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An Analysis of the Financial Performance of Indian Commercial Banks

-- Krishan Kumar
Assistant Professor,
Department of Management Studies,
BPS Women University, Khanpur Kalan,
Sonipat, Haryana, India;
and is the corresponding author.

-- Kavita
Research Scholar,
Department of Management Studies,
BPS Women University, Khanpur Kalan,
Sonipat, Haryana, India.

The Indian banking industry is currently facing challenges to implement the capital
regulations specified under Basel III norms. In implementing the new capital
regulations, the financial stability of banks plays an important role. The banks which
are in a sound financial position can easily implement the new regulations, but it is
difficult for the financially weaker banks to determine the required capital as per the
international norms. Thus, financial analysis has become the need of the hour for the
banking sector to identify the financial position. In this context, evaluating the
financial health of Indian bank has become compulsory to compete with the
environmental changes. In this context, it is quite important to study the solvency
position of Indian banks. The present study intends to analyze the financial health of
selected Indian commercial banks through the application of Altman Z-score model. It
is found that the financial health of the selected banks under study is strong and

Banking industry plays a crucial role in ensuring the stability of an economy as banks
are regarded as the central part of financial system. The stable and sound position of
bank creates an environment of high growth and leads to the development of
economy. Nowadays, the assessment of financial performance of banks has become a
serious issue due to the failure of business, high competition, increasing risk,
possibility of scams and fraud, inability to fulfil the regulatory requirements; all these
factors create chances of uncertainty in banking operations. This sometimes leads to
the insolvency of business like the largest crisis in US banks in 2008. Hence the need
for Indian banks to analyze their profits efficiently.

Good financial performance of a bank is an indicator of rapid growth and ensures

security to depositors, shareholders, employees and economy. The banking sector is
capable of channelizing the funds within economy from the surplus to deficit units.
The sound performance of banks affects the quality of the banking and financial
services offered by banks. The banking sector forms the central part of financial
system of India and plays a crucial role in the overall growth of the economy. In
India, the banking sector is facing tremendous changes after the introduction of new
regulations and banking reforms. The Basel norms have been designed to strengthen
the international banking system. With the passage of time, Basel I and Basel II have
become outdated due to unexpected crisis, higher risk, low capital base and other
deficiencies in the norms. Now, Basel III norms have been evolved to fill the gap
arising due to the failure of Basel I and II. Basel III focuses on estimation of capital,
liquidity, and risk encountered by banks, and the new capital requirements under
Basel III bring a common standard of regulations and guarantee the stability of
banks. For implementing the new regulations, the banks should have higher profits.
Thus, Indian banks need to measure their financial performance because the low
profits can hit the operations of banks and their financial position. The major issues
for banks are complying with Basel III norms and maintaining the capital
requirements specified by the Basel committee. Therefore, analyzing the profitability
of banks is required for absorbing the higher risk and proper implementation of Basel
III norms.

In the last few years, more stress has been given to the analysis of profitability of
banks because the profitability of banks determines the efficiency and enables banks
to meet the regulatory norms for ensuring the stability of banking sector. A financially
strong bank is always capable of facing a crisis and unexpected distress and
withstanding defaults in payment. Thus, financial stability of banking industry leads to
growth of the economy and stable financial system. The financial performance of
banks is generally analyzed by calculating the ratios, and profitability ratio plays a
significant role in determining whether banks are generating sufficient profits or not.

Hence, the measurement of financial health of banks is necessary because the

extreme risk can make the banks unable to discharge their financial obligations, and
insolvent banks are forced to close down their operations. Therefore, careful attention
should be given to the financial performance of banks in the current scenario to make
the banking sector more competitive.

The present study analyzes the financial performance of banks by calculating the Z-
values which predict the financial status of bank.

Literature Review
Bodla and Verma (2009) made an attempt to explain the framework of commercial
banks in India concerned with the performance and risk faced by banks. A survey was
conducted for measuring the performance, and the authors concluded that evaluation
of continuous performance would enhance the long-term survival and growth.

Nandi and Choudhary (2011) developed a model for banks which enhances the
capacity of banks to predict the risk and financial performance. The authors used the
Altman’s equation to predict the defaulters and position of banks.

Nagamani and Willaths (2015) explained that the banking industry is considered the
backbone of every economy. The assessment of the financial position of bank is vital
because the condition of the banking sector determines the health of the economy.

Ghazi (2015) opined that measurement of bank performance is important for the
bankers for protecting the banking operations against a number of risks. However,
various studies have been conducted on financial analysis and its effect on the
efficiency of banking operations, which indicate the importance of financial
statements evaluation.

Trivedi et al. (2015) found that the financial performance of banks has become a
matter of concern for the external and internal users of financial statements. For
analyzing the financial performance of firms, the financial reports and statements act
as an indicator to ascertain the stability of a business. The matters related to
measuring the banks’ performance are complicated and critical because of the
diversified role played by banks in the economy.

Titko et al. (2016) explored whether the factors such as credit deposit ratio and net
interest income determine the profitability of banks and affect the stability of Indian
banks. The performance of the banking sector is proximate in the result of
profitability ratios. The financial and nonfinancial factors affect the profitability and
overall financial performance of banks.
Baligatti and Shilpa (2016) concluded that the banks are an essential part of the
economy and make substantial contribution to the development of a country by
mobilizing funds. Thus, evaluating the financial performance of banking sector is

Financial Ratios as a Measure of Financial Soundness

Analysis of financial soundness of any business is generally based on the financial
ratios and other accounting variables.

Kivuvo and Olweny (2014) described that linear discriminant analysis was the first
statistical technique employed to systematically describe which companies recorded
bankruptcy versus survived. The unhealthy position of financial statements directly
leads to bankruptcy. The financial health of companies can be predicted by the
analysis of financial statements using the financial ratios.

Obaid and Alzaabi (2011) concluded that the financial ratios are considered as the
most frequently tool used for analyzing the financial performance. The financial
performance of a firm is revealed by analyzing the financial statement and the
possible reasons for decreasing financial performance can be found out. Financial
ratios are generally used by the users of financial statements such as investors,
creditors, lenders, stakeholders, and other users who can face considerable losses
due to business failure.

Rawi et al. (2008) found that financial ratios are the essential ingredients of financial
analysis to measure and predict the financial statements. The various types of
financial ratios depict different results, such as solvency ratios depict the stability of
firms and profitability ratios determine the level of profits earned by the firms.
Financial ratios are used to evaluate the profit and level of risk in firms.

Bashar (2015) defined that financial ratios are considered as index to measure the
possibility of bankruptcy. Financial ratio generates formulas to predict the financial
performance of the firms and forecast the financial status of the firms, whether a
business is facing bankruptcy or not. Financial ratios have been regarded as a tool to
compare the performances among the businesses in the same industry. Financial
analysis discloses the efficient level of performance of firms, and sound performance
of firms helps in accepting the new regulations easily.

The present study attempts to assess the financial performance of selected Indian
public sector and private sector banks, and a comparison of the financial health of
selected Indian public sector and private sector banks has been made.

The study uses descriptive and analytical approach. The Z-value for a period of eight
years (2009-2016) has been calculated for 10 Indian commercial banks. Five public
sector banks, viz., Bank of Baroda (BOB), Punjab National Bank (PNB), Canara Bank,
State Bank of India (SBI), and Union Bank of India (UBI), and five private sector
banks, viz., Axis Bank, Yes Bank, Kotak Mahindra Bank, IndusInd Bank and ICICI
Bank, were included in the study (see Appendix). Data has been gathered for eight
years (2009-2016) from secondary sources such as annual reports of banks and
online publications, The Economic Times, etc.

Altman Z-Score Model

The Z-score was devised in 1968 by Edward I Altman who was Assistant Professor of
Finance at New York University. It was considered as a multivariate tool used to
evaluate the possibility of insolvency within a two-year period with high accuracy.
Altman took 22 factors from the accounting reports of 66 manufacturing firms in USA
with assets of $1 mn. The 66 firms were divided into 2 parts: 33 insolvent and 33
solvent. Z-value has been calculated with the help of Multiple Discrete Analysis
(MDA). The coefficients of Z-score equation were calculated with the application of
discriminant analysis. Altman collected 22 variables considered as the standard ratios
and reduced these ratios to five common ratios. This tool is known as multiple
discriminant analysis. The corporate default and financial status of firms is generally
measured by using the Altman’s equation. Z-score is computed with the multiplication
of accounting ratios with the coefficients. Z-score model helps in analyzing the
financial status of companies with computation of financial ratios (Jayadev, 2006).
The Z-score basic tool was evolved in 1968 for manufacturing companies. Altman, in
1983, again made changes to the Z-score for the usage of private firms. The model
was devised again in 1993 for emerging firms and non-manufacturers and included
only four variables (see Table 1).
The revised four models (1993) are:

Z = 6.56 X1 + 3.26 X2 + 6.72 X3 + 1.05 X4

Z = Overall Score
X1 = Working Capital / Total Assets
X2 = Retained Earnings / Total Assets
X3 = Earnings Before Interest and Taxes/Total Assets
X4 = Book Value of Equity / Total Liabilities

X1: Working Capital/Total Assets: The ratio computes the liquidity position of the firm
and capacity to repay the amount of its lenders. A higher ratio will indicate the safe
and sound position of firms.

X2: Retained Earnings/Total Assets: The lower ratio shows less chance for
accumulating the earnings. A growing firm generally indicates high RE/TA as it has
built the profits as compared to the infant firms having low earnings, thus the
possibility of insolvency is higher in earlier years (Altman, 1968).

X3: Earnings Before Interest and Taxes/Total Assets: Depicts the profitability of firm
and higher ratio shows higher earnings and increasing profit on each investment.

X4: Book Value Equity/Total Liabilities: Reveals the financial leverage which
determines the fixed capital of firm and related to the solvency of firm. When the
market value of share is less than the total amount of debt, then the chances of
insolvency are generally high and firms are declared bankrupt.

Results and Discussion

The present study attempted to assess the financial performance of selected Indian
public and private sector banks. Average Z-score has been computed for the period of
2009-2016. The score would determine the financial status and health of the banks.
This is depicted as:

Figure 1 presents that all selected banks are financially sound and healthy. The Z-
score reveals that no banks are financially weak as the Z-score calculation has been
observed more than 1.1. The selected banks’ (five public sector and five private
sector banks)

Z-value is greater than 4.0; this proves that the financial status of banks is strong
and there is not any possibility of insolvency. SBI scored highest Z-value, followed by
Bank of Baroda. The lowest value of Z has been secured by Yes Bank, but the bank
enjoys good financial status.

Figure 2 presents the Z-score of public sector banks and predicts that banks are not
going to become insolvent because the financial position of banks is sound. Over the
last eight years, the Z-value of public banks shows increasing and decreasing trends.
The Z-score is showing increased value for banks like BOB, UBI and Canara banks.
The overall trend of Z-score for PNB is decreasing, but has increased in 2016. SBI
scored the highest Z-value in 2016, indicating that the financial status of the bank is
strong. Higher Z-score means that the banks hold a strong and healthy financial
Figure 3 depicts that no private bank is going to become insolvent as banks scored Z-
value more than 2.6. The banks are in good financial position and performing well.
Yes Bank secured the highest value, followed by IndusInd Bank. ICICI, Kotak,
IndusInd and Axis banks show decreasing value in 2010, 2011 and 2015, and Z-score
increased in 2016 and 2014.

The analysis of Z-score allots first rank to SBI in both the years 2015 and 2016
(Table 2). The second rank is given to Bank of Baroda in 2015 and 2016, which is
followed by PNB in 2016 and by IndusInd Bank in 2015. As compared to 2015, the Z-
score of all selected banks increased in 2016, except for SBI. Yes Bank recorded the
last rank in 2015 and 2016, followed by Kotak Bank in 2016 and by Axis Bank in
Figure 4 describes the comparative analysis of Z-score of selected Indian banks in
2015 and 2016. Compared to 2015, the Z-value of all selected banks had increased
except for SBI. In 2016, SBI scored higher value than other banks. But as compared
to public sector banks, the Z-value for private banks is less, which means the
financial status of public sector banks is strong and healthy.
In the present study, an attempt has been made to check whether the financial
performance of selected Indian banks is sound and healthy or not. It can be
concluded that by applying the Altman Z-score tool for the last eight years, all the
banks have been found to be solvent and enjoying a sound and healthy financial
position. The financial performances of private and public sector banks have been
observed different due to the variations in Z-score of private banks. It has been
found that the public banks are financially stronger and healthier (Tandon and Batra,

The analysis of financial position of banks is essential for bankers, financial analysts,
and other stakeholders. Z-score model is beneficial for predicting the financial status
of companies and the level of insolvency faced by firms. Stronger financial
performance would make banks more stable and ascertain the safe position that
forms a base for long-term survival, better utilization of resources and earnings, and
ensure optimum capital for absorbing risk and financial crisis. The present study is
anticipated to furnish an effective framework to bankers and other users while
making investment in banks.

Recommendations: Based on the findings, it is recommended that private banks

should make proper efforts for strengthening their financial position. The Indian
banks need to focus on profit-generating activities for sound financial performance
because the bank with high profits will be easily capable of absorbing the risk and can
compete with other banks. The Indian banks should give more consideration to Basel
capital regulations that may help in enhancing the efficiency of operations of banking
sector with strong capital base. In order to meliorate the financial position of banks,
banks need to make systematic endeavor for analyzing the financial statements
regularly and presenting the statement more truly and fairly. The acceptance of
sound policies and norms will ensure better management of banking operations,
leading to higher profitability. Banks should consider proper methods and tools for
assessing the financial statements regularly and timely. Banks should give special
attention to the factors that decrease the financial position and profits.

Suggestions for Future Research: In the present study, the financial performance of
selected Indian banks has been assessed with the help of Altman model. Other
models can also be used to analyze the financial performance. The Z-score can be
used in predicting the risk and level of distress in various sectors. This study can be
extended in future, as the financial performance of firms is a matter of concern
because it drives the other functions of business. The future research can be
extended with different years of study. The research in future can be conducted with
different samples in different economies, applying the same model. A comparative
analysis can be done for investigating the overall performance of banking sector.

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Reference # 10J-2017-02-01-01

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