CHAPTER 1:

INTRODUCTION TO THE STUDY

INTRODUCTION TO THE BANKING REFORMS INTRODUCTION TO BASEL II & BASEL 1II ACCORD

THE 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

INTRODUCTION TO THE BANKING REFORMS

In 1991, the Indian economy went through a process of economic liberalization, which was followed up by the initiation of fundamental reforms in the banking sector in 1992. The banking reform package was based on the recommendations proposed by the Narsimhan Committee Report (1991) that advocated a move to a more market oriented banking system, which would operate in an environment of prudential regulation and transparent accounting. One of the primary motives behind this drive was to introduce an element of market discipline into the regulatory process that would reinforce the supervisory effort of the Reserve Bank of India (RBI). Market discipline, especially in the financial liberalization phase, reinforces regulatory and supervisory efforts and provides a strong incentive to banks to conduct their business in a prudent and efficient manner and to maintain adequate capital as a cushion against risk exposures. Recognizing that the success of economic reforms was contingent on the success of financial sector reform as well, the government initiated a fundamental banking sector reform package in 1992.

Banking sector, the world over, is known for the adoption of multidimensional strategies from time to time with varying degrees of success. Banks are very important for the smooth functioning of financial markets as they serve as repositories of vital financial information and can potentially alleviate the problems created by information asymmetries. From a central banks perspective, such high-quality disclosures help the early detection of problems faced by banks in

the market and reduce the severity of market disruptions. Consequently, the RBI as part and parcel of the financial sector deregulation, attempted to enhance the transparency of the annual reports of Indian banks by, among other things, introducing stricter income recognition and asset classification rules, enhancing the capital adequacy norms, and by requiring a number of additional disclosures sought by investors to make better cash flow and risk assessments.

During the pre economic reforms period, commercial banks & development financial institutions were functioning distinctly, the former specializing in short & medium term financing, while the latter on long term lending & project financing.

Commercial banks were accessing short term low cost funds thru savings investments like current accounts, savings bank accounts & short duration fixed deposits, besides collection float. Development Financial Institutions (DFIs) on the other hand, were essentially depending on budget allocations for long term lending at a concessionary rate of interest.

Major Recommendations by the Narasimham Committee on Banking Sector Reforms

Strengthening Banking System

Capital adequacy requirements should take into account market risks in addition to the credit risks. In the next three years the entire portfolio of government securities should be marked to market and the schedule for the same announced at the earliest (since announced in the monetary and credit policy for the first half of 1998-99); government and other approved securities which are now subject to a zero risk weight, should have a 5 per cent weight for market risk. Risk weight on a government guaranteed advance should be the same as for other advances. This should be made prospective from the time the new prescription is put in place. Foreign exchange open credit limit risks should be integrated into the calculation of risk weighted assets and should carry a 100 per cent risk weight. Minimum capital to risk assets ratio (CRAR) be increased from the existing 8 per cent to 10 per cent; an intermediate minimum target of 9 per cent be achieved by 2000 and the ratio of 10 per cent by 2002; RBI to be empowered to raise this further for individual banks if the risk profile warrants such an increase. Individual banks' shortfalls in the

CRAR are treated on the same line as adopted for reserve requirements, viz. uniformity across weak and strong banks. There should be penal provisions for banks that do not maintain CRAR. Public Sector Banks in a position to access the capital market at home or abroad be encouraged, as subscription to bank capital funds cannot be regarded as a priority claim on budgetary resources.

Asset Quality
An asset is classified as doubtful if it is in the substandard category for 18 months in the first instance and eventually for 12 months and loss if it has been identified but not written off. These norms should be regarded as the minimum and brought into force in a phased manner. For evaluating the quality of assets portfolio, advances covered by Government guarantees, which have turned sticky, be treated as NPAs. Exclusion of such advances should be separately shown to facilitate fuller disclosure and greater transparency of operations.
For banks with a high NPA portfolio, two alternative approaches could be adopted. One

approach can be that, all loan assets in the doubtful and loss categories should be identified and their realizable value determined. These assets could be transferred to an Assets Reconstruction Company (ARC) which would issue NPA Swap Bonds. An alternative approach could be to enable the banks in difficulty to issue bonds which could from part of Tier II capital, backed by government guarantee to make these instruments eligible for SLR investment by banks and approved instruments by LIC, GIC and Provident Funds.

 The interest subsidy element in credit for the priority sector should be totally eliminated and interest rate on loans under Rs. 2 lakhs should be deregulated for scheduled commercial banks as has been done in the case of Regional Rural Banks and cooperative credit institutions.

Prudential Norms and Disclosure Requirements

In India, income stops accruing when interest or installment of principal is not paid within 180 days, which should be reduced to 90 days in a phased manner by 2002. Introduction of a general provision of 1 per cent on standard assets in a phased manner be considered by RBI. As an incentive to make specific provisions, they may be made tax deductible.

Systems and Methods in Banks

There should be an independent loan review mechanism especially for large borrowable

accounts and systems to identify potential NPAs. Banks may evolve a filtering mechanism by stipulating in-house prudential limits beyond which exposures on single/group borrowers are taken keeping in view their risk profile as revealed through credit rating and other relevant factors. Banks and FIs should have a system of recruiting skilled manpower from the open market. Public sector banks should be given flexibility to determined managerial remuneration levels taking into account market trends.

 There may be need to redefine the scope of external vigilance and investigation agencies with regard to banking business. There is need to develop information and control system in several areas like better tracking of spreads, costs and NPSs for higher profitability, , accurate and timely information for strategic decision to Identify and promote profitable products and customers, risk and asset-liability management; and efficient treasury management.

Structural Issues
With the conversion of activities between banks and DFIs, the DFIs should, over a period of time convert them to bank. A DFI which converts to bank be given time to face in reserve equipment in respect of its liability to bring it on par with requirement relating to commercial bank. Mergers of Public Sector Banks should emanate from the management of the banks with the Government as the common shareholder playing a supportive role. Merger should not be seen as a means of bailing out weak banks. Mergers between strong banks/FIs would make for greater economic and commercial sense. Weak Banks' may be nurtured into healthy units by slowing down on expansion, eschewing high cost funds/borrowings etc.
The minimum share of holding by Government/Reserve Bank in the equity of the

nationalized banks and the State Bank should be brought down to 33%. The RBI regulator of the monetary system should not be also the owner of a bank in view of the potential for possible conflict of interest. There is a need for a reform of the deposit insurance scheme based on CAMELs ratings awarded by RBI to banks.

 Inter-bank call and notice money market and inter-bank term money market should be strictly restricted to banks; only exception to be made is primary dealers. Non-bank parties are provided free access to bill rediscounts, CPs, CDs, Treasury Bills, and MMMF. RBI should totally withdraw from the primary market in 91 days Treasury Bills.

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 8% 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. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.

The final version aims at:

1. Ensuring that capital allocation is more risk sensitive; 2. Separating operational risk from credit risk, and quantifying both;

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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 (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline to promote greater stability in the financial system.

The Three Pillars of Basel II

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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 or BIA, standardized approach or TSA, and advanced measurement approach or AMA. For market risk the preferred approach is VaR (value at risk). As the Basel 2 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

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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) 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

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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.

BASEL III
BASEL III refers to a new update to the Basel Accords that is under development. While the Bank for International Settlements (BIS) does not currently specify this work as "Basel III", the term appeared in the literature as early as 2005 and is now in common usage anticipating this next revision to the Basel Accords.

The draft Basel III regulations include:

"tighter definitions of Tier 1 capital; banks must hold 4.5% by January 2015, then a further 2.5%, totaling 7%.

the introduction of a leverage ratio,

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a framework for counter-cyclical capital buffers, measures to limit counterparty credit risk, and short and medium-term quantitative liquidity ratios."

Summary of Changes Proposed in Basel III

First, the quality, consistency, and transparency of the capital base will be raised. Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings

Tier 2 capital instruments will be harmonized Tier 3 capital will be eliminated.

Second, the risk coverage of the capital framework will be strengthened. Strengthen the capital requirements for counterparty credit exposures arising from banks derivatives, repo and securities financing transactions

Raise the capital buffers backing these exposures Reduce procyclicality and

Provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses) Provide incentives to strengthen the risk management of counterparty credit exposures

Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework.

The Committee therefore is introducing a leverage ratio requirement that is intended to achieve the following objectives:

Put a floor under the build-up of leverage in the banking sector

Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures. Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers").

The Committee is introducing a series of measures to address procyclicality:

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Dampen any excess cyclicality of the minimum capital requirement; Promote more forward looking provisions;

Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and Achieve the broader macro prudential goal of protecting the banking sector from periods of excess credit growth.

Requirement to use long term data horizons to estimate probabilities of

default, downturn loss-given-default estimates, recommended in Basel II, to become mandatory

Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements.

Banks must conduct stress tests that include widening credit spreads in recessionary scenarios.

Promoting stronger provisioning practices (forward looking provisioning): Advocating a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount: = LGD*PD*EAD).

Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio.

The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.

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CHAPTER 2 COMPANY PROFILE

DHANLAXMI BANK

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2.1 COMPANY PROFILE

It was incorporated on 14th November 1927 by a group of enterprising entrepreneurs at Thrissur, the cultural capital of Kerala with a capital of Rs.11, 000 and 7 employees. It becomes a scheduled commercial bank in the year 1977. It has today a national stature with 63 branches and 26 extension counters spread over state of Kerala, Tamil Nadu, Karnataka, Andhra Pradesh, Maharashtra, Gujarat, Delhi and west Bengal.

The bank was recently received approval from the reserve bank of India for opening 66 branches and 380 ATMS across the country during the year 2009. This will increase the number of customer outlets from the current level of 279 to 550. The bank has also been permitted by RBI 5 regional offices in Kerala at Trivandrum, Ernakulam, Thrissur, Palghat and Kozhikode and also two central processing centres at thrissur and Hyderabad.

The bank serviced a business of Rs.12154.96 crores as on 31.03.2010 comprising deposits of Rs.7098.48 crores and advance of Rs.5056.48 crores. The bank made net profits of Rs.23.30 Crores for the nine month ended 31st march 2010. Its capital adequacy ratio as on 31.03.2010 was 12.47%. The bank is tech savvy and has developed technology widely as an instrument for the enhancing the quality of customer service. It has introduced centralized banking solution (CBS) on the flex cube platform extending anywhere/ anytime banking to its clientele through multiple delivery

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channels. The bank has deployed CBS in branches covering 100% of the total business. The bank has set-up a state of the art DATA CENTRE in Bangalore, to keep the networked system operational 24 hours a day and 7 days a week.

The bank lays stress on customizing service and personalizing relations. It has introduced an international debit card through a tie up with M/s visa international. As part of this overall effort, the bank has joined CASHNET. The first independent nation wide share ATM in India, the national financial switch (ATM network) of the IDRBT.

The bank has introduced Tele- banking and internet banking at all branches. It has implemented centralized CMS software by locating the CMS hub at corporate office thrissur enabling all CBS branches to do CMS operations.

The bank has put in place real time gross settlement (RTGS) and national electronic fund transfer (NEFT) systems to facilitate large value payments and settlement in real time on-line mode on a transaction by-transactions basis. The bank has ventured into insurance business. It is selling insurance products of M/s.Bajaj alliance general insurance company LTD, at their corporate agent. The bank is also a depository participant of NSDL (National Security Depository Limited) offering Demat service selected branches. With a view to making available value added services to the NRIs, the bank has set up NRI boutiques (relationship centres) at 9 location in the state of Kerala and Tamil Nadu. The bank has also plans open to specialized NRI outlets with accent of quality of service at potential locations. The bank had rupee drawing arrangements with 8 exchange houses in the Middle East. For fast money transfer,it a has tie up with the UAE and exchange & financial service for express money and money gram, wall street finance for wall street instant cash and Indusind

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bank limited for Zoha inc. the bank gas also tie up with SBI mutual funds , Birla Sunlife mutual funds and principal PNB asset management company Pvt ltd for selling their products.

The banks corporate office, thrissur, and industrial finance bank at kochi have been accredited with certification under ISO 9001 2000.

On the socio-economic front, the bank is a leading player in dispensation of micro credit among Kerala-based bank, both public and private. At the end of March 2010, the agricultural outstanding as a percentage of NBC stood at 23.68%, against RBI prescription of 18% by the end of March 2010. This involvement is part of the banks objective to act as catalysts for the economic prosperity of the country. The bank has recognized micro finance intervention as an effective tool for poverty alleviation and has streamlined the linkage between the bank and the self help groups through nearly 130 branches. The priority sector advances increased from Rs.1147.62 crores as at the end of March 2009, to Rs. 1409.28 crores as at the end of March 2010, recording a growth of 22.8%. The bank also continued its thrust on micro credit as an instrument of inclusive banking. The outstanding under this sector more than doubled from Rs. 124.40 crores as on March 31, 2009 to Rs. 270.62 crores (March 31, 2010), thereby showing a growth of 117.54%.

The bank is manage by a board of directors comprising professional drawn from various walks of life with Shri G.N.Bhajpai as chairman and Shri.Amithabh chathurvedi as the managing Director and CEO.

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CHAPTER 3

CAMELS FRAMEWORK

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The CAMELS FRAMEWORK

3.1 Introduction:
During an on-site bank exam, supervisors gather private information, such as details on problem loans, with which to evaluate a bank's financial condition and to monitor its compliance with laws and regulatory policies. A key product of such an exam is a supervisory rating of the bank's overall condition, commonly referred to as a CAMELS rating. This rating system is used by the three federal banking supervisors (the Federal Reserve, the FDIC, and the OCC) and other financial supervisory agencies to provide a convenient summary of bank conditions at the time of an exam. The acronym "CAMEL" refers to the five components of a bank's condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. A sixth component, a bank's Sensitivity to market risk, was added in 1997; hence the acronym was changed to CAMELS. (Note that the bulk of the academic literature is based on pre-1997 data and is thus based on CAMEL ratings.) Ratings are assigned for each component in addition to the overall rating of a bank's financial condition. The ratings are assigned on a scale from 1 to 5. Banks with ratings of 1 or 2 are considered to present few, if any, supervisory concerns, while banks with ratings of 3, 4, or 5 present moderate to extreme degrees of supervisory concern.

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In 1994, the RBI established the Board of Financial Supervision (BFS), which operates as a unit of the RBI. The entire supervisory mechanism was realigned to suit the changing needs of a strong and stable financia l 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 addition to the normal on-site inspections, Reserve Bank of India also conducts off-site surveillance which particularly focuses on the risk profile of the supervised entity. The Off-site Monitoring and Surveillance System (OSMOS) was introduced in 1995 as an additional tool for supervision of commercial banks. It was introduced with the aim to supplement the on-site inspections. Under off-site system, 12 returns (called DSB returns) are called from the financial institutions, wich focus on supervisory concerns such as capital adequacy, asset quality, large credits and concentrations, connected lending, earnings and risk exposures (viz. currency, liquidity and interest rate risks). In 1995, RBI had set up a working group under the chairmanship of Shri S. Padmanabhan to review the banking supervision system. The Committee 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 systems and control elements 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. All exam materials are highly confidential, including the CAMELS. A bank's CAMELS rating is directly known only by the bank's senior management and the appropriate supervisory staff. CAMELS ratings are never released by supervisory agencies, even on a lagged basis. While exam results are confidential, the public may infer such supervisory information on bank conditions based on subsequent bank actions or specific disclosures. Overall, the private

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supervisory information gathered during a bank exam is not disclosed to the public by supervisors, although studies show that it does filter into the financial markets.

CAMELS ratings in the supervisory monitoring of banks

Several academic studies have examined whether and to what extent private supervisory information is useful in the supervisory monitoring of banks. With respect to predicting bank failure, Barker and Holdsworth (1993) find evidence that CAMEL ratings are useful, even after controlling for a wide range of publicly available information about the condition and performance of banks. Cole and Gunther (1998) examine a similar question and find that although CAMEL ratings contain useful information, it decays quickly. For the period between 1988 and 1992, they find that a statistical model using publicly available financial data is a better indicator of bank failure than CAMEL ratings that are more than two quarters old. Hirtle and Lopez (1999) examine the usefulness of past CAMEL ratings in assessing banks' current conditions. They find that, conditional on current public information, the private supervisory information contained in past CAMEL ratings provides further insight into bank current conditions, as summarized by current CAMEL ratings. The authors find that, over the period from 1989 to 1995, the private supervisory information gathered during the last on-site exam remains useful with respect to the current condition of a bank for up to 6 to 12 quarters (or 1.5 to 3 years). The overall conclusion drawn from academic studies is that private supervisory information, as summarized by CAMELS ratings, is clearly useful in the supervisory monitoring of bank conditions.

CAMELS ratings in the public monitoring of banks

Another approach to examining the value of private supervisory information is to examine its impact on the market prices of bank securities. Market prices are generally assumed to

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incorporate all available public information. Thus, if private supervisory information were found to affect market prices, it must also be of value to the public monitoring of banks. Such private information could be especially useful to financial market participants, given the informational asymmetries in the commercial banking industry. Since banks fund projects not readily financed in public capital markets, outside monitors should find it difficult to completely assess banks' financial conditions. In fact, Morgan (1998) finds that rating agencies disagree more about banks than about other types of firms. As a result, supervisors with direct access to private bank information could generate additional information useful to the financial markets, at least by certifying that a bank's financial condition is accurately reported. The direct public beneficiaries of private supervisory information, such as that contained in CAMELS ratings, would be depositors and holders of banks' securities. Small depositors are protected from possible bank default by FDIC insurance, which probably explains the finding by Gilbert and Vaughn (1998) that the public announcement of supervisory enforcement actions, such as prohibitions on paying dividends, did not cause deposit runoffs or dramatic increases in the rates paid on deposits at the affected banks. However, uninsured depositors could be expected to respond more strongly to such information. Jordan, et al., (1999) find that uninsured deposits at banks that are subjects of publicly-announced enforcement actions, such as ceaseand-desist orders, decline during the quarter after the announcement. The holders of commercial bank debt, especially subordinated debt, should have the most in common with supervisors, since both are more concerned with banks' default probabilities (i.e., downside risk). As of year-end 1998, bank holding companies (BHCs) had roughly $120 billion in outstanding subordinated debt. DeYoung, et al., (1998) examine whether private supervisory information would be useful in pricing the subordinated debt of large BHCs. The authors use an econometric technique that estimates the private information component of the CAMEL ratings for the BHCs' lead banks and regresses it onto subordinated bond prices. They conclude that this aspect of CAMEL ratings adds significant explanatory power to the regression after controlling for publicly available financial information and that it appears to be incorporated into bond prices about six months after an exam. Furthermore, they find that supervisors are more likely to

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uncover unfavorable private information, which is consistent with managers' incentives to publicize positive information while de-emphasizing negative information. These results indicate that supervisors can generate useful information about banks, even if those banks already are monitored by private investors and rating agencies. The market for bank equity, which is about eight times larger than that for bank subordinated debt, was valued at more than $910 billion at year-end 1998. Thus, the academic literature on the extent to which private supervisory information affects stock prices is more extensive. For example, Jordan, et al., (1999) find that the stock market views the announcement of formal enforcement actions as informative. That is, such announcements are associated with large negative stock returns for the affected banks. This result holds especially for banks that had not previously manifested serious problems. Focusing specifically on CAMEL ratings, Berger and Davies (1998) use event study methodology to examine the behavior of BHC stock prices in the eight-week period following an exam of its lead bank. They conclude that CAMEL downgrades reveal unfavorable private information about bank conditions to the stock market. This information may reach the public in several ways, such as through bank financial statements made after a downgrade. These results suggest that bank management may reveal favorable private information in advance, while supervisors in effect force the release of unfavorable information. Berger, Davies, and Flannery (1998) extend this analysis by examining whether the information about BHC conditions gathered by supervisors is different from that used by the financial markets. They find that assessments by supervisors and rating agencies are complementary but different from those by the stock market. The authors attribute this difference to the fact that supervisors and rating agencies, as representatives of debt holders, are more interested in default probabilities than the stock market, which focuses on future revenues and profitability. This rationale also could explain the authors' finding that supervisory assessments are much less accurate than market assessments of banks' future performances.

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In summary, on-site bank exams seem to generate additional useful information beyond what is publicly available. However, according to Flannery (1998), the limited available evidence does not support the view that supervisory assessments of bank conditions are uniformly better and timelier than market assessments. CAMELS is basically a ratio-based model for evaluating the performance of banks. Various ratios forming this model are explained below :

3.2) C- Capital Adequacy:

Capital base of financial institutions facilitates depositors in forming their risk perception about the institutions. Also, it is the key parameter for financial managers to maintain adequate levels of capitalization. Moreover, besides absorbing unanticipated shocks, it signals that the institution will continue to honor its obligations. The most widely used indicator of capital adequacy is capital to risk-weighted assets ratio (CRWA). According to Bank Supervision Regulation Committee (The Basle Committee) of Bank for International Settlements, a minimum 9 percent CRWA is required. Capital adequacy ultimately determines how well financial institutions can cope with shocks to their balance sheets. Thus, it is useful to track capital-adequacy ratios that take into account the most important financial risksforeign exchange, credit, and interest rate risksby assigning risk weightings to the institutions assets A sound capital base strengthens confidence of depositors. This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world. The following ratios measure capital adequacy:

Debt Equity Ratio:

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This ratio indicates the degree of leverage of a bank. It indicates how much of the bank business is financed through debt and how much through equity. This is calculated as the proportion of total asset liability to net worth. Outside liability includes total borrowing, deposits and other liabilities. Net worth includes equity capital and reserve and surplus. Higher the ratio indicates less protection for the creditors and depositors in the banking system. Borrowings/ (Share Capital + reserves)

Total Advance to Total Asset Ratio:

This is the ratio of the total advanced to total asset. This ratio indicates banks aggressiveness in lending which ultimately results in better profitability. Higher ratio of advances of bank deposits (assets) is preferred to a lower one. Total advances also include receivables. The value of total assets is excluding the revolution of all the assets. Total Advances/ Total Asset

Government Securities to Total Investments:

The percentage of investment in government securities to total investment is a very important indicator, which shows the risk taking ability of the bank. It indicates a banks strategy as being high profit high risk or low profit low risk. It also gives a view as to the availability of alternative investment opportunities. Government securities are generally considered as the most safe debt instrument, which, as a result, carries the lowest return. Since government securities are risk free, the higher the government security to investment ratio, the lower the risk involved in a banks investments. Government Securities/ Total Investment

3.3) A Asset Quality:

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Asset quality determines the healthiness of financial institutions against loss of value in the assets. The weakening value of assets, being prime source of banking problems, directly pour into other areas, as losses are eventually written-off against capital, which ultimately expose the earning capacity of the institution. With this backdrop, the asset quality is gauged in relation to the level and severity of non-performing assets, adequacy of provisions, recoveries, distribution of assets etc. Popular indicators include nonperforming loans to advances, loan default to total advances, and recoveries to loan default ratios. The solvency of financial institutions typically is at risk when their assets become impaired, so it is important to monitor indicators of the quality of their assets in terms of overexposure to specific risks, trends in nonperforming loans, and the health and profitability of bank borrowers especially the corporate sector. Share of bank assets in the aggregate financial sector assets: In most emerging markets, banking sector assets comprise well over 80 per cent of total financial sector assets, whereas these figures are much lower in the developed economies. Furthermore, deposits as a share of total bank liabilities have declined since 1990 in many developed countries, while in developing countries public deposits continue to be dominant in banks. In India, the share of banking assets in total financial sector assets is around 75 per cent, as of endMarch 2008. There is, no doubt, merit in recognizing the importance of diversification in the institutional and instrument-specific aspects of financial intermediation in the interests of wider choice, competition and stability. However, the dominant role of banks in financial intermediation in emerging economies and particularly in India will continue in the mediumterm; and the banks will continue to be special for a long time. In this regard, it is useful to emphasize the dominance of banks in the developing countries in promoting non-bank financial intermediaries and services including in development of debt-markets. Even where role of banks is apparently diminishing in emerging markets, substantively, they continue to play a leading role in non-banking financing activities, including the development of financial markets. One of the indicators for asset quality is the ratio of non-performing loans to total loans. Higher ratio is indicative of poor credit decision-making.

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NPA: Non-Performing Assets:

Advances are classified into performing and non-performing advances (NPAs) as per RBI guidelines. NPAs are further classified into sub-standard, doubtful and loss assets based on the criteria stipulated by RBI. An asset, including a leased asset, becomes nonperforming when it ceases to generate income for the Bank.

An NPA is a loan or an advance where: 1. Interest and/or installment of principal remains overdue for a period of more than 90 days in respect of a term loan; 2. The account remains "out-of-order'' in respect of an Overdraft or Cash Credit (OD/CC); 3. The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted; 4. A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for two crop seasons; and 5. A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for one crop season. The Bank classifies an account as an NPA only if the interest imposed during any quarter is not fully repaid within 90 days from the end of the relevant quarter. This is a key to the stability of the banking sector. There should be no hesitation in stating that Indian banks have done a remarkable job in containment of non-performing loans (NPL) considering the overhang issues and overall difficult environment. The following ratios are necessary to assess the asset quality.

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Gross NPA ratio:

This ratio is used to check whether the bank's gross NPAs are increasing quarter on quarter or year on year. If it is, indicating that the bank is adding a fresh stock of bad loans. It would mean the bank is either not exercising enough caution when offering loans or is too lax in terms of following up with borrowers on timely repayments. Gross NPA/ Total Loan

Net NPA ratio:

Net NPAs reflect the performance of banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also wear down the value of the asset. Loans and advances usually represent the largest asset of most of the banks. It monitors the quality of the banks loan portfolio. The higher the ratio, the higher the credits risk

Net NPA/ Total Loan

3.4) M Management:
Management of financial institution is generally evaluated in terms of capital adequacy, asset quality, earnings and profitability, liquidity and risk sensitivity ratings. In addition, performance evaluation includes compliance with set norms, ability to plan and react to changing circumstances, technical competence, leadership and administrative ability. Sound management is one of the most important factors behind financial institutions performance. Indicators of quality of management, however, are primarily applicable to individual institutions, and cannot be easily aggregated across the sector. Furthermore, given the

31

qualitative nature of management, it is difficult to judge its soundness just by looking at financial accounts of the banks. Nevertheless, total advance to total deposit, business per employee and profit per employee helps in gauging the management quality of the banking institutions. Several indicators, however, can jointly serveas, for instance, efficiency measures doas an indicator of management soundness. The ratios used to evaluate management efficiency are described as under:

Total Advance to Total Deposit Ratio:

This ratio measures the efficiency and ability of the banks management in converting the deposits available with the banks (excluding other funds like equity capital, etc.) into high earning advances. Total deposits include demand deposits, saving deposits, term deposit and deposit of other bank. Total advances also include the receivables. Total Advance/ Total Deposit

Business per Employee:

Revenue per employee is a measure of how efficiently a particular bank is utilizing its employees. Ideally, a bank wants the highest business per employee possible, as it denotes higher productivity. In general, rising revenue per employee is a positive sign that suggests the bank is finding ways to squeeze more sales/revenues out of each of its employee. Total Income/ No. of Employees

Profit per Employee:

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This ratio shows the surplus earned per employee. It is arrived at by dividing profit after tax earned by the bank by the total number of employee. The higher the ratio shows good efficiency of the management. Profit after Tax/ No. of Employees

3.5) E Earning & Profitability:

Earnings and profitability, the prime source of increase in capital base, is examined with regards to interest rate policies and adequacy of provisioning. In addition, it also helps to support present and future operations of the institutions. The single best indicator used to gauge earning is the Return on Assets (ROA), which is net income after taxes to total asset ratio.

Strong earnings and profitability profile of banks reflects the ability to support present and future operations. More specifically, this determines the capacity to absorb losses, finance its expansion, pay dividends to its shareholders, and build up an adequate level of capital. Being front line of defense against erosion of capital base from losses, the need for high earnings and profitability can hardly be overemphasized. Although different indicators are used to serve the purpose, the best and most widely used indicator is Return on Assets (ROA).

However, for in-depth analysis, another indicator Interest Income to Total Income and Other income to Total Income is also in used. Compared with most other indicators, trends in profitability can be more difficult to interpretfor instance, unusually high profitability can reflect excessive risk taking. The following ratios try to assess the quality of income in terms of income generated by core activity income from landing operations.

Dividend Payout Ratio:

33

Dividend payout ratio shows the percentage of profit shared with the shareholders. The more the ratio will increase the goodwill of the bank in the share market. Dividend/ Net profit

Return on Asset:

Net profit to total asset indicates the efficiency of the banks in utilizing their assets in generating profits. A higher ratio indicates the better income generating capacity of the assets and better efficiency of management in future. Net Profit/ Total Asset

Operating Profit by Average Working Fund:

This ratio indicates how much a bank can earn from its operations net of the operating expenses for every rupee spent on working funds. Average working funds are the total resources (total assets or total liabilities) employed by a bank. It is daily average of total assets/ liabilities during a year. The higher the ratio, the better it is. This ratio determines the operating profits generated out of working fund employed. The better utilization of the funds will result in higher operating profits. Thus, this ratio will indicate how a bank has employed its working funds in generating profits. Operating Profit/ Average Working Fund

Net Profit to Average Asset:

Net profit to average asset indicates the efficiency of the banks in utilizing their assets in generating profits. A higher ratio indicates the better income generating capacity of the assets

34

and better efficiency of management. It is arrived at by dividing the net profit by average assets, which is the average of total assets in the current year and previous year. Thus, this ratio measures the return on assets employed. Higher ratio indicates better earning potential in the future. Net Profit/ Average Asset

Interest Income to Total Income:

Interest income is a basic source of revenue for banks. The interest income total income indicates the ability of the bank in generating income from its lending. In other words, this ratio measures the income from lending operations as a percentage of the total income generated by the bank in a year. Interest income includes income on advances, interest on deposits with the RBI, and dividend income. Interest Income/ Total Income

Other Income to Total Income:

Fee based income account for a major portion of the banks other income. The bank generates higher fee income through innovative products and adapting the technology for sustained service levels. The higher ratio indicates increasing proportion of fee-based income. The ratio is also influenced by gains on government securities, which fluctuates depending on interest rate movement in the economy. Other Income/ Total Income

3.6) L Liquidity:
An adequate liquidity position refers to a situation, where institution can obtain sufficient funds, either by increasing liabilities or by converting its assets quickly at a reasonable cost. It is, therefore, generally assessed in terms of overall assets and liability management, as mismatching

35

gives rise to liquidity risk. Efficient fund management refers to a situation where a spread between rate sensitive assets (RSA) and rate sensitive liabilities (RSL) is maintained. The most commonly used tool to evaluate interest rate exposure is the Gap between RSA and RSL, while liquidity is gauged by liquid to total asset ratio. Initially solvent financial institutions may be driven toward closure by poor management of short-term liquidity. Indicators should cover funding sources and capture large maturity mismatches. The term liquidity is used in various ways, all relating to availability of, access to, or convertibility into cash. An institution is said to have liquidity if it can easily meet its needs for cash either because it has cash on hand or can otherwise raise or borrow cash. A market is said to be liquid if the instruments it trades can easily be bought or sold in quantity with little impact on market prices. An asset is said to be liquid if the market for that asset is liquid. The common theme in all three contexts is cash. A corporation is liquid if it has ready access to cash. A market is liquid if participants can easily convert positions into cash or conversely. An asset is liquid if it can easily be converted to cash. The liquidity of an institution depends on: The institution's short-term need for cash;

Cash on hand;

Available lines of credit; The liquidity of the institution's assets;

The institution's reputation in the marketplacehow willing will counterparty is to

transact trades with or lend to the institution? The ratios suggested to measure liquidity under CAMELS Model are as follows :

Liquidity Asset to Total Asset:

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Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions. Liquid assets include cash in hand, balance with the RBI, balance with other banks (both in India and abroad), and money at call and short notice. Total asset include the revaluations of all the assets. The proportion of liquid asset to total asset indicates the overall liquidity position of the bank. Liquidity Asset/ Total Asset

Government Securities to Total Asset:

Government Securities are the most liquid and safe investments. This ratio measures the government securities as a proportion of total assets. Banks invest in government securities primarily to meet their SLR requirements, which are around 25% of net demand and time liabilities. This ratio measures the risk involved in the assets hand by a bank. Government Securities/ Total Asset

Approved Securities to Total Asset:

Approved securities include securities other than government securities. This ratio measures the Approved Securities as a proportion of Total Assets. Banks invest in approved securities primarily after meeting their SLR requirements, which are around 25% of net demand and time liabilities. This ratio measures the risk involved in the assets hand by a bank. Approved Securities/ Total Asset

Liquidity Asset to Demand Deposit:

37

This ratio measures the ability of a bank to meet the demand from deposits in a particular year. Demand deposits offer high liquidity to the depositor and hence banks have to invest these assets in a highly liquid form. Liquidity Asset/ demand Deposit

Liquidity Asset to Total Deposit:

This ratio measures the liquidity available to the deposits of a bank. Total deposits include demand deposits, savings deposits, term deposits and deposits of other financial institutions. Liquid assets include cash in hand, balance with the RBI, balance with other banks (both in India and abroad), and money at call and short notice. Liquidity Asset/ Total Deposit

3.7) S Sensitivity to Market Risk:

It refers to the risk that changes in market conditions could adversely impact earnings and/or capital. Market Risk encompasses exposures associated with changes in interest rates, foreign exchange rates, commodity prices, equity prices, etc. While all of these items are important, the primary risk in most banks is interest rate risk (IRR), which will be the focus of this module. The diversified nature of bank operations makes them vulnerable to various kinds of financial risks. Sensitivity analysis reflects institutions exposure to interest rate risk, foreign exchange volatility and equity price risks (these risks are summed in market risk). Risk sensitivity is mostly evaluated in terms of managements ability to monitor and control market risk. Banks are increasingly involved in diversified operations, all of which are subject to market risk, particularly in the setting of interest rates and the carrying out of foreign exchange transactions. In countries that allow banks to make trades in stock markets or commodity exchanges, there is also a need to monitor indicators of equity and commodity price risk.

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Interest Rate Risk Basics:

In the most simplistic terms, interest rate risk is a balancing act. Banks are trying to balance the quantity of reprising assets with the quantity of reprising liabilities. For example, when a bank has more liabilities reprising in a rising rate environment than assets reprising, the net interest margin (NIM) shrinks. Conversely, if your bank is asset sensitive in a rising interest rate environment, your NIM will improve because you have more assets reprising at higher rates Liquidity risk is financial risk due to uncertain liquidity. An institution might lose liquidity if its credit rating falls, it experiences sudden unexpected cash outflows, or some other event causes counterparties to avoid trading with or lending to the institution. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. Liquidity risk tends to compound other risks. If a trading organization has a position in an illiquid asset, its limited ability to liquidate that position at short notice will compound its market risk. Suppose a firm has offsetting cash flows with two different counterparties on a given day. If the counterparty that owes it a payment defaults, the firm will have to raise cash from other sources to make its payment. Should it be unable to do so, it too we default. Here, liquidity risk is compounding credit risk. Accordingly, liquidity risk has to be managed in addition to market, credit and other risks. Because of its tendency to compound other risks, it is difficult or impossible to isolate liquidity risk. In all but the most simple of circumstances, comprehensive metrics of liquidity risk don't exist. Certain techniques of asset-liability management can be applied to assessing liquidity risk. If an organization's cash flows are largely contingent, liquidity risk may be assessed using some form of scenario analysis. Construct multiple scenarios for market movements and defaults over a given period of time. Assess day-today cash flows under each scenario. Because balance sheets differed so significantly from one organization to the next, there is little standardization in how such analyses are implemented.

39

Regulators are primarily concerned about systemic implications of liquidity risk. Business activities entail a variety of risks. For convenience, we distinguish between different categories of risk: market risk, credit risk, liquidity risk, etc. Although such categorization is convenient, it is only informal. Usage and definitions vary. Boundaries between categories are blurred. A loss due to widening credit spreads may reasonably be called a market loss or a credit loss, so market risk and credit risk overlap. Liquidity risk compounds other risks, such as market risk and credit risk. It cannot be divorced from the risks it compounds. An important but somewhat ambiguous distinguish is that between market risk and business risk. Market risk is exposure to the uncertain market value of a portfolio. Business risk is exposure to uncertainty in economic value that cannot be mark-to-market. The distinction between market risk and business risk parallels the distinction between market-value accounting and book-value accounting. The distinction between market risk and business risk is ambiguous because there is a vast "gray zone" between the two. There are many instruments for which markets exist, but the markets are illiquid. Mark-to-market values are not usually available, but mark-to-model values provide a more-or-less accurate reflection of fair value. Do these instruments pose business risk or market risk? The decision is important because firms employ fundamentally different techniques for managing the two risks. Business risk is managed with a long-term focus. Techniques include the careful development of business plans and appropriate management oversight. Book-value accounting is generally used, so the issue of day-to-day performance is not material. The focus is on achieving a good return on investment over an extended horizon. Market risk is managed with a short-term focus. Longterm losses are avoided by avoiding losses from one day to the next. On a tactical level, traders and portfolio managers employ a variety of risk metrics duration and convexity, the Greeks, beta, etc.to assess their exposures. These allow them to identify and reduce any exposures they might consider excessive. On a more strategic level, organizations manage market risk by applying risk limits to traders' or portfolio managers' activities. Increasingly, value-at-risk is being used to define and monitor these limits. Some organizations also apply stress testing to their portfolios.

40

CHAPTER 4

RESERCH METHODOLOGY

41

DESIGN OF THE STUDY STATEMENT OF THE PROBLEM

In the recent years the financial system especially the banks have undergone numerous changes in the form of reforms, regulations & norms. CAMELS framework for the performance evaluation of banks is an addition to this. The study is conducted to analyze the pros & cons of this model.

OBJECTIVES OF STUDY
To do an in-depth analysis of the model. To analyze the bank to get the desired results by using CAMELS as a tool of measuring performance.

SCOPE OF THE STUDY

The analysis is mainly carried out to find out the performance of the Dhanlaxmi Bank. It helps to find out the strength and weakness of the Bank. The study is mainly conducted to review the performance of the company for a period of 5 years from FY 2005 06 to FY 2009 10 as revealed from the financial data of Dhanlaxmi Banks annual reports, manuals and accounting records. This indirectly helps the investors, government, employees, creditors and other stakeholders in financial forecasting and planning and also for decision making.

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RESEARCH DESIGN
To achieve my objective I have done descriptive research. The period for evaluating performance through CAMELS in his study is

five

years,

i.e. from financial year 2005-06 to 2009-2010.

METHODOLOGY
Primary Data: Primary data collected from the officers of the Bank, through direct personal interview. Secondary Data: Secondary data for the ratio analysis & interpretation was collected from Annual Report of the Bank i.e., Balance sheet and Profit and Loss a/c, journals, banks prospectus and internet.

LIMITATIONS
Despite all possible efforts undertaken to make analysis more comprehensive and scientific, a study of the present kinds bound to have certain limitations. This research was conducted with sincere efforts aiming to reduce mistakes and overcome limitations. The limitations faced were:

The study is conducted on the basis of the data provided by the bank. Conclusions are The figures taken from the financial statement for the analysis were historical in

drawn on the basis of limited data available. nature, the time value of money is not considered.

43

It was not possible to get a personal interview with the top management employees of Only CAMEL MODEL has been used for its purpose of evaluation of the Bank.

all banks under study.

CHAPTER 5

DATA ANALYSIS & INTERPRETATION

44

DATA INTERPRETATION

5.1) Capital Adequacy

Borrowings Debt Equity Ratio = Share Capital + Reserves

(Rs. In Thousands)

Year
2005 2006

Borrowings 1853 49924 40000 1205534

Share Capital 320573 320573 320573 641156 641156

Reserves 1023390 1153170 1401757 3603626 3759615

PERCENTAGE 0.137 % 3.387 % 2.322 % 0% 27.39 %

2006 2007 2007 2008 2008 2009 2009 2010

Table No. 1

45

Interpretation:
The Debt to Equity Ratio measures how much money a bank should safely be able to borrow over long periods of time. Generally, any bank that has a debt to equity ratio of over 40% to 50% should be looked at more carefully to make sure there are no liquidity problems.

Graph No. 1

Here the ratio is very less than the expected ratio from 2009 to 2010. In 2010, bank is showing 27.39 %. Its because if the increase of borrowings and a continuous increment in reserves and surplus.

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Total Advances to Total Asset Ratio

Total Advances Total Advances to Total Asset Ratio = Total Assets

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Total Advances 15943442 18394961 21020332 31960564 50062686

Total Assets 28487395 34479452 40329836 56428241 80868910

Percentage 55.96 53.35 52.12 56.63 61.90

Table No. 2

47

Interpretation:
Total Advance to Total Asset Ratio shows that how much amount the bank holds against its assets.

Graph No. 2

Here the Total Asset Ratio is continuously increasing from 61.13% to 63.98%, from 2010 2011, which shows the sound condition of the bank. As the bank is growing the

48

advances and the assets are increased in same proportion. Because of that the ratio keeps in same rate.

Government Securities to Total Investment

Govt. Securities Government Securities to Total Investment = Investment

Total

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Govt. Securities 6656560 7412629 9229910 13875787 16794051

Total Investment 7096035 8651934 10750557 15673623 20277927

Percentage 93.80 85.67 85.85 88.52 82.81

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Table No. 3

Interpretation:
This ratio shows the percent of investment in government securities. It is believed that the more investment in government security is safer. As per norms stipulated by the RBI, the banks have to maintain SLR at the rate of 25%.

Graph No. 3

50

Here the ratio was averagely 86.5% but in the last year it was decreased to 82.81% in the year 2010. The ratio was decreased in the year 2010 because of decrease in investment in government securities as compared to last two preceding years. Moreover as against statutory requirement to invest 15% out of 25% of SLR in central government securities the bank has invested 100% of SLR requirement in Govt. of India Securities. So, Dhanlaxmi Bank has adequate liquidity as per RBI norms, but it reduces their profitability.

5.2) Asset Quality

Gross NPA Ratio

Gross NPA Ratio =

Gross NPA Total Loan

(Rs. In Thousands)

Year 2005 2006 2006 2007

Gross NPA 1113800 962900

Total Loan 15943442 18394961

Percentage 6.98 % 5.23 %

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2007 2008 2008 2009 2009 2010

632100 644300 775000

21021332 31960564 50062586

3.00 % 2.01 % 1.54 %

Table No. 4

Interpretation:
This ratio is used to check whether the bank's gross NPAs are increasing quarter on quarter or year on year. If it is, indicating that the bank is adding a fresh stock of bad loans. It would mean the bank is either not exercising enough caution when offering loans or is too lax in terms of following up with borrowers on timely repayments.

52

Graph No. 4

Here the ratio is decreased from approx 6.49% to 1.98% which shows the Bank takes care of their money. Thats why their Gross NPA decreases year by year. And this is because of the concentrated efforts taken during the year to reduce the level of existing Non-Performing Assets (NPAs), as well as preventing fresh accretion of NPAs.

Net NPA Ratio

Net NPA Ratio =

Net NPA Total Loan

(Rs. In Thousands)

Year 2005 2006 2006 2007

Net NPA 459900 322400

Total Loan 15943442 18394961

Percentage 2.88 % 1.75 %

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2007 2008 2008 2009 2009 2010

185600 282400 419400

21021332 31960564 50062586

0.88 % 0.88 % 0.83 %

Table No. 5

Interpretation:
Net NPAs reflects the performance of banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also wear down the value of the asset. Loans and advances usually represent the largest asset of most of the banks. It monitors the quality of the banks loan portfolio. The higher the ratio, the higher the credits risk.

54

Graph No. 5

Above ratios show the fluctuation of NPA of Dhanlaxmi Bank during the last 5 years. The bank has lowest net NPA is 0.83% in 2009-10. Net NPA is continuously decreased from 2006 to 2010. So it is good for the bank to decrease in NPA. Because of decrease in NPA the risk of bad loans are also decreased.

55

5.3) Management Quality

Total Advances to Total Deposit Ratio

Total Advances Total Advances to Total Deposit Ratio = Total Deposit

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Total Advances 15943442 18394961 21020332 31960564 50062586

Total Deposit 25326708 30879580 36084202 49688113 70984840

Percentage 62.95 % 59.56 % 58.25 % 64.32 % 70.52 %

Table No. 6

Interpretation:
This ratio shows the investment of the bank through approving the loans against accepting the loan.

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Graph No. 6

Here the ratio is continuously increasing year by year from 62.95% to 70.52% in year 2006 to 2010. This shows good sign of the bank, if it will be increased more, than it may be risky for the bank. The number of borrowal accounts surpassed the two-lakhs-mark and stood at 2,08,962 as on March 31, 2010.

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Business per Employees

Total Income Business per Employees = No. of Employees

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Total Income 2369369 2761719 3545174 4877744 6255582

No. off Employees 486 1300 2700 3700 4200

Ratio 4875.24 2124.39 1313.02 1318.30 1489.42

Table No. 7

Interpretation: Revenue per employee is a measure of how efficiently a particular bank is utilizing its employees. Ideally, a bank wants the highest business per employee possible, as it denotes higher productivity. In general, rising revenue per employee is a positive sign

58

that suggests the bank is finding ways to squeeze more sales/revenues out of each of its employee.

Graph No. 7

The Bank is maintaining an average ratio for last three years. And the revenue per employees has decreased because of recruitment of employees by the bank.

59

Profit per Employees

Net Profit Profit per Employees = No. of Employees

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Net Profit 95158 161401 284636 574514 233037

No. off Employees 486 1300 2700 3700 4200

Ratio 195.80 124.15 105.42 155.27 55.48

Table No. 8

Interpretation:

60

Profit per employee is a measure of how efficiently a particular bank is utilizing its employees. Ideally, a bank wants the highest profit per employee.

Graph No. 8

The ratio says that, profit per employee was 1.9 lakhs in 2006 and it has decreased to .55 lakhs in 2010 which is because of the decrease in profit by 50 % as compared to 2009.

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5.4) Earnings Quality

Dividend Payout Ratio

Dividend Payout Ratio =

Dividend Net Profit

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Dividend 22440 32058 64116 64116 64116

Net Profit 95158 161401 284636 574514 233037

Percentage 23.58 % 19.86 % 22.52 % 11.16 % 27.51 %

Table No. 9

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Interpretation:

Dividend payout ratio shows the percentage of profit shared with the shareholders. The more the ratio will increase the goodwill of the bank in the share market

Graph No. 9

63

Here the average ratio during the five years is approx 22%. The ratio is much fluctuated. In 2010, it was highest at 27.51% and minimum in the year 2009 which was 11.16% only.

Return on Assets

Return on Assets =

Net Profit Total Assets

(Rs. In Thousands)

Year 2005 2006 2006 2007

Net Profit 95158 161401

Total Assets 28487395 34479452

Percentage 0.33 % 0.46 %

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2007 2008 2008 2009 2009 2010

284636 574514 233037

40329836 56428241 80868910

0.70 % 1.02 % 0.28 %

Table No. 10

Interpretation:
Return on Asset Ratio shows that how much return bank can get from their total asset. Higher the ratio is good for the bank. Because if ratio is higher than we can say that the return of bank is high.

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Graph No. 10

Here we can see that in 2006 this ratio is 0.33% and it has increased to1.02% in 2009, and in 2010 it has dropped to 0.28%. The main reason for this change in the ratio is the drop in Net profit and change in Assets.

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Operating Profit to Average Working Fund

Operating Profit Operating Profit to Average Working Fund = Avg. Working Fund

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Operating Profit 95158 161401 284636 574514 233037

Avg. Working Fund 26136171 31857765 37335743 53470834 74590610

Percentage 0.36 % 0.50 % 0.76 % 1.07 % 0.31 %

Table No. 11

Interpretation:

Earning reflect the growth capacity and the financial health of the bank. High earnings signify high growth prospects.

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Graph No. 11

Here it was increased from 0.36% in the year 2006 to 1.07% in the year 2009 which is good for the bank. Because of decrease in the net profit, the ratio was dropped in the year 2010 to 0.31%.

68

Net Profit to Average Assets

Net Profit Profit to Average Assets = Net Average Assets

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Net Profit 95158 161401 284636 574514 233037

Average Assets 27466012.5 31483423.5 37404644 48379038.5 68648575.5

Percentage 0.34 % 0.51 % 0.76 % 1.18 % 0.33 %

Table No. 12

Interpretation:
Net profit to average asset indicates the efficiency of the banks in utilizing their assets in generating profits. A higher ratio indicates the better income generating capacity of the assets and better efficiency of management.

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Graph No. 12

In this, the ratio has continuously increased year by year from 0.34% in 2006 to 1.18% in the year 2009. This is a good time for Bank to be 'giving back', for it has just completed a very successful year. And in 2010 it has dropped to 0.33%. The main reason for this change in the ratio is the drop in Net profit.

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Interest Income to Total Income

Interest Income Interest Income to Total Income = Total Income

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Interest Income 2098865 2465375 3182851 4084150 5345706

Total Income 2369369 2761719 3545174 4877744 6255582

Percentage 88.58 89.26 89.77 83.73 85.45

Table No. 13

Interpretation:

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Interest income to total income ratio shows that how much interest income earn from total income.

Graph No. 13

The bank was maintained on an average same percentage from 2006 to 2009 of 89.20%. In 2008 it was decreased to 83.73% and in 2010 it has increased to 85.45.

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Other Income to Total Income

Other than Interest Income Other Income to Total Income = Total Income

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Other Than Interest Income 270504 296344 362323 793594 909876

Total Income 2369369 2761719 3545174 4877744 6255582

Percentage 11.41 % 10.73 % 10.22 % 16.26 % 14.54 %

Table No. 14

Interpretation:

73

Fee based income account for a major portion of the banks other income. The bank generates higher fee income through innovative products and adapting the technology for sustained service levels. The higher ratio indicates increasing proportion of fee-based income. The ratio is also influenced by gains on government securities, which fluctuates depending on interest rate movement in the economy.

Graph No. 14

The Bank has averagely 11% part of income is from other way of income which is good for the bank from 2006 to 2007.And in last two years it shows 16.26 % and 14.54 %,

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which shows that, Bank earning from government security and through providing innovative products.

4.5) Liquidity
Liquidity Asset to Total Asset

Liquidity Asset Liquidity Asset to Total Asset = Total Assets

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009

Liquidity Asset 3087784 6050654 6924336 6860655

Total Assets 28487395 34479452 40329836 56428241

Percentage 10.83 % 17.54 % 17.15 % 12.15 %

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2009 2010

7503283

80868910

9.27 %

Table No. 15

Interpretation:

Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions.

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Graph No. 15

Here the ratio is continuously decreasing from 2008 to 2010, which was very high at 17.54 in 2007 and very low at 9.27 in 2010. The ratio was decreased because of increment in total assets.

Government Securities to Total Assets

Govt. Securities Government Securities to Total Assets = Assets

Total

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008

Govt. Securities 6656560 7412629 9229910

Total Assets 28487395 34479452 40329836

Percentage 23.36 % 21.49 % 22.88 %

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2008 2009 2009 2010

13875787 16794051

56428241 80868910

24.59 % 20.76 %

Table No. 16

Interpretation:

Government securities to total asset ratio shows that, what percentage of government securities bank has against total assets. Higher the ratio is good for the bank because if this ratio is higher than we can say that bank is more investing in government securities.

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Graph No. 16

This ratio was fluctuating during the five years. At last in the year 2010 the ratio was 20.763%. In the year 2009, the G-sec investment was decreased as compared to last years preceding year and the total assets were increased also increased.

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Approves Securities to Total Assets

Approved Securities Approved Securities to Total Assets = Assets

Total

(Rs. In Thousands)

Year

Approved Securities

Total Assets

Percentage

2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

25631 5849 8117 3654 1749894

28487395 34479452 40329836 56428241 80868910

0.09 % 0.01 % 0.02 % 0.006 % 2.16 %

Table No. 17

Interpretation:
Approved securities include securities other than government securities. This ratio measures the Approved Securities as a proportion of Total Assets. Banks invest in approved securities primarily after meeting their SLR requirements, which are around 25% of net demand and time liabilities. This ratio measures the risk involved in the assets hand by a bank.

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Graph No. 17

The ratio was continuously decreased from 0.01% in the year 2006 to 0.006% in the year 2009. The ratio is continuously decreased because of decrement in Approved securities. In the last year 2010 the ratio was increased to 2.16, because of the increment in investment in approved securities.

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Liquidity Asset to Total Deposit

Liquidity Asset Liquidity Asset to Total Deposit = Total Deposit

(Rs. In Thousands)

Year 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010

Liquidity Asset 3087784 6050654 6924336 6860655 7503283

Total Deposit 25326708 30879580 36084202 49688113 70984840

Percentage 12.19 % 19.59 % 19.18 % 13.80 % 10.57 %

Table No. 18

Interpretation:

The ratio shows how much part of the deposits invested into the liquidity asset, which can be easily convert in to monetary value in the time of need.

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Graph No. 18

Here the ratio was 19.59 % in 2006 and after fluctuation it was 10.57 % in 2010. The ratio was decreased because of increment in deposits and approx 10 % increment in assets in the year 2010.

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6.2) ANALYSIS

COMPONENT RATINGS TO THE BANK

Now, after analyzing the ratio next, task to do is to give weightage to all the parameters according to the importance of the ratios. Each component will be given weightage according to the importance of itself and ratios covered in that particular point. The total weightage allocated to the all parameters would be out of 100. The weightage given to different parameters is as follows:

TABLE - 19 Component Weightage Parameters Capital Adequacy Asset Quality Management Earnings Liquidity Total Weightage 27 % 16 % 15 % 18 % 24 % 100 %

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Ratio Wise Weightage:

After giving the importance to the each parameter, now its turn to give the weightage according to the importance of the ratio we will allocate the weightage to the each particular ratio. The weightage given to the each ratio is as follows.
Table No. 20 RATIO Capital Adequacy Debt Equity Ratio Total Advances to Total Assets Ratio Government Securities to Total Investment Asset Quality Gross NPA to Total Loan Net NPA to Total Loan Management Total Advances to Total Deposit Business per Employees Profit per Employees Earnings Dividend Payout Ratio Return on Assets Operating Profit to Average Working Fund Net Profit to Average Assets Interest Income to Total Income Other Income to Total Income Liquidity Liquidity Asset to Total Assets G-Sec to Total Assets Approved Securities to Total Security Liquidity Asset to Total Deposit Total WEIGHTAGE Out of 27 % 9% 9% 9% Out of 16 % 8% 8% Out of 15 % 5% 5% 5% Out of 18 % 3% 3% 3% 3% 3% 3% Out of 24 % 6% 6% 6% 6% 100 %

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After allocating the weightage, we have made frequency classes according to the results found from the ratios for each ratio of each parameter. He frequency classes for each ratio are as follows:

Capital Adequacy
Table No. 21 Ratios
Debt-Equity Ratio Total Advances to Total Assets G-Sec to Total Invest.

1
Below 0.15 Below 50 Below 82

2
0.15 - 1 50 - 53 82 - 84

4
1-3 53 - 55 84 - 86

Marks 5
3- 9 55 - 57 86 - 88

6
9 - 18 57 - 59 86 - 88

8
18 - 27 59 - 61 88 - 90

9
Above 27 Above 61 Above 90

Asset Quality
Total No. 22 Marks 5
4-6 1 1.5

Ratios
Gross NPA to Total Loan Net NPA to Total Loan

1
Above 10 Above 3.5

2
8 - 10 2.5 3.5

3
6-8 1.5 2.5

6
2-4 0.75 - 1

7
1-2 0.50 0.75

8
Below 1 Below 0.50

Management Quality
Table No. 23 Marks 3
55 - 65 1500 2000 100 - 150

Ratios
Total Advance to Total Deposit Business per Employee Profit per Employee

1
Below 50 Below 1000 Below 50

2
50 - 55 1000 1500 50 - 100

4
65 70 2000 3000 150 - 200

5
Above 70 Above 3000 Above 200

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Earnings Quality
Table No. 23 Marks 1.5 2.0
12 - 18 0.50 0.75 0.50 0.75 0.50 0.75 82 - 84 12 - 14 18 - 25 0.75 - 1 0.75 - 1 0.75 - 1 84 - 86 14 -16

Ratios
Dividend Payout Ratio Return on Assets Operating Profit to Avg. Working Fund Net Profit to Avg. Assets Interest Income to Total Income Other Income to Total Income

0.5
Below 10 Below 0.25 Below 0.25 Below 0.25 Below 80 Below 10

1.0
10 12 0.25 0.50 0.25 0.50 0.25 0.50 80 - 82 10 - 12

2.5
25 - 30 1 1.25 1 1.25 1 1.25 86 - 88 16 - 18

3.0
Above 30 Above 1.25 Above 1.25 Above 1.25 Above 88 Above 18

Liquidity
Table No. 25 Marks 3.5
12 - 14 21 - 23 0.5 - 1 12 - 15

Ratios
Liquidity Asset to Total Asset G-Sec To Total Assets Approved Sec to Total Assets Liquidity Asset to Total Deposit

1
Below 10 Below 20 Below 0.05 Below 10

2
10 - 12 20 - 21 0.05 0.5 10 - 12

5
14 - 16 23 - 24 1-2 15 - 18

6
Above 16 Above 24 Above 2 Above 18

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After allocating classes for the each ratio and for the five years, now we will give marks, on the basis of average of their average of performance during the last five years i.e. 2006 to 2010.
RATIO Capital Adequacy Debt Equity Ratio Total Advances to Total Assets Ratio Government Securities to Total Assets Asset Quality Gross NPA to Total Loan Net NPA to Total Loan Management Total Advances to Total Deposit Business per Employees Profit per Employees Earnings Dividend Payout Ratio Return on Assets Operating Profit to Average Working Fund Net Profit to Average Assets Interest Income to Total Income Other Income to Total Income Liquidity Liquidity Asset to Total Assets G-Sec to Total Assets Approved Securities to Total Security Liquidity Asset to Total Deposit Table No. 26 Marks Out of 9 Marks 5 5 5 Out of 8 Marks 6 5 Out of 5 Marks 3 4 3 Out of 3 Marks 2 1.5 1.5 1.5 2.5 1.5 Out of 6 Marks 3.5 3.5 2 5

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Overall Rating of the Bank

Parameters Capital Adequacy Asset Quality Management Quality Earning Quality Liquidity TOTAL Table No. 27

Marks 15 11 10 10.5 14 60.5

After going through the whole process, I found that, bank has scored 60.5 Marks

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CHAPTER 6 FINDINGS, RECOMMENDATIONS & CONCLUSION

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FINDINGS

Capital adequacy:
The capital adequacy ratio of the bank is above the minimum requirements and above the industry average.

Assets:
The bank has maintained a standard for the NPAs in the period of 2006 2007. And then onwards, its decreasing every year.

Management:
Professional approach that has been adopted by the banks in the recent past is in right direction & also it is the right decision.

Earnings:
It has shown a good growth record for its ROA. But last year it has gone down in its performance with low profit.

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Liquidity:
Banks should maintain quality securities with good liquidity to meet contingencies. The Bank is fulfilling this requirement by maintaining highest credit deposit ratio.

RECOMMENDATIONS

1) The banks should adapt themselves quickly to the changing norms.

2) The system is getting internationally standardized with the coming of BASELL III accords so the banks should strengthen internal processes so as to cope with the standards.

3) The banks should maintain a 0% NPA by always lending and investing or creating quality assets which earn returns by way of interest and profits.

4) The banks should find more avenues to hedge risks as the market is very sensitive to risk of any type.

5) Have good appraisal skills, system, and proper follow up to ensure that banks are above the risk.

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CONCLUSION
The report makes an attempt to examine the performance of the Dhanlaxmi Bank based on the CAMEL Model. The study has brought many interesting results, some of which are mentioned as below:
Gross NPA and Net NPA ratio has registered declining trend for the bank during the last

five years. Thus, it indicates for improvement in the asset quality position of the banks.
In Management Quality, we have found that Business per Employee Ratio and Profit per

Employee Ratio is decreased during the last five years. This shows the growth of the bank as well as efficiency of the employee, which is not very good in the banks and it will help the bank to grow in future.
In Earnings Quality, the major part of income of the bank is from Interest income.

Because

their large part of investment is in Government Securities. A little change in

Interest Rate will effect on it more.

The Liquidity ratios of the Dhanlaxmi Bank indicate better liquidity of the bank.

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From the above analysis I would like to conclude that Dhanlaxmi bank has high efficiency in terms of Capital Adequacy, Assets Quality, Earning Quality and Liquidity. After evaluating all the ratios, the bank scored 60.5 Marks.

BIBLIOGRAPHY

Books
Jain P K, Financial Management Text & Problems Maheswari S N, Management Accounting

Websites Visited
www.dhanbank.com www.allbankingsolutions.com/camels.htm www.shkfd.com.hk/glossary/eng/RA.htm

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