Financial Performance of Banks

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The Icfai Journal of Bank Management, Vol. VII, No.1, 200850

The present study was undertaken to examine and understand how financialmanagement plays a crucial role in the growth of banking. It is concerned with examining the profitability position of the selected sixteen banks (BANKEX-based) for a period of

five years (2000-01 to 2006-2007). The study reveals that the profitability positionwas reasonable during the period of study when compared with the previous years.

Return on Investment proved that the overall profitability, and the position of selectedbanks was sustained at a moderate rate. With respect to debt equity position, it wasevident that the companies were maintaining 1:1 ratio, though at one point of timeit was very high. Interest coverage ratio was continuously increasing, which indicatedthe companys ability to meet the interest obligations. Capital adequacy ratio wasconstant over a period of time. During the study period, it was observed that thereturn on net worth had a negative correlation with the debt equity ratio. Interest income to working funds also had a negative association with interest coverage ratioand the Non-Performing Assets (NPA) to net advances was negatively correlated withinterest coverage ratio.

Financial Performanceof Banks in India

Introduction: Indian Banking Sector

The banking sector picked up momentum during 2005-06. Bank credits witnessed a strong expansion

for the second year in succession. A steady growth in deposits was also observed. It was the first time,

since the nationalization of banks in 1969, that investment by the commercial banks in the government

securities declined in absolute terms (by Rs. 19,514 cr.) in any single year.

Currently banking in India is considered as fairly mature in terms of supply, product range

and reach. In terms of quality of assets and capital adequacy, Indian banks are considered

to have a strong and transparent position. As the growth in the Indian economy is expected to

be strong for quite some time, especially in its services sector, the demand for banking servicesis also expected to be stronger.

Indian Banking Sector Banking on Reforms

The financial sector reforms set in motion in 1991 have greatly changed the face of Indian banking.

While the banking system in India has done fairly well in adjusting to the new market dynamics,

greater challenges lie ahead.

Harish Kumar Singla*

* Senior Lecturer, The Icfai Business School, Dehradun, India. E-mail: [email protected]

2008 The Icfai University Press. All Rights Reserved.


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51Financial Performance of Banks in India

The Indian banking system has witnessed significant changes during the last decade.

There have been new banks, new instruments, mergers and takeovers, reconstruction, newopportunities and, along with all these, new challenges.

While deregulation of banks opened up new vistas to augment revenues, it has also posedgreater competition and risks. The financial sector reforms introduced in the early 1990sas a part of the structural reforms have affected almost al l the banking operations.The broader objectives of the financial sector reforms were to enhance efficiency and productivity.

Financial sector reforms were carried out in two phases.

To create productive and profitable financial institutions; and

To strengthen the financial system and put it on a par with global standards.

Financial sector reforms in India started with the deregulation of interest rates. Banks now

have complete flexibility to decide their interest rate structures and manage their assets andliabilities accordingly. The SLR has been gradually reduced from a peak of 38.5% to 25%.The Cash Reserve Ratio (CRR) was reduced from its peak level of 15% maintained during 1989-92 to4.5% in June 2003; presently it is at 6%.

In the second phase, persistent efforts have been made towards the adoption of internationalbenchmarks by the Reserve Bank of India (RBI). As a part of the financial sector reforms, theregulatory norms with respect to capital adequacy, income recognition, asset classification andprovisioning have moved towards convergence with the international accounting standards.In turn, these measures have enhanced the transparency of the balance sheet of the banks andinfused accountability in their functioning.

Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)

Act, 2002 has helped to reduce the levels of NPAs targeted, towards improved risk management practices.The minimum Capital to Risk Assets Ratio (CRAR) was set and the banks which were not able to comply

with the new norms were allowed to raise the capital from the market.

In line with the amendment to incorporate market risk in Basel I, separate capital charge formarket risk was also introduced in 2004.

The banks are required to disclose capital adequacy, asset quality, and maturity distributionof select items of assets and liabilities, profitability, country risk exposure, risk exposuresin derivatives, segment reporting, and related party disclosures as per the accounting standards.

RBI issued guidelines on asset-liability management and risk management systems in banksin 1999, guidance notes on credit risk management and market risk management in october 2002,

and the guidance note on operational risk management in 2005.RBI set guidelines for the establishment of new banks in the private sector and the foreign

banks with a view to enhance efficiency and productivity through competition. Foreign DirectInvestment (FDI) in the private sector banks is now allowed up to 74%.

The smooth functioning of the payment and settlement system is a pre-requisite for financial stability.The Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), was set up inMarch 2005 for giving policy direction in the area of payment and settlement systems. A risk freepayments and settlements system in government securities and foreign exchange was established by the

Clearing Corporation of India Limited (CCIL), which is set up by the banks.


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In the post-reform period, assets/liabilities of banks have grown consistently at a high rate.

The financial performance of banks also improved as reflected in their increased profitability. Another important development is the sharp reduction in the NPA to net advanc es (Append ix).

It is evident that we are at the beginning of this new phase in the Indian banking, but with

a competitive pressure, both domestic and external, public sector banks have to push hard.

Future of Indian Banking

A few broad challenges facing the Indian banks are:

Threat of risks from Internationalization;

Implementation of Basel II norms;

Improvement of advanced risk management systems;

Implementation of new accounting standards and reporting norms; Enhancement of transparency;

Enhancement of customer support; and

Application of information technology (security system).

Indian banking stands at the threshold of a mega change in the next three to five years.

Many new situations as compared to the present scenario are predicted to emerge. However, participants

and analysts in the industry have to seize the opportunities. Standard and Poors, which compares

Indian and Chinese banking, prescribes risk management as a thrust area for India.

The Indian banking has come of age in the past few years. Overall, it has been a period when

banks have thrived. We have seen the growth of some Indian banks to great levels. But there is still

a fair way to go before an Indian bank can truly announce its global arrival. The Indian rural

market is playing a big role in charting out a trend for the growth of banks. With the economy

surging, the income levels have increased in rural areas.

Finally, if there is something to watch out for in the coming decade or so it is the case for

Mergers and Acquisitions (M&As). Instead of a large number of small banks, we need to have a

small number of large banks. Its high time that India also gets some share on the list o f the largest

banks in the world. Consolidation is the way to go.

To conclude, banks in India, be it public, private Indian or foreign, have to use the following

three mantras for success and meet the future challenges.

Tapping into the rural market;

Risk management under Basel perspective; and

Consolidation

Research Methodology

Problem Statement

Financial statements have two uses in financial analysis. First, they are used to present a historical record

of the firms over a period of time, and a trained analyst can use this to find the factors that have influenced

the growth of the firm. Second, they are used to forecast a course of action for the firm.


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The development of industries depends on several factors such as human, technology, and quality,

marketing and financial, among which the financial aspect assumes a significant role in determiningthe growth of industries. In this context, the researcher is interested in undertaking an analysis of the

financial performance of the banking sector companies to examine and understand how management

of finance plays a crucial role in the growth. Hence, the present study entitled as Financial Performance

of Banks in India: Some Evidence to Select Banks has been undertaken.

Objectives of the Study

To study the growth and development of Indian banking sector;

To study the behavior of profitability of select banks; and

To analyze the factors determining the profitability.

Testing of Hypothesis

When Return on Investment (ROI) increases, Earnings Before Interest and Taxes

(EBIT) remain the same.

When Interest income increases, ROI remains the same.

When ROI increases, Net NPA to Net advances remains the same.

When interest coverage ratio increases, debt equity ratio remains the same.

Data and the Source

The study is entirely based on secondary data. All the banks of BANKEX Index are sample units.

Data regarding performance of banks was collected for a period of six years, i.e., 2001-06.

Necessary data was obtained from CMIE-PROWESS.

Framework of Analysis

For the purpose of analysis, various ratios are studied extensively. Statistical measures like correlation

analysis, multiple regression (linear) analysis and testing of hypothesis are used for comparison.

Significance of the Study

The study will throw light on the overall financial performance of banking sector as a whole in the past

five years.

Highlights of the Ratio Analysis

The primary objective of any business is to earn. The investors want adequate return on their investment.

Tables 1(a, b, c, d, e, f, h and i) throw light on the various dimensions of business.

Table 1(a) shows that the interest coverage ratio is continuously increasing, which indicatesthe companys ability to meet the interest obligations.

Table 1(b)displays net profit ratio, which shows a continuous decline, nearly 7% in the

past five years.

Table 1(c)is the ratio of debt to equity. Debt equity ratio was highest in year 2003 and

later reduced to reach a level of 1:1 apex.

Table 1(d)displays the return on net worth which shows an exceptionally poor

performance in the year 2004.


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Analysis of Data

Table 1a: Ratio Analysis

Interest Coverage % 2001 2002 2003 2004 2005 2006

Mean 119.375 123.625 127.125 137.5 133.8125 132.4375

Median 112.5 118 127 137 132 131

Standard Deviation 25.07555 31.49365 19.70744 34.18187 22.51583 018.25

Sample Variance 628.7833 991.85 388.3833 1168.4 506.9625 333.0625

Kurtosis 11.26099 009.630193 002.600671 005.421835 001.230355 003.31296

Skewness 3.238613 002.474353 000.620503 1.355460 -0.529310 0.62204

Minimum 103 70 92 36 79 84

Maximum 207 229 178 199 173 17

Largest (1) 207 229 178 199 173 170

Smallest (1) 103 70 92 36 79 84

Table 1b: Net Profit Ratio

NP Ratio % 2001 2002 2003 2004 2005 2006

Mean 70.80688 69.68563 69.02688 64.61813 62.04125 63.8925

Median 70.27 71.495 70.565 66.89 63.35 68.775


Sample Variance 27.89616 45.96109 33.74625 187.9408 86.71969 92.57555

Kurtosis 2.447236 6.592492 1.190823 9.219947 7.121573 7.211428

Skewness 1.152431 2.26922 0.96472 2.52976 2.20516 2.47414

Range 22.47 28.17 23.82 66.04 41 38.46

Minimum 62.6 48.25 54.81 18.85 32.28 32.9

Maximum 85.07 76.42 78.63 84.89 73.28 71.36

Largest (1) 85.07 76.42 78.63 84.89 73.28 71.36

Smallest (1) 62.6 48.25 54.81 18.85 32.28 32.9

Table 1c: Ratio of Debt To Equity

DE Ratio % 2001 2002 2003 2004 2005 2006

Mean 138.5625 164.375 172.9375 118.9375 101 106.0625

Median 91.5 94 93.5 84.5 80 91


Sample Variance 18328.13 45274.65 45902.06 11836.2 5340.933 4185.796

Kurtosis 5.278822 10.2227 5.129249 9.402674 5.833998 1.02578

Skewness 2.348741 3.079709 2.405769 2.93009 2.228481 0.525596

(Contd...)


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Table 1f: Interest Income in Proportion to Working Funds

Interest Income to2001 2002 2003 2004 2005 2006Working Funds %

Mean 9.32375 9.515625 9.195625 8.304375 7.55625 7.403125

Median 9.815 9.455 9.15 8.215 7.535 7.3


Sample Variance 6.653692 0.69816 0.653133 0.632413 0.568532 0.217236

Kurtosis 13.37411 -0.81968 0.74762 2.235845 3.787752 0.74216

Skewness 3.51546 0.299591 0.02514 1.055697 1.584356 0.408411

Range 11.54 2.72 2.6 3.23 3.03 1.49

Minimum 0 8.39 7.89 7.19 6.71 6.69

Maximum 11.54 11.11 10.49 10.42 9.74 8.18

Largest (1) 11.54 11.11 10.49 10.42 9.74 8.18

Smallest (1) 0 8.39 7.89 7.19 6.71 6.69

Table 1g: Operating Profit

Operating ProfitRatio % 2001 2002 2003 2004 2005 2006

Mean 1.569375 2.48 2.668125 2.916875 2.3875 2.20875

Median 1.47 2.17 2.605 2.965 2.5 2.185


Sample Variance 0.42526 1.76248 0.908896 0.73873 0.38162 0.121678

Kurtosis 1.54802 6.763178 3.891249 4.54265 3.990322 0.00493

Skewness 0.30294 2.03314 0.721173 1.64983 1.3017 0.41337

Range 2.83 6.33 4.63 3.72 2.87 1.26

Minimum 0 0.32 0.61 0.38 0.65 1.49

Maximum 2.83 6.65 5.24 4.1 3.52 2.75

Largest (1) 2.83 6.65 5.24 4.1 3.52 2.75

Smallest (1) 0 0.32 0.61 0.38 0.65 1.49

Table 1h: Non-Performing Assets

NPA to Net 2001 2002 2003 2004 2005 2006Advances %

Mean 5.116875 4.93875 3.9 2.188125 1.505625 0.8525

Median 5.435 5.4 4.18 2.61 1.42 0.855


Sample Variance 9.90205 7.623812 4.955907 2.095176 0.81104 0.2597

Kurtosis 0.31725 0.845846 0.45443 0.99339 1.16679 0.28708

(Contd...)

(...contd)


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Skewness 0.213572 0.203729 0.1355 0.09841 0.11569 0.319159

Range 11.23 11.09 7.81 4.5 2.6 1.87

Minimum 0 0 0.11 0 0.2 0

Maximum 11.23 11.09 7.92 4.5 2.8 1.87

Largest (1) 11.23 11.09 7.92 4.5 2.8 1.87

Smallest (1) 0 0 0.11 0 0.2 0

(...contd) Table 1h: Non-Performing Assets

NPA to Net 2001 2002 2003 2004 2005 2006Advances %

Table 1(e)capital adequacy ratio remains more or less constant over a period of time.

Table 1(f)Interest income in proportion to working funds is reducing overall though

marginally.

Table 1(g)operating profit is very low and sustained at 2%, not showing any signs

of growth.

Table 1(h)Non-performing assets are continuously reducing in percentage to net

advances.

Table1(i)Return on Investment (ROI) is also reducing, which is not

a good sign.

Highlights of the Correlation Analysis

Correlation analysis helps in understanding how two variables are related to each other and how

a cause and effect relation can be established among them (Table 2).

Interest coverage ratio has a strong negative correlation with net profit ratio, debt equity

ratio, interest income to working funds ratio, ROI and net NPA to net advances ratio,

Table 1i: Return on Investment (ROI)

ROI % 2001 2002 2003 2004 2005 2006

Mean 7.6302 7.118744 7.31265 6.01045 5.105294 5.094881

Median 7.02125 7.14095 7.20585 6.1675 5.1366 5.13445


Sample Variance 3.819302 3.010726 0.604976 1.684268 0.277288 0.188978

Kurtosis 9.42432 5.29169 0.12886 2.107684 0.67277 1.08627

Skewness 2.780251 1.83366 0.142676 0.98087 0.266146 0.38724

Range 8.8005 7.6181 3.0065 5.5541 1.6894 1.3697

Minimum 5.4237 1.865 5.8015 2.7055 4.3679 4.3466

Maximum 14.2242 9.4831 8.808 8.2596 6.0573 5.7163

Largest (1) 14.2242 9.4831 8.808 8.2596 6.0573 5.7163

Smallest (1) 5.4237 1.865 5.8015 2.7055 4.3679 4.3466


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InterestCoverageRatio

1

Net ProfitRatio 0.8921* 1

Debt EquityRatio 0.64467* 0.851095* 1

Capital

AdequacyRatio

0.735902* 0.68321* 0.21535 1

InterestIncome toWorkingFunds

0.77931* 0.950428* 0.902935* 0.50258 1

OperatingProfit toWorkingFunds

0.681754* 0.36383 0.100254 0.798289* 0.13406 1

Net NPA to Net

Advance

Ratio

0.87111* 0.953617* 0.821529* 0.60461* 0.976463* 0.31872 1

ROI 0.81614* 0.971849* 0.867313* 0.6309 0.974271* 0.25223 0.962074* 1

Table 2: Correlation Analysis

Note: * Correlation is significant at the 0.01 level (2-tailed).

InterestCoverage

Ratio

Net ProfitRatio

DebtEquityRatio

CapitalAdequacy

Ratio

InterestIncome to

WorkingFunds

OperatingProfit toWorking

Funds

Net NPAto Net

AdvanceRatio

ROI

while it has a positive relati on with the operating profi t to working funds.

Net profit ratio has a strong negative relation with capital adequacy while strong positive

relation with debt equity, Interest income to working funds, net NPA to Net advances

and ROI.

Debt equity ratio has positive relations with interest income to working funds, net NPA

to net advances and ROI.

Capital adequacy ratio is linked negatively with net NPA to net advances.

Interest income to working funds is having a strong degree of positive relation with net NPA

to net advances and ROI.

Multiple Regression AnalysisThe following multiple regression equation is used in the model to describe the relationship between

dependent and independent variables:

Y = + 1 X 1+ 2 X 2+ 3 X 3+ 4 X 4+ 5 X 5+ 6 X 6


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Where

Y = Earnings before Interest and Tax (EBIT) (dependent variable)

= Intercept

1 = Coefficient of Interest Coverage Ratio

2 = Coefficient of Debt Equity Ratio

3 = Coefficient of Capital Adequacy Ratio

4 = Coefficient of Net NPA to Net Advances Ratio

5 = Coefficient of Interest Income to Working Funds Ratio

6 = Coefficient of ROI

X 1 = Interest Coverage Ratio

X 2 = Debt Equity Ratio

X 3 = Capital Adequacy Ratio

X 4 = Net NPA to Net Advance Ratio

X 5 = Interest Income to Working Funds

X 6 = ROI

Table 3a: Model Summary (2001-06)

Model R R Square Adjusted R Std. ErrorSquare of the Estimate

6 0.476 0.226 0.289 6535.38

Table 3b: Analysis of Variance (ANOVA)

Model Sum of Squares df Mean Square F Sig.

Regression 112434297.658 6 18739049.610 0.439 0.836(f)

Residual 384401127.428 9 42711236.381

Total 496835425.086 15

It is observed from the multiple regression equation for the period (2001-06) that the

correlation coefficient was 0.476 (Table 3a). The six selected independent variables in the study

collectively contributed 22.6% to earnings before interest and taxes. The analysis of variance(multiple regressions) in Table 3b shows F value of 0.439; it ind icated tha t the mul tiple

regression equation is not significant.

Testing of Hypothesis

Hypothesis is an assumption to be tested. The statistical testing of hypothesis is the most important

technique in statistical inference. Hypothesis tests are widely used in business and industry for making

decisions. The following are the hypotheses framed and tested by using test of significance ( t -test)

at 1% level of significance (Tables 3c, 4a, b, c and d).


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(Constant) 44261.027 57914.644

Interest Coverage Ratio 171.765 224.295

Debt Equity Ratio 7.806 18.814

Capital Adequacy Ratio 1467.863 2287.996

Net NPA to Net Advance Ratio 256.717 1820.615

Interest Income to Working Funds 4182.836 4698.983

ROI 63.747 4721.444

Table 3c: Coefficients

Un-Standardized Coefficients

B Std. ErrorModel

1. H 0 = When ROI increases, EBIT remains same.

H a = When ROI increases, EBIT also increases.

ROI-EBIT 4416.861 5755.330 1438.832 7483.66 1350.06 3.069 15 0.0077

Table 4(a): Hypothesis 1

t -Test

Paired Differences

t df Sig.(2-

tailed)Mean Std.

Deviation

Std.ErrorMean

95% ConfidenceInterval of the

Difference

Lower Upper

Calculated t value 3.06 is more than the table value 2.58 at 1% level of significance, so the null

hypothesis cannot be accepted, i.e., when ROI increases EBIT remains the same which means that

with increase in ROI, EBIT also increases.

2. H 0 = When interest income increases, ROI remains the same.

H a = When interest income increases, ROI also increases.

Interest

Income-ROI2.171 0.921 0.230 1.680 2.662 9.425 15 1.082

Table 4b: Hypothesis 2

t Test

Paired Differences

t df

Sig.

(2-tailed)

Mean Std.Deviation

Std.ErrorMean

95% Confidence

Interval of theDifference

Lower Upper


hypothesis cannot be accepted, i.e., when interest income increases, ROI remains the same which

means that when interest income increases, ROI also increases.


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3. H 0 = When ROI increases, Net NPA to Net advances remains same.

H a = When ROI increases; Net NPA to Net advances also increases.

Net NPA to

Net Advance

-ROI

3.29 1.90 0.475 4.30 2.281 6.93 15 4.79

Table 4(c): Hypothesis 3

t -Test

Paired Differences

t df Sig.(2-

tailed)Mean Std.

Deviation

Std.ErrorMean


Difference

Lower Upper


hypothesis cannot be accepted, i.e., when ROI increases net NPA to Net advances remains the same

and we can say that when ROI increases, net NPA to net advances also increases.

4. H 0 = When interest coverage ratio increases, Debt equity ratio remains same.

H a = Higher the interest coverage ratio, Higher the debt equity ratio.

Interest

Coverage-

Debt Equity4.66 118.280 29.57 67.69 58.36 0.157 15 0.876

Table 4d: Hypothesis 4

t -Test

Paired Differences

t df Sig.(2-

tailed)Mean Std.

Deviation

Std.

ErrorMean


Difference

Lower Upper

Calculated t value 0.15 is less than the table value of 2.58 at 1% level of significance,

so the null hypothesis cannot be rejected, i.e., when interest coverage ratio increases, debt

equity ratio remains the same.

ConclusionWith the increasing levels of globalization of the Indian banking industry, and the evolution

of universal banks, competition in the banking industry will intensify further. Though the potential

and ability exist, Indian banks have to be faster now to sustain the growth. Strong capital positions

and balance sheets place banks in a better position to deal with and absorb the economic shocks.

From the study of the financial performance analysis of selected banks, it can be concluded

that the financial positions of banks is reasonable. Debt equity ratio is maintained at an adequate

level throughout and NPAs also witnessed a decline during the study period. The ROI remains

at a very low position, which is a worrying factor.


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We can conclude that the banking sector, which is going through major reforms, is one of the

emerging sectors and will grow at a sustained rate over a period of time.

References

1. Address by Mr V Leeladhar, Deputy Governor of the Reserve Bank of India, at the Annual Washington

Conference of the Institute of International Bankers, Washington DC, March 5, 2007.

2. Hamsalakshmi R and Manicham M (2005), Financial Performance Analysis of Selected Banks,

Finance India , Vol. XIX, No. 3, September.

3. Khan M Y and Jain P K (2001), Financial Management, Text and Problems , Tata McGraw Hill

Publishing Company Ltd., New Delhi.

4. Mayers and Berly (2005), Principles of Corporate Finance , Tata McGraw Hill Publishing Company

Ltd., New Delhi.

5. Pandey I M (2001), Financial Management , Eighth Revised Edition, Vikas Publishing House

Pvt. Ltd., New Delhi.

6. Ross (2005), Corporate Finance , Tata McGraw Hill Publishing Company Ltd., New Delhi.

1. Allahabad Bank

2. Andhra Bank

3. Bank of Baroda

4. Bank of India

5. Canara Bank

6. Centurion Bank of Punjab Ltd.

7. Federal Bank Ltd.

8. HDFC Bank Ltd.

9. ICICI Bank Ltd.

10. Indian Overseas Bank

11. Kotak Mahindra Bank Ltd.

12. Oriental Bank of Commerce

13. Punjab National Bank

14. State Bank of India

15. UTI Bank Ltd.

16. Union Bank of India

Appendix

List of Banks Selected

S. No. Company Name

Reference # 10J-2008-02-04-01


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Financial Performance of Banks