould be greater than 19.5 percent of the total risk weighted assets of commercial banks in order to be a strong capital base. But none of the banks under study has the capital fund greater than 19.5 percent of the total risk weighted capital. As indicated by TCR, on the average, capital adequacy of joint venture banks is fair during the study period. Total capital adequacy ratio less than 15 and equal to 12 indicates that capital adequacy is fair and on the average this ratio falls within this range. 47The Journal of Nepalese Business Studies4.2 Asset QualityIt is obvious from the theoretical prescription that the health of commercial banks largely depends on the quality of assets held by them, and quality of the assets relies on the financial health of their borrowers. As stated earlier, many indicators can be used to measure the quality of assets held by commercial banks. But, here, only two simple indicators non-performing asset ratio and loan loss reserve ratioare used to measure the quality of assets being held by banks. The increasing trend of these ratios shows the deteriorating quality of commercial bank assets. In general, 5 percent to 10 percent of non-performing assets is considered as satisfactory level of quality of bank assets, shelve 2 Indicators of Asset Quality of Sampled Banks