Class 5 & 6

Class 5&6

CAMEL Rating

Bank publishes their CAMEL rating in their Balance Sheets

· C – Capital Adequacy

· A – Asset quality

· M – Management Quality

· E – Earnings Quality

· L – Liquidity

Capital Adequacy

· CA Ratio (CAR)

· D/E Ratio

· Advances to assets Ratio

· Securities to total investment ratio

All assets carry a risk of deterioration & the result is erosion of equity. Equity shows the firm’s ability to repay as and when the liability matures.

Earlier parameters of judging the bank’s performance – Business / Profit / Number of branches

Valuation Methods – The most conservative method is used for bank’s valuation

· Net asset Value (as on given date)

· P/E Ratio

· DCF Method (Future business earnings are discounted and not the assets)

CAR – Each of the assets carries a risk of non-realization (except cash)

Bank’s Assets (in decreasing order of liquidity)

· Cash – Zero Composite Risk

· Bank Balance – Maximum 5% risk

· Investments – Mostly in government securities as SLR & shares – 10%

ü SL R includes cash, gold, investment in unencumbered government securities

§ Unencumbered – It means Net. If as a Bank, I purchased $100 value of securities and I owe $20, then my unencumbered government security value is $80 (and not $100). It is a portion which is not mortgaged. Carry zero risk (no default risk)

ü Shares – Means for listed companies in stock market

· Advances

ü Corporate & Retail

ü 4 categories – Criterion is DPD (Days past due date)

§ Standard Asset (less than or equal to 90 days overdue installment)

§ Sub Standard Asset (More than 90 Days overdue installment but less than or equal to 90 days + 1 year overdue installment)

§ Doubtful Asset

§ Loss Asset

ü Criterions of NPA

§ Limit Expiry

§ Over-Limit

§ INS (Interest not served)

§ MAD (Minimum Amount Due)

ü Swing – Turnover for the year – Volume of money traded / generated / exchanged during the year

· PPE

· OA

· Miscellaneous Assets

***Capital should always be greater than risk weighted asset

Capital = Z = Paid up Capital + Reserves + Surplus in P&L account + Excess of reserves

Risk Weighted Asset = Y = (i = 1to N)∑ Cash * (Wi Ri) where W = Value of Asset i; R = Risk of default of Asset i.

Basal Committee says – Z > 8% (Y)

Advances to Asset Ratio = Advances / (Total Assets – Contra Items)

It shows better deployment of assets when advances increases.

0.6 = Good Deployment = (Advances / Total Assets) ……… [0.4 is SLR, CRR, WC]

General Reserve - Every bank has to transfer 20% of their profit to a reserve (called General Reserve) before dividend is declared (to protect capital of creditors). Regulators permission is needed for using general reserve.

· Forex fluctuation reserve – To cater to forex fluctuation

· Investment fluctuation reserve – Buying & Selling of Government securities

Securities (Government Bonds)to investment (Shares + Security) ratio – If high, then least risk

Asset Quality

2 Ratios

· Gross NPA / Net Advances

· Net NPA / Net Advances

Net Advances – Do not consider credit balance of OD account for calculating advances

Gross NPA – Provisions for NPA = Net NPA (Actual NPA)

Net NPA shows the ability of the bank to provide for NPA & should be justifiable with the profitability.

Quality of Management

· MV / Equity Capital

· Total Advances / Total Deposits = Credit Deposit Ratio

· Business per employee

· Profit per employee

Banks NPA may be high due to lending to priority sector. Credit guarantee corporations are formed to provide for NPA of priority sector for banks (Loans to farmers, defense personnel, students in low income group)

Earnings Quality

High spread for public sector bank = As dividend is received by the bank

Liquidity

Liquid Asset – Cash, Balances in current account with commercial bank / RBI, investment is central government securities, gold

Approved securities – Regulators approve investment in these securities for maintaining SLR requirements (may not belong to Government) like Mumbai municipal corporation bond. Here, repayment of principle and interest is guaranteed by government (state or central)

Ever Greening of Accounts – Give more time to NPAs to become standard assets or grant NPAs loans to pay off their current NPA debts