CHAPTER I

INTRODUCTION

1.1 GENERAL BACKGROUND

Nepal, a newest republic country in the South Asia, is sandwiched between two large
countries The People's Republic of China in the North and India in the rest sides with
open borders. It has an agro-based economy with around 80% populations
depending on agriculture for their livelihood and a population around 26.49 million
with growing rate of 1.35 per annum. The main reason for its agro-based economy is
attributed to its geographical construction, where a major portion of the country is
composed of hills and terai (plain lands) very suitable for agriculture. The other
reason is due to its low literacy rate, average literacy ratio of 65.90% where men and
women comprise 75.10% and 57.40% respectively which has restricted the people to
primitive and traditional forms of occupation. Due to geographical and topographical
structure, about 60% people have no access to physical facilities and about 25.20%
people still live below absolute poverty line.

The economic growth rate of Nepal is about 4.63% in FY 2068/69. It is very low and
lowest in comparison to South Asian Neighbours. It is because of the dominant
traditional subsistence agricultural occupation. Even now agriculture covers only
37.78% of total GDP of the nation. Agriculture, though crucial in Nepalese economy,
has not been commercialized and is going on with the century-back technology. It is
not like an occupation but like a way of life in Nepalese situation. Still, due to the lack
of irrigation facilities and also due to difficult topographical realities, agriculture is
dependent on monsoon and hence the growth rate of Nepal basically rests on the
monsoon conditions every year.

Nepal in the present context is running from the critical situation. It is under
rundown situation politically, socially, technologically and economically as well. If

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one has to choose the most critical situation then it will be economically with no
doubt. Due to various problems in Nepalese economy reassured by socially,
politically and technologically Nepal is advancing its development in diminishing rate.

Improvements in global and regional economic growth signal positive results for our
two neighbouring countries China & India. However, our country Nepal suffers from
problems that inhibit economy at down level due to imbalance between resource
mobilization & expenditure, saving & investment and export & import. Endemic
problems such as low per capita income (US $ 735), trade deficit, low growth rate,
unemployment & migration, continue to plague our country. In FY 2068/69, the
economy is registered at around 4.63% growth rate, which is hardly enough to make
perceptible impact in the economy.

Even after almost 50 years of planned development, the country is unable to

overcome structural deficiency, rigidity and development disparity (Shrestha, 1998).
Instead, major areas and population of the country are kept outside the market net.
The eventual consequence for the economy has been the low resource efficiency and
productivity all over the country leading to absolute poverty, income disparity and
unemployment as well as low income and saving. This has had a negative effect on
investment and growth. The country today is economically in a low equilibrium
population trap, which is undermining the smooth transition of the so called
traditional economy to a modern and diversified structure suitable for the
competitive world under the WTO framework (World Bank, 2004).

So, Nepal has been facing the problem of accelerating the pace of economic
development for many decades. The economic development is a way out to remove
all ills for steeping up low income, living standards and market for developments
thereby increasing the growth of the economy. One of the basic elements in
achieving a self-reliant growth of the economy and for sustaining the desired level of
economic development is an accelerated rate of investment or capital formation in
the economy. Increasing investment through exploiting available resources with

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private sectors participation can succeed desire of development. The rate of
investment or capital formation depends upon the efficiency of the financial system.
The markets, instruments, bank and financial institutions that comprise this system
facilitate the efficient production of goods and services and thereby contributing the
society’s well being. The financial system performs this function by channeling the
nation’s saving into best uses. It does this by bringing together those who have
surplus funds to lend and those who wish to borrow to finance their expenditures.

The financial institution is that organization which plays a vital role in collecting
unused funds from the individual households, general public, business institutions
and mobilize those funds to the needy sectors such as business, industrial,
agricultural, production, service, manufacturing even in infrastructure sector and
government bodies. It plays and acts as an intermediary role between savers of funds
and users of the funds. It collects the funds in terms of deposits & provides low
interest to depositors and lends those funds in terms of loans & charge high interest
from borrowers and also offers a wide menu of financial services. This is how the
financial institution makes profit, by serving the public.

Bank, a financial institution, plays a vital role in the economic development of the
country. The function of bank is not only to accept deposit and grant loans, but also
to include wide range of services to the different strata of society, to facilitate the
growth of trade & commerce, industry and agriculture of the economy. Bank is a
resource for the economic and social development, which maintains the self
confidence of each individual and various sectors in the nation. In the absence or
insufficiency of banking and financial facilities, the growth of economic development
becomes stagnant. So, bank can be considered as the backbone of overall socio-
economic development of the country.

In every country outset of economic development is quite different but there is no

debate about the significant roles of banking sector for the economic development
of a country, as they are considered as the main source of finance. But the banking

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system in Nepal is still in its infant stage as compared to other development
countries. However, their important role in the economic development of the
country has been fully realized and these banks are being oriented in their activities
best suited for the overall economic development.

New innovations, deregulation and globalization in banking sector have contributed

a lot in making banking business more complex and potentially riskier. This has
presented new challenges to bank supervisors with respect to the structuring of their
ongoing supervision. In response, supervisors have developed new methods and
processes for monitoring and assessing banks on an ongoing basis. Particular
attention is being paid in this regard to improve the quality of bank examinations and
to the development of systems that can assist supervisors and examiners in
identifying changes, particularly deterioration, in banks' financial condition as early
as possible.

CAMELS framework is considered as one commonly used framework for analyzing

the health of individual financial institution, which looks at six major aspects of a
financial institution: Capital adequacy, Asset quality, Management soundness,
Earning, Liquidity, and Sensitivity to market risk. The purpose of CAMELS framework
is to determine a bank's overall condition and to identify its strength and weakness in
respect of financial, operational and managerial aspects of an individual institution.

HBL and EBL are significantly similar in many aspects in terms of their volume and
quality of financial performance in various sectors. The purpose of this study is to
measure & evaluate the financial performance and efficiency between HBL and EBL
in the framework of CAMELS Components. This study will be focused on - are these
two banks being success to follow the CAMELS thereby meet the compliance of NRB?

1.2 BRIEF PROFILE ABOUT BANKS UNDER STUDY

1.2.1 HIMALAYAN BANK LIMITED (HBL)

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Himalayan Bank Limited was established in 1992 in joint venture with Habib Bank
Limited of Pakistan. The Bank’s operation was commenced from January 1993 AD
under the company act 1964 AD. It is the first commercial bank of Nepal with
maximum share holding by the Nepalese private sector. Its ownership is composed
of founder share holding 51 percent, Habib Bank Limited of Pakistan 20 percent,
Karmachari Sanchaya Kosh 14 percent and public 15 percent. Despite the cut-throat
competition in the Nepalese Banking sector, Himalayan Bank has been able to
maintain a lead in the primary banking activities - Loans and Deposits.

Legacy of Himalayan lives on an institution that's known throughout Nepal for its
innovative approaches to merchandising and customer service. Products such as
Premium Savings Account, HBL Proprietary Card and Millionaire Deposit Scheme
besides services such as ATMs and Tele-banking were first introduced by HBL.

All Branches of HBL are integrated into Globus (developed by Temenos), the single
Banking software where the Bank has made substantial investments. This has helped
the Bank provide services like ‘Anywhere Branch Banking Facility’, Internet Banking
and SMS Banking. Living up to the expectations and aspirations of the Customers and
other stakeholders of being innovative, HBL very recently introduced several new
products and services. Millionaire Deposit Scheme, Small Business Enterprises Loan,
Pre-paid Visa Card, International Travel Quota Credit Card, Consumer Finance
through Credit Card and online TOEFL, SAT, IELTS, etc. fee payment facility are some
of the products and services. HBL also has a dedicated offsite ‘Disaster Recovery
Management System’. Looking at the number of Nepalese workers abroad and their
need for formal money transfer channel; HBL has developed exclusive and
proprietary online money transfer software- HimalRemitTM. By deputing our own
staff with technical tie-ups with local exchange houses and banks, in the Middle East
and Gulf region, HBL is the biggest inward remittance-handling Bank in Nepal. All this
only reflects that HBL has an outside-in rather than inside-out approach where
Customers’ needs and wants stand first.

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1.2.1.1 HBL is not only a Bank, It is committed Corporate Citizen

Corporate Social Responsibility (CSR) holds one of the very important aspects of HBL.
Being one of the corporate citizens of the country, HBL has always promoted social
activities. Many activities that do a common good to the society have been
undertaken by HBL in the past and this happens as HBL on an ongoing basis.
Significant portion of the sponsorship budget of the Bank is committed towards
activities that assist the society at large.

1.2.1.2 The Bank’s Vision

Himalayan Bank Limited holds of a vision to become a Leading Bank of the country by
providing premium products and services to the customers, thus ensuring attractive
and substantial returns to the stakeholders of the Bank.

1.2.1.3 The Bank’s Mission

The Bank’s mission is to become preferred provider of quality financial services in the
country. There are two components in the mission of the Bank; Preferred Provider
and Quality Financial Services; therefore we at HBL believe that the mission will be
accomplished only by satisfying these two important components with the Customer
at focus. The Bank always strives positioning itself in the hearts and minds of the
customers.

1.2.1.4 The Bank’s Objective

To become the Bank of first choice is the main objective of the Bank.

The present share holding pattern of HBL is as follows:

Table - 1.1
EQUITY PARTICIPATION OF HBL
(Rs. In Million)
PERCEN
S. NO. EQUITY PARTICIPATION
T

6
 1 Promoters 51 EQUITY PARTICIPATION OF HBL

15%
2 Karmachari Sanchaya Kosh 14
3 Habib Bank Limited 20
20% 51%
4 General Public 15
CAPITAL AND RESERVES  
14%
Authorized Capital Rs. 3,000
Issued Capital Rs. 2,400
Promoters Karmachari Sanchaya Kosh Habib Bank Limited General Public

Paid up Capital Rs. 2,400

(Source: Annual Report of Himalayan Bank Limited, 2011/12)

1.2.2 EVEREST BANK LIMITED (EBL)

Everest Bank Limited (EBL) started its operations in 1994 with a view and objective of
extending professionalized and efficient banking services to various segments of the
society. The bank is providing customer-friendly services through its Branch Network.
All the branches of the bank are connected through Anywhere Branch Banking
System (ABBS), which enables customers for operational transactions from any
branches.

With an aim to help Nepalese citizens working abroad, the bank has entered into
arrangements with banks and finance companies in different countries, which enable
quick remittance of funds by the Nepalese citizens in countries like UAE, Kuwait,
Bahrain, Qatar, Saudi Arabia, Malaysia, Singapore and U K.

Bank has set up its representative offices at New Delhi (India) to support Nepalese
citizen remitting money and advising banking related services.

1.2.2.1 Joint Venture Partner

Punjab National Bank (PNB), joint venture partner (holding 20% equity in the bank)
of EBL is the largest nationalized bank in India. With its presence virtually in all the
important centers at India, Punjab National Bank offers a wide variety of banking
services which include corporate and personal banking, industrial finance,

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agricultural finance, financing of trade and international banking. Among the clients
of the Bank are Indian conglomerates, medium and small industrial units, exporters,
non-resident Indians and multinational companies. The large presence and vast
resource base have helped the Bank to build strong links with trade and industry.

1.2.2.2 Awards

 The bank has been conferred with “Bank of the Year 2006, Nepal” by the banker,
a publication of financial times, London.
 The bank was bestowed with the “NICCI Excellence award” by Nepal India
chamber of commerce for its spectacular performance under finance sector

1.2.2.3 Pioneering achievements

 Recognizing the value of offerings a complete range of services, EBL has

pioneered in extending various customer friendly products such as Home Loan,
Education Loan, EBL Flexi Loan, EBL Property Plus (Future Lease Rental), Home
Equity Loan, Vehicle Loan, Loan Against Share, Loan Against Life Insurance Policy
and Loan for Professionals.
 EBL was one of the first banks to introduce Anywhere Branch Banking System
(ABBS) in Nepal.
 EBL has introduced Mobile Vehicle Banking system to serve the segment deprived
of proper banking facilities through its Birtamod Branch, which is the first of its
kind.
 EBL has introduced branchless banking system first time in Nepal to cover
unbanked sector of Nepalese society.
 EBL is first bank that has launched e-ticketing system in Nepal. EBL customer can
buy yeti airlines ticket through Internet.

The present share holding pattern of EBL is as follows:

Table - 1.2
EQUITY PARTICIPATION OF EBL

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 (Rs. In Million)
PERCEN
S. NO. EQUITY PARTICIPATION
T EQUITY PARTICIPATION OF EBL

1 Promoters 50 30%

2 Punjab National Bank 20

50%
3 General Public 30
CAPITAL AND RESERVES  
20%
Authorized Capital Rs. 2,000
Issued Capital Rs. 1,392 Promoters Punjab National Bank General Public

Paid up Capital Rs. 1,392

(Source: Annual Report of Everest Bank Limited, 2011/12)

1.3 IMPORTANCE OF THE STUDY

The importance of this study lie mainly in identifying problem or deteriorating FI, as
well as for categorizing institution with deficiencies in particular component areas.
Further, it assists in following safety and soundness trends and in assessing the
aggregate strength and soundness of the financial industry. As such, the study assists
the stakeholders in fulfilling their collective mission of maintaining stability and
public confidence. It would helpful for the senior management involved in day-to-day
operations. Bankers and Examiners, alike can use this study to further understanding
of a bank's financial condition.

The study benefits to lot of groups like shareholders, management team of bank,
general public who act as depositors and their customers and policy makers of the
concerned banks. The general public will find them ease to categorize the
commercial banks on their performance standards and can invest accordingly. On the
other hand, the management can do their bank's SWOT analysis on the basis of
CAMELS analysis and can plan accordingly. With the help of this analysis, Nepal
Rastra Bank can easily set standards for the banks and can advise them to improve
accordingly.

In gist, the importance of the study can be pointed as follows:

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1. To the policy makers

This study will be very important from the point of view of policy makers of the
concerned banks, central bank and academic professionals to formulate plans and
policies on the basis of the performance of the bank.

2. To the management

This study will be important to the management of bank to know the loose areas and
gaps, which can be corrected timely.

3. To the outsiders

As every investor and customers (depositors, loan takers) will not have well
knowledge about the real financial performance of the concerned banks, this study
will be important to aware them and also personnel of other banks to understand
the bank's financial condition and take right decisions at the right time.

4. To the further researcher

As CAMELS analysis has little been researched in the context of Nepal, the new
researchers, teachers and scholars will find it a literature for their future research
works.

1.4 STATEMENT OF THE PROBLEM

Nepal’s economic progress is being declined and political stability is not cleared, the
number of financial institution is being increased day by day. In the recent time,
there are 32 commercial banks, 90 development banks, 67 finance companies, 25
micro-credit development bank and 16 saving & credit co-operatives (Limited
Banking) in Nepalese financial market (NRB, 2012). The number of Co-operatives is
uncountable and there are many more financial institutions in pipeline. Besides,

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Nepal has already entered in WTO and there is probability of influx of international
bank in the banking sector of Nepal, which will further make banking even more
competitive. Nepalese Financial Institutions should be ready to compete with
international banks.

Another problem is Nepal Rastra Bank's current regulation for authorized share
capital increment. Nepal Rastra Bank, the central bank of Nepal already ruled the
Nepalese bank to increase their capital to 2000 million, 640 million and 200 million
for 'A', 'B' & 'C' class of financial institutions respectively by the end of 2070 BS. So it
has been seemed that the banks are trying to increase their capital by various
method like declaring bonus and right share. The need for capital requirement may
lead some of the financial entities to go for merger and acquisition.

The main objective of a Financial Institution is to increase its returns which often
come at the cost of various increased risk like Credit Risk, Liquidity Risk, Interest Rate
Risk, Market Risk, Technology Risk, Operational Risk, Insolvency Risk etc. It is very
difficult to call the FIs sound though they are earning profit since they may be
exposed to aforesaid risks. Questions are being raised over the validity of their
balance sheet and profit & loss account. If the suspicion comes true, it will prove very
costly to the depositors, creditors and national economy as a whole. In view of this it
is important that FIs should manage these risks and have appropriate policies,
processes and practices accordingly so that management will follows and uses in
appropriate time.

In this divergent scenario the measurement of the banks and financial institutions
technical viability is getting more important. As the case of problem bank has been
arising, the measurement techniques to analyze the overall soundness of the
financial institutions should be implemented. The CAMELS analysis is one of the
potent tools to do so. Several academic studies have examined whether and to what
extent CAMELS analysis is useful in the supervisory monitoring of banks. With
respect to predicting bank failure, there is evidence that CAMELS analysis are useful,

11
even after controlling for a wide range of publicly available information about the
condition and performance of banks. Some other empirical study has examined a
similar question and finds that although CAMELS analysis contains useful
information, it decays quickly.

The example of some banks like Nepal Bangladesh Bank Ltd, Nepal Credit &
Commerce Bank Ltd. and Lumbini Bank Ltd. have shown that even the big capital
base bank can face problem like negative net worth, lower capital adequacy than
required, management problem etc. The supervisor in our context Nepal Rastra Bank
use CAMELS analysis as a tool for onsite inspection. In this case the use of CAMELS
analysis to figure out the financial as well as technical viability of the bank and
financial institutions is utmost essential. However, the tough competition among
banks with regard to management improvement, transparencies of transaction,
globalization of marketing and compliance of NRB rules and regulation will make
them hard to sustain with better performance.

Normally, general public are interested to invest their small saving amount in
common stocks, mainly stocks of financial institutions such as commercial banks,
development banks and finance companies rather than in stocks of industrial sector.
But the main problem is general public cannot perfectly analyze which financial
institution to invest and which to stay away. The recent trend shows that investors
are investing their entire funds in single equity rather than applying the concept of
portfolio and investing in different equities of different sectors. Without proper
information and guidance, investors are suffering from huge losses and bearing high
risk. Therefore, this thesis tries to evaluate and compare the soundness of selected
two commercial banks through the CAMELS analysis. The author hopes that this
thesis will somehow help the investors to know the financial soundness of these
institutions and help to make right investment decisions.

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The elementary objective of this research is to scrutinize the financial condition of
selected banks in the framework of CAMELS Components and is an attempt to find
out the answers of following research questions:

 Are selected banks maintaining adequate capital adequacy? Is it in line with the
regulated minimum capital requirement?
 Are banks managing the level and trend of Asset Composition? What is the
quality of bank's Loans and Loan Loss provision mix for the smooth functioning of
their business?
 Is banks' management competent enough to handle the contemporary pressure
and problems of the business and take their organization to a new height?
 Are banks earning enough revenue and profit to satisfy their depositors and
shareholders? What are the level, trend and stability of selected bank's earnings?
 Are banks maintaining enough liquidity to run their business smoothly? Is it in line
with the regulated minimum liquidity requirement?
 Are banks responding efficiently to the market risk?

1.5 OBJECTIVES OF THE STUDY

The overall objective of the study is to evaluate and compare the financial
performance of the selected banks and also to ascertain the financial position in the
framework of CAMELS Components.

The specific objectives of the study are as follows:-

i. To evaluate and analyze capital adequacy of selected banks and compare with
regulatory minimum capital requirement.

ii. To analyze the quality of assets and evaluate asset composition.

iii. To evaluate the management quality of selected banks.

iv. To evaluate the level, trend and persistent of the banks’ earning.

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v. To analyze and evaluate the liquidity condition of the banks and compare with the
regulatory minimum liquidity requirement.

vi. To analyze the sensitivity of market risk of selected banks.

vii. To provide suggestions and recommendations to the concerned banks for future
improvement.

1.6 FOCUS OF THE STUDY

In Nepal, Nepal Rastra Bank (NRB), the Financial Institutions' regulatory authority
uses the CAMELS (Capital, Assets, Management, Earning, Liquidity, and Sensitivity)
analysis for assessing the financial health soundness of financial institutions. The
research study is focused on assessing the financial condition and performance of
HBL & EBL and also to identify and monitor the current and potential areas of risk by
using descriptive and analytical research design. More specifically, the study focuses
on the trend analysis of Capital adequacy ratio, Non-performing loan ratio, Loan loss
provision ratio, Total expense to total income ratio, Earning per employee, Return on
equity, Return on assets, Earning per share, Liquidity, Sensitivity to Market Risk and
other related ratios with respect to NRB standard during the period of past five years
starting from FY 2064/65 to FY 2068/69.

1.7 LIMITATIONS OF THE STUDY

Although this study is done to portrait the accurate information of the current
position of the selected banks but due to some condition it has some limitations of
its own kind. The limitations of this study are as follows:

i. This study is based on annual report published by the concerned banks for the
period from FY 2064/65 to FY 2068/69.

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ii. This study will show the financial performance of concerned two banks based on
CAMELS Components. The result of this study may not be applicable to other
banks of Nepal.

iii. The whole study will base on secondary data collected from the concerned banks,
NRB as well and also from various journals, articles, dissertations etc. So, it does
not concern with detail experimental research.

iv. Limited resources like time and cost factor have also constrained the study to
conduct at a desirable extent.

v. Data taken for the analysis are also from website and the authenticity of the data
is dependent on the accuracy of the website used.

1.8 ORGANIZATION OF THE STUDY

This whole study is divided into five chapters for proper identification.

Chapter I The first chapter deals with the introductory part of the study which
includes general introduction, brief profile about banks under study, importance of
the study, statement of the problem, objectives of the study, focus of the study,
limitations of the study and organization of the study

Chapter II The second chapter deals with the review of different literature in regards
to the theoretical analysis and review of books, journals, articles, unpublished thesis
and other independent research in this related field of study. Therefore it includes
conceptual framework and other relevant research studies.

Chapter III The third chapter deals with the research methodology used to carry out
this research work. It includes research design, population and sample, nature and
sources of data, method of data collection, data processing techniques and tools for
analyzing data by using statistical and financial tools.
15
Chapter IV The fourth chapter is the presentation and analysis of data, which is the
main chapter of the study. This chapter is concerned with the application of defined
research method on the collected data and information. The generated results after
the application of research method on data will be analyzed and interpreted in this
chapter. Based on the data CAMELS analysis will be done using statistical and non-
statistical tools. This chapter also includes major findings of the study.

Chapter V The fifth chapter is associated with the main summary, conclusion and
recommendations on the base of the study. This chapter summarizes the whole
thesis report, presents conclusion of all the analysis and tries to provide
recommendation on the basis of study. The references and appendices are also
included as supplements to the above chapters.

CHAPTER II

REVIEW OF LITERATURE
Review of literature is basically a stock taking of available literature in the field of
research. It supports a researcher to explore relevant and true facts for reporting
purposes. In course of research review, existing literature can help to check chances
of duplication. Thus, one can find what studies have been conducted and what
remains to go with.

This chapter depicts upon existing literature and research related to the present
study for the purpose of finding out what had already been explained and how this
research adds to required dimension. This study is about the comparative financial
performance analysis of two commercial banks. So the theoretical aspect of the topic
on financial performance analysis is reviewed in this chapter. Also this chapter
focuses on the concept of commercial bank, bank supervision, CAMELS components
and review of research papers. Beside these, current stage of the related research
work and related dissertations have been reviewed and summed up.

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2.1 CONCEPTUAL FRAMEWORK

This section presents the theoretical aspects of the study, which include the concept
of commercial bank, functions of commercial bank, bank supervision, concept of
CAMELS components and more.

2.1.1 CONCEPT OF COMMERCIAL BANK

A commercial bank is a profit-seeking business firm, dealing in money or rather

dealing in claims to money. It is a financial institution (FI) that creates deposit
liabilities which circulate as money in the economy. Like other industrial or
commercial enterprise, a bank too, seeks to earn maximum income through the
suitable employment of its resources. It is a financial intermediary - a sort of a
middleman between people with surplus funds and people in need of funds. It
accepts deposits for the purpose of lending or investment and thereby hopes to
make a profit - profits which are adequate enough to enable the bank to pay interest
at the prescribed rates to its depositors, meet establishment expenses, build
reserves, pay dividend to the shareholders, etc. (Shrestha, 2009)

In general, commercial banks are those FIs, which play the role of financial
intermediary in collection and disbursement of funds from surplus unit to deficit unit.
It is established with a view to provide short term debt necessary for trade and
commerce of the country as well individual households for their personal and
business use along with other ordinary banking business such as collecting the
surplus in the form of deposit, lending debts by discounting bills of exchange,
accepting valuable goods in security, acting as an agent of the client etc.

2.1.2 FUNCTIONS OF COMMERCIAL BANK

The basic function of commercial bank is to accept the deposits from unproductive
sectors and channelize them in the productive sectors. By this, they earn profit as
interest by advancing the fund as loan at the interest rate higher than its cost. In the
mean time, the banks generate capital for economic development of a country. Now-

17
a-days the services provided by bank have been expanded to many areas as of
human wants and development of technology. The commercial banks in Nepal
provide the following main banking functions. (Singh, 2009)

2.1.3 BANK SUPERVISION

Tuning with the present scenario of globalization and increased economical activities
in the country, commercial banks are now introducing complex and innovative
banking products. In the mean time, the probability of loss becomes significant to
banks, which are running behind in the competition. In case of insolvency, the public
depositors as well as the shareholders of the bank may suffer significantly which
adversely affect the overall banking sector. The supervision of banks is essential to
find out the solvency position and take corrective action in time when needed. This
has amplified as well as diversified the functions to be performed by the Bank
Supervision Department of NRB. This section deals with the concept of bank
supervision, objective of bank supervision and the process of supervision. (Shrestha,
2010)

2.1.3.1 Concept of Bank Supervision

The success of the banking system is not possible without an effective and efficient
risk management of its operation. As commercial banks are now involved in complex
and innovative banking products they are exposed to many risks. The Board of
Governors of the Federal Reserve System defined six safety and soundness risks in SR
Letter 95-51, issued in November 1995. These risks are defined as follows:

 Credit Risk arises from a potential borrower failing to perform on an obligation.

 Market Risk is the risk to a FI's condition resulting from adverse movements in
market interest rates or prices.
 Liquidity Risk is the potential that an institution will be unable to meet its
obligations as they come due because of an inability to liquidate assets or obtain
adequate funding.

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 Operational Risk arises from the potential that inadequate information systems,
operational problems, breaches in internal controls, fraud or unforeseen
catastrophes will result in unexpected losses.
 Legal Risk arises from the potential that unenforceable contracts, lawsuits or
adverse judgments can disrupt or otherwise negatively affect the operations or
condition of a banking organization.
 Reputational Risk is the potential that negative publicity regarding an institution's
business practices, whether true or not, will cause a decline in the customer base,
costly litigation or revenue reductions.

However, an implicit framework for the regulation and supervision of banks can be
found in the Core Principles for Effective Banking Supervision issued by the Basel
Committee on Banking Supervision in 1997. The framework can be interpreted as
comprising four distinct yet complementary sets of arrangements:

 Legal and institutional arrangements for the formulation and implementation of

public policy with respect to the financial sector, and the banking system in
particular;
 Regulatory arrangements regarding the formulation of laws, policies,
prescriptions, guidelines or directives applicable to banking institutions (e.g. entry
requirements, capital requirements, accounting and disclosure provisions, risk
management guidelines);
 Supervisory arrangements with respect to the implementation of the banking
regulations and the monitoring and policing of their application;
 Safety net arrangements providing a framework for the handling of liquidity and
solvency difficulties that can affect individual banking institutions or the banking
system as a whole and for the sharing of financial losses that can occur (e.g.
deposit insurance schemes or winding-up procedures).

2.1.3.2 Objectives of Bank Supervision

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The overall objective of this comprehensive process of supervision is to guarantee
that banks can be established, operated and restructured in a safe, transparent and
efficient manner.

A bank supervisory agency like NRB in Nepal is responsible for monitoring the
financial conditions of commercial banks and FIs and enforcing related legislation and
regulatory policy. Although much of the information needed to do so can be
gathered from regulatory reports and on-site examinations which are needed to be
verify of their accuracy and gather further supervisory information. Most research
has explored the value of this private information, both to the bank supervisors and
to the public who monitor banks through the financial markets. Overall, supervisory
risk assessment and early warning systems assist in:

 Systematic assessment of banking institutions within a formalized framework

both at the time of on-site examination and in between examinations through
off-site monitoring;
 Identification of institutions and areas within institutions where problems exist or
are likely to emerge;
 Prioritization of bank examinations for optimal allocation of supervisory resources
and pre-examination planning; and Initiation of warranted and timely action by
the supervisor. (FRB, 1995)

2.1.3.3 Process of Bank Supervision

Ongoing banking supervision consists of a differentiated mix of Supervision. There

are basically three types of supervisory system. They are:

1. Off-site Supervision

Off-site monitoring is the minimum tool for ongoing supervision. Supervisory

authorities, which do not have the mandate or resources to carry out periodic on-site
examinations, rely extensively on this method to monitor the financial condition and
performance of banks and to identify those institutions that may need closer

20
scrutiny. The process involves analyzing and reviewing periodic financial and other
information received by the supervisor relating to banks’ activities. Supervisors are
responsible for reporting requirement covering, for instance, balance sheet and
profit and loss statements, business profile, loans, investments, liabilities, capital and
liquidity levels, loan loss provisions, etc. This helps the central bank to judge whether
they have accomplished the legal requirements and the compliance instruction given
them regarding the issues like capital adequacy, cash reserve ratio, priority sector
loan, deprived sector loan, classification of loan and provision and profitability. (NRB,
2063)

2. On-site Supervision

During on-site examinations, supervisors make an overall assessment of a banking

institution on the premises of the organization. Examinations by specialized and
trained bank examiners allow a more hands-on assessment of qualitative factors
such as management capabilities and internal control procedures that may not be
reflected adequately in regulatory reports. Supervisors check various files and
examine whether they are recorded and maintained as per rules and regulations.
Especially, the documents about loan accounts, expenses, letter of credit, bank
guarantee, remittance etc are checked properly. Supervisory authorities may also
commission outside organizations such as external auditors to undertake a full on-
site examination or to review specific areas of operations within a banking
institution. For conformity, supervisors can randomly verify the physical balance of
cash and other assets with records. (Sahajwala and Bergh, 2000)

3. Special Supervision

Special supervision is conducted only for special purpose. It is not conducted

regularly. Depending upon the nature of crisis and objective, the process and method
of special supervision may vary from one case to another. Mostly, special supervision
is conducted only in the following circumstances

21
a. When a bank suffer a great loss or economic crisis,

b. When government or central bank feels that a bank is indulged in major fraud,

c. When majority of shareholders request the central bank for the special
supervision,

d. When a bank is decided to go into liquidation. (NRB, 2002)

2.1.4 CONCEPT OF "CAMELS"

Federal Reserve Bank of New York (1997) has defined the component of CAMEL as
rating system which produces a composite rating of an institution's overall condition
and performance by assessing five components: Capital adequacy, Asset quality,
Management administration, Earnings, and Liquidity. The CAMEL was later updated
with inclusion of sixth component, Sensitivity to Market Risk, now is referred to as
the CAMELS rating system.

CAMEL was originally developed by the FDIC for the purpose of determining when to
schedule an on-site examination of a bank. The FFIEC is revised in January 1997, the
UFIRS, which is commonly referred to as the CAMEL rating system. This system was
designed by regulatory authorities to quantify the performance and financial
condition of the banks which it regulates.

The most important criteria for determining the appropriateness of FIs to act as a
financial intermediary are its solvency, profitability, and liquidity. In this respect, the
BCBS of the Bank of International Settlements (BIS), since 1988, has recommended
using Capital adequacy, Assets quality, Management quality, Earning and Liquidity
(CAMEL) as criteria for assessing FI.

During on-site examination of bank, 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

22
exam is a supervisory rating of the bank's overall condition, commonly referred to as
a CAMELS rating. (Sahajwala and Bergh, 2000)

CAMELS is one of the best tools used to rate the quality of commercial banks. It is an
international bank-rating system with which bank supervisory authorities rate
institutions according to these six factors. In Nepal, this method has been adopted by
Nepal Rastra Bank and publishes it time to time. NRB plays the supervisory role for
evaluating bank's financial condition though rating the bank's in accordance to
CAMELS is still in its initial phase.

2.1.5 COMPONENTS OF CAMELS

2.1.5.1 Capital Adequacy

The Capital Adequacy ratio was adopted in 1988 by the Basel Committee on Banking
Supervision as a benchmark to evaluate whether banks operating in the G-10
countries have adequate capital to survive likely economic shocks. The ratio calls for
minimum levels of capital to

(i) provide a cushion against losses due to default arising from both on and off
balance sheet exposures;

(ii) demonstrate that bank owners are willing to put their own funds at risk;

(iii) provide quickly available resources free of transactions and liquidation costs;

(iv) provide for normal expansion and business finance;

(v) level the playing field by requiring universal application of the standard to
internationally active banks; and

(v) Encourage less risky lending.

The Basel Capital Accord of 1988 defined capital, the numerator in the risk asset
ratio, as follows:

23
Tier I (Core Capital) capital includes issued and paid-up share capital, noncumulative
preferred stock, and disclosed reserves from post tax retained earnings. It is the
highest quality capital, and should form no less than 50 percent of total regulatory
capital.

Tier II (Supplementary Capital) capital include a range of other items, including

undisclosed reserves that have passed through the profit and loss account;
conservatively valued revaluation reserves; revaluation of equities held at historical
cost can be included at a discount; general loan loss reserves, up to 1.25 percent of
risk-weighted assets; hybrid debt instruments available to support losses without
triggering liquidation; and subordinated term debt, up to a maximum of 50 percent
of Tier I capital. Goodwill and investments in other banks and financial institutions
should normally be deducted. For most banks the use made to Tier II capital is much
less than 50 percent.

2.1.5.1.1 BASEL Capital Accord

The Basel Committee on Banking Supervision (BCBS) is a committee of banking

supervisory authorities that was established by the central bank governors of the
Group of Ten countries in 1975. It consists of senior representatives of bank
supervisory authorities and central banks from Belgium, Canada, France, Germany,
Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United
Kingdom, and the United States. It usually meets at the Bank for International
Settlements (BIS) in Basel, where its permanent Secretariat is located.

Starting with its publication of "International Convergence of Capital Measurement

and Capital Standards" in July 1988, popularly known as Basel I Capital Accord, BCBS
set out a minimum capital requirement of 8% for banks. Prior to that, the committee
introduced 25 core principles on effective banking supervision. In 1996, the
committee incorporated market risk in the 1988 capital accord. With a major revision
of the 1988 accord, there followed by the revised publication of the Committee's first

24
round of proposals for revising the capital adequacy framework in June 1999
popularly known as Basel II Capital Accord. Since then, it is revised in January 2001,
April 2003 and released its final revised framework updated in November 2005. In
this accord, the concept and rationale of the three pillars (minimum capital
requirements, supervisory review, and market discipline) approach was introduced,
on which the revised framework is based. In the revised framework BCBS retains key
elements of the 1988 capital adequacy framework, including the general
requirement for banks to hold total capital equivalent to at least 8% of their risk-
weighted assets; the basic structure of the 1996 Market Risk Amendment regarding
the treatment of market risk; and the definition of eligible capital.

The new Basel capital accord (Basel II), shall be applicable to internally active banks
all over the world with effect from end of 2006. Implementing the new accord in
Nepal has been a challenging task for the supervisors as well as FIs. Hence, certain
preparatory homework is needed to Nepalese financial system to implement BASEL
II. NRB and FIs need to have coordinated effort efficiently in Nepalese banks and FIs
to establish certain baseline for the effective implementation of BASEL II. In this
regard, second interaction program was held in Nepal with the banks executives to
make them aware of the new development. The commercial banks so far has shown
positive attitude towards the implementation of Basel II. "New Capital Accord
Implementation Preparatory Core Committee" was drafted "NRB's Concept Paper on
New Capital Accord". According to the program of New Capital Accord
implementation, concept paper was forwarded to all the commercial banks for
comments and recommendations. A form was also developed so that commercial
banks classify their exposures as per the new approach, which was reviewed by the
"Basel-II Implementation Working Group". NRB has adopted Basel Core Principles for
Effective Supervision as guideline for supervision of commercial banks. Core principle
methodology adopted by BCBS provides a uniform template for both self-assessment
and independent assessment. It involves four part qualitative assessment system:
Compliant, Largely Compliant, Materially Non-Compliant, and Non-Compliant. For

25
each principle essential and additional criteria are defined. To achieve a "compliant'
assessment with a principle, all essential and additional criteria must be met without
any significant deficiencies. A "largely compliant" assessment is given if only minor
shortcomings are observed, and these are not seen as sufficient to raise serious
doubts about the authority's ability to achieve the objective of that principle. A
"materially noncompliant assessment is give n when the shortcomings are sufficient
to raise doubts about the authority's ability to achieve compliance, but substantial
progress has been made. A "non-compliant" assessment is given when no substantial
progress towards compliance has been achieved.

There is no doubt that the new accord though complex carries a lot of virtues and
will be a milestone in improving banks internal mechanism and supervisory process
and beneficial to the commercial banks. (BCBS, 1998)

2.1.5.1.2 Capital Adequacy Norms by NRB

NRB has from time to time stipulated minimum capital fund to be maintained by the
banks on the basis of risk weighted assets. The total capital fund is the sum of core
capital and supplementary capital. According to the NRB unified directives for Banks
and Non-Bank FIs issue number E. Pra. Ni. No. 01/061/62 (Ashad 2062 B.S.), the
capital funds of a bank comprise the following:

Core Capital: Core Capital of a bank includes paid up equity, proposed bonus share,
share premium, non-redeemable preference shares, general reserve, retained
earnings, accumulated profit and loss and other free reserves. However, where the
amount of goodwill exists, the same shall be deducted for the purpose of calculation
of the core capital.

Supplementary Capital: Supplementary capital includes general loan loss provision,

exchange fluctuation reserve, assets revaluation reserve, hybrid capital instruments,
unsecured subordinated term debt and possible investment loss reserve.

26
Banking and Financial Institution Ordinance (BAFIO) (2063) also assimilates the same
things, which were included and explained in NRB Act 2058, in regard of bank capital.
NRB Act is effective from 1st Shrawan 2058 (July 16, 2001). According to the NRB
unified directive 2067 issued for Banks and Non-Bank FIs, minimum paid-up capital
requirement for establishment of commercial banks is as under:

Table - 2.1
MINIMUM PAID-UP CAPITAL REQUIREMENT FOR ESTABLISHMENT OF FIs
REGIONAL
LEVEL NATIONAL
* 4-10 DISTRICTS* 1-3 DISTRICTS*
A (COMMERCIAL BANKS) 2000 - - -
640 - 300# 300#
B (DEVELOPMENT BANKS)
- - 200 100
3000# - - 300#
C (FINANCE COMPANIES)
200 - - 100
D (SAVING & CREDIT CO-
100 60
OPERATIVES) 20 10
* All over Nepal except Kathmandu Valley.
# FIs doing leasing activities
All existing banks and FIs are required to raise capital base to minimum paid up capital
by mid Ashad 2070 BS through proportionate paid- up capital increment every year.
(Source: NRB Unified Directives, 2067)

According to NRB directives, commercial banks should maintain their CAR minimum
to 10% and core capital 6%, which is created to protect the interest of the
depositors. In the event of non-fulfillment of CAR in any quarter, the banks should
fulfill the shortfall amount within next six months. If any bank does not fulfill the
minimum CAR within the specified period, NRB may initiate any of the following
actions:

 Restriction on announcing for dividend and bonus share.

 Suspension of opening new branch.
 Restriction on acceptance of new deposits
 Restriction on advancing new loans.
 Suspension of access to refinancing facilities of Nepal Rastra Bank.
 Restriction on lending activities of the licensed institution.

27
 Any actions may also be initiated under section 100 of NRB Act 2058.

2.1.5.2 Assets Quality

Asset quality is one of the most critical areas in determining the overall condition of a
bank. The primary factor effecting overall asset quality is the quality of the loan
portfolio and the credit administration program. Loans are usually the largest of the
asset items and can also carry the greatest amount of potential risk to the bank's
capital account. Securities can often be a large portion of the assets and also have
identifiable risks. Other items which impact a comprehensive review of asset quality
are other real estate, other assets, off-balance sheet items and, to a lesser extent,
cash and due from accounts, and premises and fixed assets. This is one of the most
critical factors in determining overall condition of any bank. Primary factors that can
be considered are the quality of loan portfolio, mix of risk assets and credit
administration system. The assets quality helps to maintain the smoothness of the
organization. (BCBS, 1998)

2.1.5.2.1 Evaluation of Asset Quality

Prior to assigning an asset quality rating, several factors should be considered. The
factors should be reviewed within the context of any local and regional conditions
that might impact bank performance. In addition, any systemic weaknesses, as
opposed to isolated problems, should be given appropriate consideration. The
following is not a complete list of all possible factors that may influence an
examiner's assessment; however, all assessments should consider the following:

 The adequacy of underwriting standards, soundness of credit administration

practices, and appropriateness of risk identification practices,
 The diversification and quality of the loan and investment portfolios,
 The existence of asset concentrations,
 The adequacy of loan and investment policies, procedures, and practices,

28
 The ability of management to properly administer its assets, including the timely
identification and collection of problem assets,
 The adequacy of internal controls and management information systems.
(Shrestha, 2010)

2.1.5.2.2 Non-Performing Assets (NPAs)

Loans and advances of FIs need to be serviced by either the principal or the interest
of the amount borrowed in stipulated time as agreed by the parties. NRB unified
directives E. Pra. Ni. No. 02/061/62 (Ashad 2062 BS) for Banks and Non Bank FIs
defines Non Performing Loans as loans classified as Substandard, Doubtful and Loss
or Bad Loans which are past due by principal for more than 3 months.

NRB unified directives for Banks and Non-Bank FIs through directive number E. Pra.
Ni. No. 02/061/62 (Ashad 2062 BS) classifies NPL, according to international practice,
into three categories depending on the temporal position of loan default.
Substandard, Doubtful and Loss or Bad Loan is the categories on the basis of the time
barred to repay either interest or the principal. The degree of NPA assets depend
solely on the length of time the asset has been in the form of non-obliged by the
loanee. The more time it has elapsed the worse condition of assets is being perceived
and such assets are treated accordingly. However, the treatment of NPAs depends
according to countries. No uniform rule seems to apply.

2.1.5.2.3 Factors causing NPAs

Dhungana (2006) in his column broadly categorized into internal and external factors
for high level of NPA in Nepalese banking system. The following factors can also be
the reason for causing NPA:

 NPAs may arise due to failure of business for which loan was used. Whatever may
be the reasons for failure of business, it obstructs the carrying out of timely
payments of financial obligations.

29
 On the other part of appraising institutions, the defect in appraising projects
breed mismatch not only in investment planning but also in receivables due to
defective projection of returns. Large portion of NPAs in developing countries
arise due to defective and standard credit appraisal system.
 Monitoring of projects in time provide insurance against failure of enterprises
through rectification of minor flaws that ape ear during the course of operation.
Inability of sound monitoring system can also lead to failure of the project.
 The resources of FIs collected through deposits from people may be misutilized.
Recklessness or negligence on the part of the officials while approving the loan
will turn into default.
 Attitude of the officials that does not amount to sincere corporate culture also
leads to breed drawbacks in the payment of dues to FIs.
 The credit programmes sponsored by the government are regarded as the source
of NPAs. For political benefits government, without assessing the financial
feasibility of the credit programme, announces and compels the credits agencies
to go along with the declared policies.
 Moreover, dishonest politicians often want free ride of on the amounts of loan
delivered by credit agencies under government designed programmes. Such loans
are hardly recoverable. The fact is evidenced from the experience in Nepal and
India by the manifestation of higher percentage of NPAs found in priority sector
loans.
 Quite often the definition of the NPAs and accounting norms adopted by
concerned agencies also amount to higher or lower magnitude of such assets.
Each institution may have different norms to declare the assets whether it is not
performing. The income cycle of the project and amount of loan involved, set the
instalments of loan repayment. The nature of project also determines the level of
NPAs.
 Slow down in economy, global as well as domestic particularly in industrial sector,
contributed to adversely affect the bottom-line of borrowable units and their

30
 capacity to service the debt. Recession debars the economic activities to run
smoothly which affect the performance of FIs.

2.1.5.2.4 Effects/Implications of NPAs

Of the total assets of commercial banks in Nepal, total credit accounted 47.2% in the
fiscal year 1997/98 (NRB, 1999). Empirically, it has been seen that Nepal having
lower proportion of loan in respect of total assets provided cushion to make ample
provision and therefore were least affected by the financial crisis.

The credit institutions are repelled from further investment after the interest accrual
or due principal repayment has stopped. As the assets declared NPA emanate from
the deposits, it puts the depositors fund at risk. The credit agencies are put to an
extra amount of liability by regulatory authorities in the form of provision. The
amount required for provision depends on the level of NPAs and their quality. Rising
level of NPAs create a psyche of worse environment especially in the financial sector.
Depositors are not interested to save. Rather the hard earned savings are diverted to
consumptions. Consequently the savings pattern hence investment is affected
thereby creating an unhealthy atmosphere in the financial sector. (Shrestha, 2010)

2.1.5.2.5 NRB Directives related to Assets quality

NRB unified directive for Banks & Non-Bank FIs (Ashad 2062 BS), through directive
number E. Pra. Ni. No. 02/061/62 requires the banks to classify outstanding loans
and advances on the basis of aging of Principal amount. As per the directive the
Loans and Advances should be classified into the following four categories:

Pass: Loans and Advances whose principle amount are not past due over for 3
months included in this category. These are classified and defined as performing
loans.

Substandard: All loan and advances that are past due for a period of 3 months to 6
months included in this category.

31
Doubtful: All loans and advances, which are past due for a period of 6 months to 1
year, included in this category.

Loss or Bad: All loans and advances which are past due for more than 1 year and
have least or thin possibility of recovery or considered unrecoverable shall included
in this category. Besides this, any loan whether past due or not, in situations of
inadequate security, borrower declared insolvent, no whereabouts of the borrower
or misuse of borrowed fund, are to be classified as Loss or Bad category.

Table - 2.2
PREVAILING DIRECTIVES AS TO CLASSIFICATION OF LOANS
CLASSIFICATION LOAN LOSS
CATEGORY DURATION OVERDUE
OF LOANS PROVISION
Performing Loan Standard Pass/Good Upto 1 to 3 months 1%
Sub-Standard 3 to 6 months 25%
Non-performing
Doubtful 6 months to 1 years 50%
Loan
Loss/Bad Loans more than 1 years 100%
(Source: NRB Unified Directives, 2067)

2.1.5.3 Management Quality

The performance of the other four CAMEL components will depend on the vision,
capability, agility, professionalism, integrity, and competence of the financial
institution's management. A sound management is crucial for the success of any
institution. The success of any institution depends on the competency of its
management. In fact, the management not only makes suitable policy and the
business plans, but also implements them for the short term and the long term
interests, which helps achieve aimed objectives of bank and financial institutions
(BCBS, 1998). Therefore for efficient and effective management, the bank should
have following other qualities:

2.1.5.3.1 Qualities of Good Management

 Proper structure of the management

 Qualitative Human resources management
 Customer care department

32
 Use of modern Information technology
 Adequate management of loan and advances
 Fair Decision Making
 Proper Communication system
 Working Atmosphere and management

There is a universal phenomenon that good management can make and poor
management can break an organization. Thus any organization, be it a bank, must be
serious towards its management and hence hire professionals to increase the
management efficiency and effectiveness to produce wonderful results for the
organization.

2.1.5.3.2 Staff Motivation

Besides, the human resources are considered the most valued assets for any
organization, who’s effective and efficient contributions help in organizational
growth. Management can enhance the efficiency of their staffs through-

 Self directed work team.

 Job rotation.
 Total quality management, procedures and processes.
 Encouragement of innovative and creative behaviour.
 Extensive employee involvement and high level of skilled training.
 Contingent pay based in performance.
 Coaching and monitoring.
 Significant amounts of information sharing.
 Cross functional integration.
 Comprehensive employee recruitment and selection procedure (Shrestha, 2010)

2.1.5.4 Earning Quality

The quality and trend of earnings of an institution depend largely on how well the
management manages the assets and liabilities of the institution. The financial

33
institution must earn reasonable profit to support asset growth, build up adequate
reserves and enhance shareholders' value. Good earnings performance would inspire
the confidence of depositors, investors, creditors, and the public at large. An analysis
of the earnings helps the management, shareholders and depositors to evaluate the
performance of the bank, sustainability of earnings and to forecast growth of the
bank (BCBS, 1998). Under the UFIRS, in evaluating the adequacy of a FI’s earnings
performance, consideration should be given to:

 The level of earnings, including trends and stability,

 The ability to provide for adequate capital through retained earnings,
 The quality and sources of earnings,
 The level of expenses in relation to operations,
 The adequacy of the budgeting systems, forecasting processes, and management
information systems in general,
 The earnings exposure to market risk such as interest rate, foreign exchange,
Price risks.

2.1.5.4.1 Evaluation of Earnings Performance

Earnings quality is the ability of a bank to continue to realize strong earnings

performance. It is quite possible for a bank to register impressive profitability ratios
and high volumes of income by assuming an unacceptable degree of risk. An
inordinately high ROA is often an indicator that the bank is engaged in higher risk
activities. For example, bank management may have taken on loans or other
investments that provide the highest return possible, but are not of a quality to
assure either continued debt servicing or principal repayment. Seeking higher rates
for earning assets with higher credit risk will boost short-term earnings. Eventually,
however, earnings may suffer if losses in these higher risk assets are recognized.

An institution's asset quality has a close relationship to the analysis of earnings

quality. Poor asset quality may necessitate increasing the PLLL to bring the ALLL to an

34
appropriate level and must be reviewed for impact on earnings quality. (Shrestha,
2010)

2.1.5.5 Liquidity

Liquidity means the capability of the bank to meet the demand on the customer’s
deposits. Liquidity is a sensitive factor for the banking sector. All the banks all over
the world invest a significant amount of total deposit on the government securities in
their respective central banks to ascertain to meet the liquidity shortages in the
banks in case of huge unanticipated withdrawals. Banks are highly encouraged to
invest in the government securities because it is as good as liquid assets and there is
no risk in government securities. Banks maintain liquidity in various forms like ready
cash at its disposal, certain percentage at central bank (NRB) as a statutory
requirement, makes placements in other banks and some percentage is utilized in
investment on government securities.

Liquidity ratios are used to judge a bank ability to meet short-term obligation. It is
the comparison between short-term obligation and short-term resources available to
meet such obligation. In evaluating the adequacy of a FI’s liquidity position;
consideration should be given to the current level and prospective sources of
liquidity compared to funding needs, as well as to the adequacy of funds
management practices relative to the institution’s size, complexity, and risk profile.
(BCBS, 1998)

Liquidity is rated based upon, but not limited to, an assessment of the following
evaluation factors:

 The adequacy of liquidity sources compared to present and future needs and the
ability of the institution to meet liquidity needs without adversely affecting its
operations or condition.
 The availability of assets readily convertible to cash without undue loss.
 Access to money markets and other sources of funding.

35
 The level of diversification of funding sources, both on- and off-balance sheet.
 The degree of reliance on short-term, volatile sources of funds, including
borrowings and brokered deposits, to fund longer-term assets.
 The trend and stability of deposits.
 The ability to securitize and sell certain pools of assets.
 The capability of management to properly identify, measure, monitor, and
control the institution's liquidity position, management information systems, and
contingency funding plans. (Shrestha, 2010)

2.1.5.5.1 Liquidity Management Techniques

Techniques for liquidity assessment have evolved over the years with the significant
changes in the monetary policy operating procedures. Despite the uncertainty in
predicting liquidity conditions, econometric models could be used to provide first
indicative forecasts, given the estimated structure of interrelationships based on past
information. The treasury or fund manager of any banks and FIs should adopt
following techniques for effective liquidity management. (Shrestha, 2010)

Liquidity Planning: The liquidity planning entails the accurate estimation of liquidity
needs and the structuring of the portfolio to meet the expected liquidity needs. To
ensure that funds are available to meet the liquidity needs at the lower cost, the
treasury manager of the banks and FIs must manage its money position to comply
with the reserve requirements as well as managing its liquid sources.

Managing the Cash Position: A cash position refers to the amount in the process of
collection and currency and demand balances due from other banks and the central
bank. Numerous transactions that cause an inflow or outflow of cash during a day
continually change the cash position of the banks and FIs. Because cash yields no
income, cash holdings must be limited to a minimum. The treasury/ fund manager
may invest any excess cash or may acquire additional cash sources from interbank
loans or from discount window at the central bank.

36
Managing the Liquidity Position: Once the liquidity needs of the banks and FIs have
been estimated, the treasury manager must decide how these needs are to be
funded. The banks and FIs must choose between two general liquidity management
strategies, namely, asset management and liquidity management. In the asset
management, assets are sold to meet liquidity needs. In the liability management,
money is borrowed to meet liquidity needs. A combination of these strategies is
normally employed.

Controlling Liquidity Risk: To assess how well the banks and FIs are managing its
liquidity position, the management should be cautious on the following signals from
the marketplace that indicate a pending liquidity problem:

 Public confidence in terms of withdrawal of deposits from the banks and FIs.
 Share price behaviour, falling share prices indicate perceived liquidity problems.
 Risk premiums on money market borrowings.
 Losses because of the hasty sale of assets for liquidity purposes.
 Inability to meet the demands of new credits customers.
 More frequent and larger borrowings from the central bank.

2.1.5.5.2 NRB Directives related to Liquidity

For compliance of liquidity maintenance, the NRB applies following procedures:

a. NRB balance (CRR) will be calculated as a weekly basis. (Every Sunday to

Saturday)

b. NRB balance will be calculated weekly average deposit of 15 days ago. In case of
fully off week, it will be calculated weekly average deposit of previous week.

c. For the purpose of NRB balance calculation, the total deposit liability and balance
of NRB will be calculated as total daily balance divided by 7 on weekly average basis
by counting from Sunday to Saturday. Previous balance will be taken in the case of
off day.

37
d. Weekly statement of deposit balance to be submitted to NRB Inspection and
Supervision Department within 7 days from the end of the week end by filling the
specific direction Form No. 13.1.

In the case of shortfall of the NRB balance the applicable rate of penalties are as
follows:

First time shortfall = Equivalent to bank rate on shortfall amount

Second time shortfall = Equivalent to 2 times of bank rate on shortfall amount

Third time shortfall and all subsequent shortfalls = Equivalent to 3 times of bank rate
on the shortfall amount. (NRB, 2062)

2.1.5.6 Sensitivity to Market Risk

Sensitivity to market risk refers to the risk that causes due to the changes in market
conditions which would adversely affect the earnings and/or capital. One of the
market risks is the interest rate risk also called price risk. It is the risk that is caused
by changes in market interest rate. A bank may have different types of assets and
liabilities. Some assets and liabilities are sensitive to changes in interest rate. Such
assets and liabilities are called rate sensitive assets (RSA) and rate sensitive liabilities
(RSL). (BCBS, 1998)

The sensitivity to market risk component reflects the degree to which changes in
interest rates, foreign exchange rates, commodity prices, or equity prices can
adversely affect a FI's earnings or economic capital. When evaluating this
component, consideration should be given to: management's ability to identify,
measure, monitor, and control market risk; the institution's size; the nature and
complexity of its activities; and the adequacy of its capital and earnings in relation to
its level of market risk exposure. For many institutions, the primary source of market
risk arises from non-trading positions and their sensitivity to changes in interest
rates. In some larger institutions, foreign operations can be a significant source of
market risk. For some institutions, trading activities are a major source of market

38
risk. Market risk is rated based upon, but not limited to, an assessment of the
following evaluation factors:

 The sensitivity of the FI's earnings or the economic value of its capital to adverse
changes in interest rates, foreign exchanges rates, commodity prices, or equity
prices.
 The ability of management to identify, measure, monitor, and control exposure to
market risk given the institution's size,
 Complexity and risk profile.
 The nature and complexity of interest rate risk exposure arising from non trading
positions.
 Where appropriate, the nature and complexity of market risk exposure arising
from trading and foreign operations. (Shrestha, 2010)

2.1.5.6.1 Interest Rate Risk Measurement System Approaches

Interest rate risk measurement systems use an earnings approach, an economic

value approach, or a blend of those two approaches. NRB unified directive (2062
B.S.) number E. Pra. Ni. No. 05/061/62 requires the banks to classify the assets and
liabilities on the basis of repayment maturity and conduct Gap Analysis of the
maturity mismatch. The FDIC, Risk Management Manual of Examination policies
(2005) states different approaches to measure the Interest Rate Risk discussed as
under.

The earnings approach focuses on risks to report earnings, usually over a shorter-
term time horizon. Typically, earnings systems estimate risk for up to two years. In
addition, estimating future earnings permits regulatory capital forecasts. The
earnings approach traditionally focuses on net interest income. However, many
systems now incorporate components that measure the price risk from instruments
accounted for at market value or lower-of-cost or market value. Maturity gap

39
analysis and simulation models are examples of earnings approaches to IRR
measurement.

The economic value approach estimates the bank's Economic Value of Equity (EVE)
for forecasted interest rate changes. EVE represents the net present value of all
asset, liability, and off-balance sheet cash flows. Interest rate movements change the
present values of those cash flows. This method assumes that all financial
instruments will be held until final payout or maturity. The economic value approach
might provide a broader scope than the earnings approach, since it captures all
anticipated cash flows. The economic value approach best suits banks that mark
most instruments to market. At banks that value most instruments at historical cost,
economic value measurements can also effectively estimate interest rate risk.
However, in those banks, EVE changes might be recognized over a longer time frame
(through reported earnings). As a result, banks often blend the two approaches.
Management may use an earnings approach to evaluate short-term performance
and an economic approach to monitor the bank's long-term viability. Despite using
different methodologies, the two approaches generally should provide a consistent
view of interest rate risk exposures.

2.1.5.6.2 Gap Analysis

Gap analysis is the most well known ALM (Asset-Liabilities Management) technique,
normally used to manage interest rate risk, though it can also be used in liquidity risk
management. The “gap” is the difference between interest sensitive assets and
liabilities for a given time interval. In gap analysis, each of the bank's asset and
liability categories is classified according to the date the asset or liability is re-priced,
and “time buckets”, groupings of assets or liabilities, are placed in the buckets,
normally overnight-3 months, >3-6 months, >6-12 months, and so on.

Analysts compute incremental and cumulative gap results. An incremental gap is

defined as earning assets less funding sources in each time bucket; cumulative gaps

40
are the cumulative subtotals of the incremental gaps. If total earning assets must
equal total funding sources, then by definition, the incremental gaps must always
total zero and therefore, the last cumulative gap must be zero. Analysts focus on the
cumulative gaps for the different time frames.

2.1.5.6.3 Types of Gap

a. Liabilities-Sensitive Gap

A liabilities-sensitive gap is called negative gap. It occurs when interest-bearing

liabilities exceed interest-earning assets for a specific or cumulative maturity period,
that is, more liabilities re-price than assets. In this situation, a decrease in interest
rates should improve the net interest rate spread in the short term, as deposits are
rolled over at lower rates before the corresponding assets. On the other hand, an
increase in interest rates lowers earnings by narrowing or eliminating the interest
spread.

b. Asset-Sensitive Gap

A positive or asset-sensitive gap occurs when interest-earning assets exceed interest-

bearing liabilities for a specific or cumulative maturity period, that is, more assets re-
price than liabilities. In this situation, a decline in interest rates should lower or
eliminate the net interest rate spread in the short term, as assets are rolled over at
lower rates before the corresponding liabilities. An increase in interest rates should
increase the net interest spread.

Most banks have a positive gap because most banks borrow long and lend short, so
their assets will mature later than their liabilities. For example, a bank will have rate
sensitive deposits, which can be withdrawn any time, but the majority of its rate
sensitive loans are not due to be paid back anywhere from a year up to 25 years in
the case of a mortgage. When a bank has a positive gap (RSA > RSL), a rise in interest

41
rates will cause a bank to have asset returns rising faster than the cost of liabilities.
But if interest rates fall, liability costs will rise faster than asset.

2.1.5.6.4 Limitation of Gap Analysis

Gap analysis is subject to limitations. Gap analysis does not capture basis risk or
investment risk, is generally based on parallel shifts in the yield curve, does not
incorporate future growth or changes in the mix of business, and does not account
for the time value of money. Moreover, simple gap analysis (based on contractual
term to maturity) assumes that the timing and amount of assets and liabilities
maturing within a specific gap period are fixed and determined, therefore ignoring
the effects of principal and interest cash flows arising from honouring customer
drawdown on credit commitments, deposit redemptions, and prepayments, either
on mortgages or term loans, as well as the timing of maturities within the gap period.
Depending on the interest rate environment, the mix of assets and liabilities (both on
and off-balance sheet), and the exercise of credit and deposit options by customers,
these deficiencies may represent a significant interest rate risk to an institution.
Accordingly, the use of gap reports should be complemented with present-value
sensitivity systems, such as duration analysis or simulation models.

Gap systems use an accrual approach to identify risk to net interest income.
Typically, gap systems identify maturity and re-pricing mismatches between assets,
liabilities, and off-balance sheet instruments. Gap schedules segregate rate-sensitive
assets, rate- sensitive liabilities, and off-balance sheet instruments according to their
re-pricing characteristics. Then, the analysis summarizes the re-pricing mismatches
for each defined time horizon. Additional calculations convert that mismatch into risk
to net interest income. Gap analysis may identify periodic, cumulative, or average
mismatches. The most common gap ratio formula is:

Rate-Sensitive Assets - Rate-Sensitive Liabilities

Average Earning Assets

42
2.2 REVIEW OF RELATED STUDIES AND PAPERS

The research studies and work papers carried out by different scholars within various
geographical region including dissertations conducted by Nepalese scholars are
reviewed in this section, which are related with financial performance analysis of
commercial bank and the areas of the study.

2.2.1 REVIEW OF RESEARCH AND WORK PAPERS

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.

Sahajwala and Van Den Bergh (2000) based their work paper of Basel Committee on
Banking Supervision on a study of a number of new bank monitoring systems
currently in use or under development in various G10 countries. Such systems are
collectively termed "supervisory risk assessment and early warning systems". The
objective of the paper was to provide an overview of the different approaches taken
by bank supervisors and to make a preliminary general assessment of the methods
that are being used or developed. The study reveals that supervisory authorities are
now clearly moving towards putting in place more formal, structured and risk
focused procedures for ongoing banking supervision. Individual approaches and
systems have been developed and adopted, typically in the 1990s, with a greater
focus on risk profiles and risk management capabilities of individual banking

43
institutions and on the generation of timely warning of potential changes to a bank's
financial position. These new and modified systems have contributed positively to
the supervisory process, and supervisors are working towards refining the systems
further in order to improve the systems' accuracy and predictive power.

Baral (2005), using the annual reports data set of joint venture banks and NRB
supervision reports, he examined the financial health of joint venture banks in the
CAMEL framework for a period ranging from FY 2001 to FY 2004. The health checkup
which was conducted on the basis of publicly available financial data concludes that
the financial health of joint venture banks is better than that of the other commercial
banks. The study further indicates that the CAMELS component indicators of the
joint venture banks are not much encouraging to manage the possible shocks.

2.2.2 REVIEW OF DISSERTATIONS

Prior to this, several thesis works have been conducted by various researchers
regarding different aspects of commercial banks like financial performance, capital
structure, liquidity, investment policy, interest rate structure, resources mobilization
etc. The excerpts from the findings of some of these research works are presented
which are relevant for this study.

Thapa (2001) has presented the evaluation of the liquidity, assets management
efficiency, profitability and risk position of NBBL in comparison Nabil and NGBL and
examine the fund mobilization and investment policy of NBBL through off-balance
sheet and on-balance sheet activities in comparison to other two banks. Through
research the researcher found that the liquidity position of NBBL is comparatively
not better than of Nabil and NGBL. The liquidity ratios are moderately fluctuating
which means the bank has not properly formulated stable policy. As per the study,
NBBL is not in better position regarding its on balance sheet as well as off-balance
sheet activities in compare to Nabil and NGBL and it does not seem to follow any

44
definite policy regarding the management of its assets. The researcher at the last
suggested following a specific policy in investment and she further recommended to
maintain the optimum level of relationship among deposit and loan and advances,
outside assets and net profit and to maintain the adequate recovery rate.

Joshi (2002) on his study has concluded that liquidity position is important factors
and may causes serious problem if the bank has maintained low liquidity than
required. Gradual increase in the amount of funded debt and highly geared capital
structure seems to be negative performance for the bank. On the other hand, return
on assets and equity is also less than satisfactory level. In his view, the bank should
invest its resources in more productive sectors and equity financing should be
emphasized. The research is only revolving around the liquidity aspect of the banks
but has totally ignored the assets quality and earnings of the bank.

Bhattarai (2004) on his research study has attempted to examine the norm and
standard laid down by Nepal Rastra Bank relating to capital adequacy, loan
classification and provisioning by making a comparative study between Nepal SBI
Bank and Nepal Bangladesh Bank. The study was undertaken to find out the impact
of the changes in Nepal Rastra Bank's directives on the performance of the
commercial banks. An effort was also made to find out whether the directives were
implemented and that Nepal Rastra Bank was taking enough steps to monitor the
implementation. The study reveals that there was a significant impact of the
directives on the various aspects of the commercial banks. For instance, the
increased provisioning amount would decrease the overall profitability of the
commercial banks. It was also found that both the banks would fall short in
supplementary capital, however, maintained its total capital according to new
directives relating to capital adequacy norms.

Though the research had covered major part, it did not clearly mention about the
quality of the commercial bank except the capital adequacy, loan standard laid down
by Nepal Rastra bank.

45
Sharma (2005) in his paper tried to conclude with following key points:

i. Paid up Capital of Nepalese Commercial Banks is increasing indicating banks

maintain the capital standards set by NRB
ii. Total equity capital is growing as compared to total debt.
iii. The fluctuating interest coverage ratio of the Nepalese Commercial Banks
indicates the earnings stream and interest expenses are inconsistent over the
period of past five years. The debt servicing capacity of the Nepalese Banks is not
highly satisfactory but it is sufficient to meet the interest expenses in all years and
is continuously improving.
iv. The capital adequacy ratios of the banks are adequate against set norms of NRB
indicating sound financial health and sufficient to meet on banking operation.
v. The total capital fund and capital adequacy ratios are fluctuating which indicate
fluctuating risk adjusted assets of the banks.
vi. Core Capital and supplementary capital ratios are in line with the NRB norms.
Bhandari (2006) used descriptive analysis in his research work of evaluating financial
performance of Himalayan Bank in the framework of CAMEL during 1999 to year
2004 AD. The analysis revealed adequate capital of the bank. The non-performing
loan though in decreasing trend is still a matter of concern. The bank is still with
better ROE however it is in decreasing trend. The decreasing trend of net interest
margin shows management slack monitoring over the bank's earning assets. The
liquid funds to total deposit ratio is above the industrial average ratio. NRB balance
and cash in vault to total deposit ratios are below the industrial average ratio during
the study period.

Shrestha (2009) on her thesis has concluded that:

i. The both banks' Core capital adequacy ratio variated positively. The total capital
adequacy ratio is above NRB norms. This means the bank has adequately
maintained its internal sources and running with adequate capital and the capital

46
 fund of the bank is sound and sufficient to meet the banking operation as per
NRB standard.
ii. Assets composition of both banks like in every banks remained largely in the
loans and investment. The decreasing trend of non-performing loans and
advances ratio of both banks helps to conclude that the bank is aware of
nonperforming loans and adopting the appropriate policies to manage this
problem and to increase the quality of asset.
iii. The both banks is managed and operating efficiently since the total expenses to
total revenues ratios are in decreasing trend. This could be, but not limited to
management efficiencies.
iv. The banks mean ROA ratio is above the 1% benchmark and ROE shows that the
return per unit of equity invested by the shareholders is increasing year by year.
Increasing trend of ROA concludes that the net income for each unit of asset of
the bank is appreciating.
v. The liquid assets to total deposit ratio is in decreasing trend. The investment in
liquid assets is in decreasing trend and switched into more profitable but high risk
assets. However, they have met the compliance of NRB requirement.

And has recommended the followings for the bank:

i. The banks need to keep additional cushion reserve in the form of general reserve,
capital adjustment reserve, dividend equalization fund. Besides this, bank is
recommended to increase its capital fund either through internal sources or
decrease investment in risky assets in the future.
ii. Although both of the banks has been decreasing the proportion on
nonperforming loans to total loans and advances which is a good sign to the
bank, however, the bank requires checking this tendency before they are
ultimately written-off from the books.
iii. The total expenses to total revenue of both banks are in decreasing trend which is
good indication for organization. Both of the banks are recommended to adopt

47
 the further more corrective actions in order to enhance the earning per
employee.
iv. The earning quality ratios i.e. return on equity, return on assets and earnings per
share of both banks are sound and the bank need to maintain this level. The bank
needs to increase the revenues and further control the operating expenses which
would be cushion in competitive environment.
v. The bank is recommended to increase its yield as its net profit. The decreasing
trend of profit of the bank may lose the confidence of the shareholders and other
stakeholders.

Shrestha (2010) on his thesis has concluded that most of the commercial banks
undertaken for the study has passed most CAMEL standard, hence from this aspect
we can say that all of them are financially and commercially sound. From our study it
shows that the bank having good management quality has good earnings and the
banks which full comply with the CAMEL and NRB standard will sure to have good
results than other banks. But since large numbers of financial institutions are already
operating in the country and many are ready to enroll in the market the banks
efficiency may not just be reflected by the CAMEL indicators. As large banking
institution of developed nation following the CAMEL standard going bankrupt, we
cannot just rely on CAMEL to measure the financial soundness and health of our
banking institution. Proper socio-economic analysis, competitors analysis, changing
perspective of the people, customer oriented quality service, transparency and
fulfillment of corporate social responsibility might be key issues for the success of the
banking institution in coming days. As the banks of 21st century are facing lots of
challenges, their strategy should be to develop customer loyal, dynamic and
competent management team who can foresee and address the emerging problems
and challenges before their competitors.

And has recommended the followings for the bank:

48
i. All the sampled banks have higher CAR and CCR than the standards set by the
NRB; hence banks can lower these ratios and make more capital available for
investment.
ii. All the sampled banks have higher provision for loan loss than required. Higher
provision means less capital for investments. Hence, banks are suggested to keep
provision enough, only to cover for non performing loans.
iii. Earnings per employee of NIC, Siddhartha and Kumari bank is higher than
Machhapuchchhre and Laxmi, hence these banks are suggested to increase the
productivity of the employees or downsize the number of employees.
iv. Generally return on assets greater than 1% is considered good but since Laxmi
and Machhapuchchhre bank have ROA less than 1 percent, they are suggested to
increase their assets utilization capacity or dispose of unnecessary assets.
v. Financial institution's liquidity and solvency are directly affected by portfolio
quality which should be carefully analyzed on the basis of collectability and loan
loss provisioning. As liquidity has inverse relationship with profitability, financial
institution must strike a balance between liquidity and profitability. Hence, banks
are suggested to keep LADR ratio minimum as possible and encouraged to take
calculated risks and invest capital in other sectors where returns are higher.
vi. Most of the commercial banks have higher CAR ratio than required by the NRB
standard, excess liquidity means less fund for investment, hence all of the banks
undertaken for study are suggested to maintain minimum level of liquidity and
make funds available for investment and look for new areas of investment.

2.2.3 REVIEW OF ARTICLES

Shrestha (2046) in his article has concluded that the capital base of financial
institutions should neither be too much leading to inefficient allocation of scares
resources nor too weak to expose to extreme risk. The study accepts that the
operations of the banks and the degree of risk associated with them are subject to
changes country wise, bank wise and time period wise.

49
NRB, Bank & Financial Institution Regulation Department (2062) has published 15
commercial banks' ranking (excluding Nepal Bank and Rastriya Banijya Bank). The
ranking was done on the basis of CAELS rating system. The five areas examined are
represented by the acronym "CAELS."

The five factors examined are as follows:

C - Capital adequacy

A - Asset quality

E - Earnings

L - Liquidity

S - Sensitivity to Market Risk.

Following is the table reflecting the ranking presented by the Nepal Rasta Bank using
the "CAELS" rating standard:

Table - 2.3
RANKING OF COMMERCIAL BANKS USING THE "CAELS" RATING STANDARD
*NRB RATING *NRB RATING
COMMERCIAL BANKS
(POUSH 2061) (CHAITRA 2061)
Nepal Industrial & Commercial Bank 11 1
Everest Bank 1 2
Standard Chartered Bank Nepal 2 3
Nabil Bank 5 4
Laxmi Bank 3 5
Nepal Investment Bank 10 6
Bank of Kathmandu 12 7
Machhapuchchhre Bank 4 8
Siddhartha Bank 13 9
Nepal SBI Bank 9 10
Nepal Bangladesh Bank 8 11
Himalayan Bank 6 12
Kumari Bank 7 13
Nepal Credit & Commerce Bank 14 14
Lumbini Bank 15 15
(Source: Kantipur Daily, Ashad 27, 2062)

50
The total point for this rating was 13,480 where Nepal Industrial & commercial bank
had scored 1,250 points out of 13,480 and saved the position of 1st among the other
commercial banks. Previously, this bank was on 11th position. With the better
performance and remarkably change in Capital standard and the profit earned
resulted this bank as in 1st position while rating.

This was the one of the international standard used by Nepal Rastra Bank for ranking
the commercial banks and published to public ever. Nepal Rastra Bank, however,
ignored the management quality for analysis and in return for ranking of commercial
banks. With this step of publicizing the banks ranking, Nepal Rastra Bank had helped
public directly and indirectly for monitoring and evaluating the commercial banks.

Shrestha (2005) in her article has tried to emphasize the importance of M factor in
CAELS rating system. In the article, the focuses were merely on the management
quality. She had tried to conclude that CAELS is incomplete without M factor, thus
focused on CAMEL rating. The article showed that the management quality shouldn't
be ignored while ranking the commercial banks. She tried to show us how
management quality play the vital role and how it exists consistent relationship
between efficiency and independent measures of performance and reveals
relationship between efficiency and soundness. She had summarized that any bank's
success or failure also depends upon management quality no matter what is the size
of the bank nor does profitability of the bank. For rating this missing M factor, she
had taken the parameter like board member, promoters, market perception and pro-
activeness of management. As Nepal Rastra bank excluded the management factor,
she has excluded "S" factor due to the lack of information on portfolios of individual
banks.

Even though, this article shows the criticism against the article published by Nepal
Rastra Bank, she is also suggesting and awaking Nepal Rastra Bank and general
people to consider M factor while making any decision. Anyways, she had also
welcomed this kind of rating used by Nepal Rastra Bank generalizing this is the right

51
track direction where transparency will not only open up the possibility for the
general public to evaluate performance of banks, it will also positively impose an
ever essential sense of flaxen competition among the banks to earn integrity based
on their performance.

2.2.4 RESEARCH GAP

During my research period we found that many studies by different people have
either focuses on comparative study of a particular banks in specific area or have
done the research work in analyzing the liquidity or profitability part of the bank.
Though they have well tried to explain the area but unable to touch all the ground
for analyzing the bank as a whole. Different studies show the particular area's pros
and cons of the bank. The whole studies revolve around the specific area and ignored
the other essential part of banking industry business in order to be a good bank.

In my study I have tried well to my knowledge to cover all the aspects and elements
to identify the good bank. For this purpose I have identify the tool to rate the bank
performance and its quality as a whole. The tool being CAMELS framework which has
successfully elaborate Capital Adequacy, Assets Quality, Management Quality,
Earning, Liquidity and Sensitivity to Market Risk. This is the model by which we can
gain ample knowledge of the bank as a whole.

In the context of Nepalese banking environment, there are few academic researches
found conducted in the frame work of CAMEL components. However, these
researches lack analysis of the 6th component i.e., Sensitivity of Market Risk.
Therefore, this study attempts to evaluate financial performance of HBL and EBL on
all the six components of CAMELS framework using annual reports of five
consecutive years. This research will be helpful to understand the overall condition
and performance of these two banks.

52
 CHAPTER III

RESEARCH METHODOLOGY

'Research Methodology' is a way for systematically solving the research problem. In

other words, research methodology indicates the methods and processes employed
in the entire aspects of the study. It refers to the various sequential steps to be
adopted by a researcher in studying a problem with certain object/objects in view
(Kothari; 1990). This chapter highlights about the methodology adopted in the
process of present study i.e. it incorporates Research design, Nature and Sources of
Data, Population and Sample, Data collection procedure and lastly, Methods of
Analysis. This chapter offers the methods of investigation to accomplish the
objectives as set in Chapter I in this study. So, it is the methods, steps, and
guidelines, which are to be followed in analysis, and it is a way presenting the
collected data with meaningful analysis. The following are the details of research
methodology used in the analysis.

3.1 RESEARCH DESIGN

"Research design is the plan, structure, and strategy of investigation conceived so as

to obtain answers to research questions and to control variance. The plan is the
overall scheme or program of the research. It includes an outline of what the
investigator will do from writing the hypothesis and their operational implications to
the final analysis of data.” (Kerlinger; 1978)

The research design is of both descriptive and analytical nature. Descriptive research
is used to compare and to assess the opinions, behaviours of the firms and to
describe the situation and events occurring during the study period whereas

53
analytical research is used to find out the result employing financial as well as
statistical tools. For the analytical purpose, the annual reports published by the
selected banks and other related publications were collected for FY 2064/65 to FY
2068/69. In this study both descriptive and analytical research design is used.

The above mentioned research methodology will be used to reflect an assessment of

the financial condition of Himalayan Bank Limited and Everest Bank Limited based on
the CAMELS components. Descriptive cum analytical research methodology has been
followed and all information and data are methodically studied under specific major
heading shown to achieve the desired objectives. In order to achieve the objectives,
various financial and statistical tools for fact findings and systematically analyzing
wide range of collected data are applied.

3.2 POPULATION AND SAMPLE

There are altogether 32 commercial banks functioning in Nepal. In this study

"Comparative Analysis of Financial Status & Performance Evaluation of HBL & EBL in
the Framework of CAMELS Components" is studied. Thus, 32 commercial banks are
taken as the population and HBL & EBL are chosen as the sample two banks under
study.

3.3 NATURE AND SOURCE OF DATA

This study is based on secondary sources of data information. The annual reports of
the concerned banks form the major sources of data. The regulatory data were
collected from NRB directives and reports. The basic conceptual information was
collected through BASEL, FDIC and NRB publications and work papers. Likewise
unpublished master’s level thesis and studies have also been taken as a source of
data. Thus, the information related to the past and current works were collected
from the following sources:

 NRB publication reports, statistical bulletins and its official website

54
 Basel Committee publications through its official website
 Various research papers and dissertations
 Various articles published in journals
 Official Website of concerned banks

3.4 METHODS OF DATA COLLECTION

In order to get the reliable information based on the objectives of the study, the
required materials and information are collected by consulting the library at
Tribhuvan University, Patan Multiple Campus and Shanker Dev Campus as well as
Internet Surfing and related text books. The annual reports of each bank for the
study period were obtained from their Head offices and internet surfing to the banks'
official website. NRB regulatory directives, statistical bulletins and other related
publication were obtained through internet surfing to NRB's official website.
Likewise, the review of working papers conducted by various international scholars
on the related matter was done through internet surfing to various websites. For the
purpose of analysis of data, 5 years will be taken as sample from FY 2064/65 to FY
2068/69.

3.5 DATA PROCESSING TECHNIQUE

For the purpose of this study first of all the raw data information from published
documents and audited annual financial statements of concerned banks were
manually extracted into the computer files of Microsoft Excel program which acted
as master database file. The collected data are refined f and then has been grouped
accordingly to their nature in tabular form and processed further to carry out
financial ratio calculation through financial and statistical functions and graphical
illustrations through chart program. This processing procedure is required for
sequential analysis and interpretation of data to meet the objective of this research
study.

55
3.6 DATA ANALYSIS TOOL

The study comprises calculations and interpretations of various ratios to evaluate &
compare the financial performance of concerned banks. These analyze result in
presentation of information that will help in appropriate decision making process.
The presentation & analysis of collected data is the core of the research work.

To achieve the objectives of the study some financial and statistical tools have been
used. The data extracted from financial statement and other available information
are systematically processed and tabulated in various table under different headings
according to their nature and are then analyzed by applying different financial and
statistical tools through tables, graphs and charts to interpret the findings. The major
tools used for the analytical and descriptive analysis of the study are as follows:

3.6.1 FINANCIAL TOOLS

For proper financial analysis of data, ratio analysis is the best tool. It is a simple
analysis tool under which ratios are taken to express the relation between two or
more data. Through ratio analysis we can establish the relationship among the data
and research into conclusion.

In this study financial ratio tools are used to determine the performance of the banks
in the framework of CAMELS components. These ratios are categorized in
accordance of the CAMELS components which include Capital Adequacy, Asset
Quality, Management Efficiency, Earning, Liquidity and Sensitivity to Market Risk.
Following category of key ratios are used to analyze the relevant components in
terms of CAMELS.

3.6.1.1 Capital Adequacy (C of CAMELS)

56
Capital is the life blood of every business without which no one can imagine the
business. It is termed different to different person. Professional economic speaks of
it as wealth whereas business person speak of it as total assets. Whatever may be
the term used, capital is the fund raised to finance different assets. Sources may be
either short-term or long-term capital fund is shareholder’s total claim on the bank.

i. Capital Adequacy Ratio (CAR)

Capital Adequacy Ratio is expressed as a percentage of an entity's equity to its

assets-at-risk. It takes into account the most important financial risks-foreign
exchange, credit and interest rate risks, by assigning risk weightings to the
institution's assets. Capital adequacy ratio is calculated on the basis of Core capital
Supplementary capital and Risk Weighted Assets (RWA) of the bank. This ratio is used
to protect depositors and promote the stability and efficiency of financial system and
to examine adequacy of the total capital fund.

To measure capital adequacy ratio:

Total Capital Fund

CAR= ×100
Risk Weig h ted Assets

where,

Total capital fund = Core capital + Supplementary capital

Total risk weighted asset = Total assets - Loan loss provision - Risk free assets

ii. Core Capital Ratio (CCR)

Core Capital is a capital of permanent nature comprising of Paid-Up Capital, Share

premium, Non Redeemable Preference Share, General Reserve Fund, Dividend
Equalization Fund, Capital Redemption Reserve, Capital Equalization Reserve,
Retained Earnings, Accumulative Profit & Loss accounts and Other Free Reserves. The
CCR shows the relationship between the total core capital or internal sources and
total risk adjusted assets.

57
To measure core capital ratio:

Core Capital Fund

CCR= ×100
Risk Weighted Assets

3.6.1.2 Assets Quality (A of CAMELS)

Assets are the most vital factors in determining the strength of the bank. The major
asset for the bank is loan and advances. This is the highest risk carrying asset item
that needs crucial assessment. Banks collect funds in the form of capital, deposits,
borrowing, etc. It mobilizes these funds to generate certain returns by giving loans
and advances to the users of money to invest in various alternatives. A significant
part of the banks income is generated from the lending activities. Basically there are
two types of loan:

i. Performing Loan (PL)

Loans usually form the largest of the asset items and carry the greatest amount of
potential risk to the bank’s capital account. The primary factor affecting overall asset
quality is the quality of the loan portfolio and the credit administration program.

Performing loan is the loan in which the interest is paid timely or overdue up to 90
days after the day of disbursement of sanctioned loan. It is also known as good loan
or pass loan.

ii. Non-performing Loan (NPL)

The loan which has been past due either in the form of interest servicing or principal
repayment beyond the due date of 3 months after disbursement of sanctioned loan
falls under NPL as well as other loans graded as possible default. There are three
types of NPL:

 Sub-standard Loan: Loans overdue by more than 3 months up to 6 months.

 Doubtful Loan: Loans overdue by more than 6 months up to 1 year.

58
 Bad Loan: Loans overdue by more than 1 year.

Following ratios are used to analyze the Assets Quality

i. Non-performing Loan (NPL) Ratio

The non-performing loan ratio indicates the relationship between non-performing

loan and total loan. It measures the proportion of non-performing loan in total loan
and advances. The ratio is used to analyze the asset quality of the bank.

To measure NPL Ratio:

Total NPL
NPL Ratio= ×100
Total Loans∧Advances

ii. Loan Loss Coverage Ratio

The loan loss coverage ratio provides an indication of the adequacy of bank’s loan
reserve to cover or absorb possible future loan losses. It is sometimes called the
"Coverage Ratio" because it gives an indication of how well the reserve covers
potential loan losses. Greater loan loss coverage is required to allow in income
statement if high loss is expected. Higher ratio implies higher portion of non-
performing loan portfolio.

To measure Loan Loss Coverage Ratio:

Total Loan Loss Provision

Loan Loss Coverage Ratio= ×100
Total NPL

iii. Loan Loss Provision Ratio

The provision for loan losses is a charge to current earnings to build the Allowance
for Loan and Lease Losses (ALLL). The ALLL is a general reserve kept by banks to
absorb loan losses. While it measures the possibility of loan default, it reflects
adequacy to absorb estimated credit losses associated with the loan and lease
portfolio of the bank. Loan loss provision ratio provides useful insight into the quality

59
of banks loan portfolio and bad debts coverage, and the adequacy of loan loss
provisions. It indicates how efficiently banks manages its loan and advances and
makes effort for the loan recovery.

The ratio of loan loss provision to total loans and advances describes the quality of
assets that a bank is holding. The provision for loan loss reflects the increasing
probability on non-performing loans in the volume of total loans and advances. Loan
loss provision on the other hand signifies the cushion against future contingency
created by the default of the borrowers. The high ratio signifies the relatively more
risky assets in the volume of loans and advances. It is calculated by using the
following model.

To measure Loan Loss Provision Ratio:

Total Loan Loss Provision

Loan Loss Provision Ratio= ×100
Total Loans∧ Advances

3.6.1.3 Management Efficiency (M of CAMELS)

Management is the core part of any business or organization. The success of any
institution depends on the competency and efficiency of its management. While the
others factors can be quantified fairly easily from current financial statements,
management quality being subjective is difficult to quantify. As such no particular
factor can be pointed out as a concrete measure for assessing Management quality.
The qualitative assessment of aspects like Depth and Succession of top management,
Technical Aspects, Internal Control decisions, Operating and Lending decisions,
Involvement of Board of Directors, Willingness to serve community needs etc,
illustrate the level of management quality as these decisions are reflected in the final
balance sheet. To measure management efficiency following ratios are calculated as
follows:

i. Earning Per Employee Ratio

60
Earning per employee is the numerical relationship between net profits after taxes to
total number of employees. It measures the productivity degree of employees in the
organization and also indicates per unit contribution of employee. Low or decreasing
earnings per employee can reflect inefficiencies as a result of overstaffing, with
similar repercussions in terms of profitability. (IMF, 2000)

To measure Loan Loss Provision Ratio:

Net Profit after Tax

Earnings Per Employee Ratio= × 100
Total Number of Employess

ii. Total Expense to Total Income Ratio

The profitability of an institution is determined by the gap of Total Income and Total
Expense which are in direct control and under monitoring of the management. It
measures the total expenditure and total revenue generated by the banks. It is an
important ratio to measure management quality since the profitability of an
institution is determined by the gap of Total Income and Total Expense.

The total expense to total income ratio is the expression of numerical relationship
between total expenses and total incomes of the bank. A high or increasing ratio of
expense to total income can indicate that FIs may not be operating efficiently. This
can be, but is not necessarily due to management deficiencies. In any case, it is likely
to negatively affect profitability (IMF, 2000).

To measure Total Expense to Total Income Ratio:

Total Expense
Total Expense ¿Total Income Ratio= × 100
Total Income

3.6.1.4 Earning (E of CAMELS)

61
Generally, earning is the ultimate result of any business. Earning shows that the bank
is working efficiently in each and every sector. In this Earning component of CAMELS,
following three ratios are used for analysis.

i. Earnings per Share (EPS)

Earnings per share provide a direct measure of the return flowing to the bank's
owners- its stockholders- measured relative to the numbers of shares to the public. It
gives the strength to the share in the market. It measures the amount value of
shareholders gain from each share held. It is an important ratio for an investor
because of its relationship to the dividend and market price. Higher EPS indicates
higher return for the shareholders.

To measure the Earning per Share Ratio:

Net Profit after Tax

Earnings per Share= ×100
Total Number of Shares

ii. Return on Assets (ROA)

Return on assets is the numerical relationship between net incomes after taxes to
total assets of a bank. It is primarily an indicator of the quality of assets, managerial
efficiency to utilize the institution's assets into net earnings. Higher the ROA, higher
is the quality of assets and efficient asset utilization. It ensures a company’s success
in earning a return for all provider of capital. Generally, the return on assets ratio
should be 1% and higher is desired to the banking industry.

To measure the Return on Assets Ratio:

Net Profit after Tax

Return on Assets Ratio= ×100
Tota l Assets

iii. Return on Equity (ROE)

62
The return on equity indicates the relationship between net profits after taxes to
total equity capital. It measures a company’s success in earning a return flowing to
the bank's shareholders for holding the shares of the company. Computed as the
ratio of net profit after tax to total equity, it reflects the income earned from its
internal sources. Return on equity reveals how well the bank uses the resources of
owners. ROE of 15% is treated as standard and banking industry are desired to have
higher than this. Higher ROE indicates better utilization of the capital fund and higher
investment by the shareholders.

To measure the Return on Equity Ratio:

Net Profit after Tax

Return on Equity Ratio= × 100
Total Shareholder s ' Fund

3.6.1.5 Liquidity (L of CAMELS)

Liquidity refers to the speed and ease with which an asset can be converted to cash
without significant loss of value. In banking term, liquidity means ability of bank to
satisfy ones liability on demand of customer. On liquidity following three ratios are
used for analysis.

i. Cash Reserve Ratio (CRR)

It is the minimum amount of reserves a bank must hold in the form account balance
with NRB. This ratio ensures minimum level of the bank's first line of defense in
meeting depositor's obligations. Commercial banks are required to maintain cash
reserve ratio in the form of NRB Balance specified as the Percentage of total deposits
balance of two weeks before. Total Deposit means Current, Savings and Fixed
Deposit Account as well as Call Account deposit and certificates of deposits. For the
purpose, deposits held in convertible foreign currency, employees guarantee amount
and margin account will not be included. (NRB Directive, 2067)

To measure the Cash Reserve Ratio:

63
 NRB Balance
CRR= ×100
Total Deposit less Margin Deposit

ii. Cash & Bank Balance (C & B) Ratio

Cash and bank balance to total deposits ratio is a numerical relationship between
total cash and bank balance (liquid assets) of the bank to their respective total
deposits. The higher ratio implies better liquidity position.

To measure the Cash & Bank Balance Ratio:

Total Cash∧Bank Balance

C∧B Ratio= × 100
Total Deposit

iii. Investment in Government Securities Ratio

Banks all over the world contribute a significant amount of total deposits in their
respective central banks to meet liquidity shortages in case of huge unanticipated
withdrawals. As per NRB direction, only investments made in government securities
are considered liquid. Banks are highly encouraged to invest in the government
securities as there is no risk involved.

To measure the Investment in Government Securities Ratio:

Total Inv .∈Govt . Securites

Investment ∈Govt . Securities= ×100
Total Deposit

3.6.1.6 Sensitivity to Market Risk (S of CAMELS)

Sensitivity to market risk refers to the risk that causes due to the changes in market
conditions which would adversely affect the earnings and/or capital. On sensitivity to
Market Risk following two ratios are used for analysis.

i. GAP Ratio

64
GAP ratio is used to examine whether bank's rate sensitive assets (RSA) are sufficient
enough to cover its rate sensitive liabilities (RSL). It is calculated as the ratio between
RSA and RSL. It is computed by expressing RSA divided by RSL.

To measure the GAP Ratio:

RSA
GAP= ×100
RSL

ii. Interest Rate Sensitivity Ratio:

The interest rate sensitivity (IRS) is used to determine whether changes in interest
rate positive or negatively affect the bank's net interest margin or profitability. It can
be computed by expressing cumulative GAP as a percentage of total risk sensitive
assets (RSA).

To measure the Interest Rate Sensitivity Ratio:

Cumulative GAP
IRS= ×100
RSA

3.6.2 STATISTICAL TOOLS

3.6.2.1 Mean

A simple mean is used to summarize the data as a representation of mass data. It is

the sum of the observations divided by the number of observations. It describes the
central location of the data. It is sometimes stated as a simple arithmetic average.
Thus, the mean is expressed as

Σx
Χ=
n

where,

Χ = Mean

x = Individual Observation

65
n = Number of Observation

During the analysis of data, mean is calculated by using the statistical function of
excel data sheet on computer.

3.6.2.2 Standard Deviation

Standard deviation is a simple measure of the variability or the absolute measure of

dispersion of the values and shows the deviation or dispersion in absolute term
(Kothari, 1989). Formulated by Francis Galton in the late 1860s, the standard
deviation remains the most common measure of statistical dispersion. A useful
property of standard deviation is that it is expressed in the same units as the data. In
addition to expressing the variability of a population, standard deviation is commonly
used to measure confidence in statistical conclusions. A low standard deviation
indicates that all of the data points are very close to the same value (the mean) while
high standard deviation indicates that the data are "spread out" over a large range of
values. Here, the standard deviation is used to find out the deviation in absolute
term. Standard deviation is determined as:

√[ Σ x2 Σ x 2
σ=
n ( )]
−
n

where,

σ = Standard Deviation

x = Individual Observation

n = Number of Observation

During the analysis of data, standard deviation is calculated by using the statistical
function 'stdevpa' of Excel data sheet on computer.

3.6.2.3 Coefficient of Variation

66
Coefficient of variation is the relative measure of dispersion based on the standard
deviation (Kothari, 1978). It is most commonly used to measure the variation of data
and more useful for the comparative study of variability. The standard deviation can
sometimes be misleading in comparing the risk of uncertainty, surrounding
alternatives as they differ in size or scale. To adjust the problem, the standard
deviation can be divided by mean to compute coefficient of variation. The coefficient
of variation is more useful when we consider investments, which have different level
of risks. It is calculated as

σ
C . V .=
Χ

where,

C.V. = Coefficient of Variation

σ = Standard deviation

Χ = Mean

CHAPTER IV

DATA PRESENTATION AND ANALYSIS

This chapter deals with the data presentation of HBL & EBL through different ratio
analysis in the framework of CAMELS Components as prescribed in Chapter III -
Research Methodology. Then after the generated results will be analyzed and
interpreted by using statistical and non-statistical tools. The data collected from
different sources has been refined and documented in excel tables, which are further

67
processed to analyze and arrive at the findings on the financial conditions of HBL and
EBL. This chapter also includes major findings of the study.

4.1 CAPITAL ADEQUACY

Capital adequacy indicates whether the bank has enough capital to absorb
unexpected losses that may occur at any time in the course of business activities. It is
required to maintain depositor confidence and preventing the bank from going
bankrupt. The banks have to maintain the capital adequacy ratio specified by Nepal
Rastra Bank from time to time. Capital adequacy ratio is equal to the ratio of Core
Capital and Supplementary Capital to the aggregate of Risk Weighted Assets (RWA).

Capital Adequacy component analysis of HBL & EBL is made based on the regulations
and standard ascertain by NRB as to maintaining minimum risk based Core & Total
capital standard. The minimum risk based capital standard includes a definition for
Risk Based Capital, a system for calculating RWA by assigning on and off balance
sheet items to broad risk categories. Capital Adequacy Ratios take into account the
most important financial risks-foreign exchange, credit and interest rate risks, by
assigning risk weightings to the institution's assets.

4.1.1 CORE CAPITAL RATIO

Core Capital, which is a capital of permanent nature, comprise of Paid Up, Share
premium, Non-Redeemable Preference Share, General Reserve, Dividend
Equalization Fund, Capital Adjustment Reserve, Retained Earnings, Profit & Loss
accounts and disclosed reserves that are considered freely available to meet claims
against the bank. Table - 4.1 presents the observed Core Capital Ratio during the
study period and minimum core capital standard set by NRB in the corresponding
period along with variance from NRB Standard.

Table - 4.1

68
 CORE CAPITAL RATIO
(Rs. In Million)
VARIANCE
HBL EBL MINIMUM (+ / - %)
NRB
PERIOD CORE CORE
CORE CORE STANDAR
RWA CAPITAL RWA CAPITAL D% HBL EBL
CAPITAL CAPITAL
TO RWA TO RWA
2064/6 2,469.7 1,900.8 21,039.8 3.6 3.0
25,624.47 9.64 9.03 6
5 9 6 8 4 3
2065/6 3,074.4 1,981.5 25,619.7 2.8 1.7
34,905.89 8.81 7.73 6
6 4 8 5 1 3
2066/6 3,414.6 2,537.0 30,240.4 2.6 2.3
39,357.06 8.68 8.39 6
7 4 9 3 8 9
2067/6 3,916.9 2,927.1 34,583.5 2.8 2.4
44,124.52 8.88 8.46 6
8 7 7 5 8 6
2068/6 4,600.1 3,990.9 41,525.3 3.6 3.6
47,934.90 9.60 9.61 6
9 5 2 5 0 1
Mean 9.12 8.65
Standard Deviation(S.D.) 0.41 0.63
Coefficient of Variation(C.V.) 0.05 0.07
(Source: Annual Reports of HBL & EBL)

As shown in the above Table - 4.1, the core capital ratio of HBL was maximum in FY
2064/65 with 9.64% whereas minimum ratio of 8.68% in FY 2066/67. The core capital
ratio of EBL was maximum in FY 2068/69 with 9.61% and minimum ratio of 7.73% in
FY 2065/66 and thereafter increased continuously due to respective increase in Core
Capital and RWA in the following year.

The above presented figure represents that both banks have been able to fulfill the
statutory requirement of NRB i.e. 6%. The average of CCR of HBL shows higher than
EBL with 9.12%. EBL seems better than HBL as it has the least CCR ratio of 7.73% and
exceeds the statutory requirement of NRB which means that it is able to utilize its
capital in better ways than HBL. The CV of both banks is 0.05 and 0.07 which means
that both the banks are equally consistent.

69
 FIGURE - 4.1
Graphical representation showing Core Capital Ratio between
HBL and EBL

10.00

8.00
HBL
6.00 EBL

4.00

2.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.1 shows, core capital ratio of HBL variated positively in all the 5
years of the study period, with maximum positive variance of 3.64% in FY 2064/65
and minimum positive variance of 2.68% in FY 2066/67. Similarly, core capital ratio of
EBL also variated positively during the study period with maximum positive variance
of 3.61% in FY 2068/69 and minimum positive variance of 1.73% in FY 2065/66. Both
the banks were able to maintain positive variance greater than 6% as per statutory
requirement of NRB during the five years of study period.

In general, both banks were able to maintain core capital ratio adequately above the
NRB statutory standard during the study period. It means the banks are applying
adequate amount of internal sources of shareholders' fund with significant core
capital adequacy ratio in all the years over the study period.

4.1.2 CAPITAL ADEQUACY RATIO

Capital adequacy ratio above the NRB standard indicates adequacy of capital and
signifies higher security to depositors, higher internal sources and higher ability to
cushion operational and unanticipated losses. The lower value, on the contrary,

70
 indicates lower internal sources, comparatively weak financial position and lower
security to depositors.

Table - 4.2
CAPITAL ADEQUACY RATIO
(Rs. In Million)
MINIMUM
NRB VARIANCE
HBL EBL
STANDARD (+ / - %)
%
PERIOD
CAPITA CAPITA
CAPITAL L FUND CAPITAL L FUND
RWA RWA HBL EBL
FUND TO FUND TO
RWA RWA
2064/6 3,253.5 2,406.0
25,624.47 12.70 21,039.88 11.44 11 1.70 0.44
5 2 6
2065/6 3,845.2 2,703.8
34,905.89 11.02 25,619.75 10.55 10 1.02 0.55
6 1 7
2066/6 4,218.3 3,257.1
39,357.06 10.72 30,240.43 10.77 10 0.72 0.77
7 6 4
2067/6 4,711.2 3,605.8
44,124.52 10.68 34,583.55 10.43 10 0.68 0.43
8 4 4
2068/6 5,283.9 4,574.7
47,934.90 11.02 41,525.35 11.02 10 1.02 1.02
9 0 5
Mean 11.23 10.84
Standard Deviation(S.D.) 0.75 0.36
Coefficient of Variation(C.V.) 0.07 0.03
(Source: Annual Reports of HBL & EBL)

The above Table - 4.2 tabulates the bank's Total Capital Fund and RWA to show the
Total Capital Adequacy Ratio of respective banks and its comparison with minimum
NRB standard. As tabulated above, the total capital fund to RWA of HBL was
maximum in FY 2064/65 with 12.70% and decreased continuously, whereas
minimum ratio of 10.68% in FY 2067/68. The reason of this decrease was due to
comparatively high increase of RWA. Total capital adequacy ratio of EBL was
maximum in FY 2064/65 with 11.44% and minimum ratio of 10.43% in FY 2067/68.

The above presented table represents that both banks have been able to fulfill the
statutory requirement of NRB in each year of study period. The average of CAR of
HBL is 11.23% which is higher than EBL with 10.84% and exceeds the statutory

71
requirement of NRB. The CV of HBL is 0.07 and EBL is 0.03 which means that both the
banks are very consistent to each other.

FIGURE - 4.2
Graphical representation showing Capital Adequacy Ratio between
HBL and EBL

12.00

9.00 HBL
EBL

6.00

3.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.2 exhibits the data tabulated in Table - 4.2. As shown in the
figure, the capital adequacy ratio of HBL was above the minimum NRB standard with
maximum positive variance of 1.70% and minimum positive variance of 0.68% in FY
2064/65 and FY 2067/68 respectively. In the case of EBL the total capital to RWA is
high to some extent than HBL in FY 2066/67 however the ratio is found fluctuating in
all the study period with maximum positive variance of 1.02% in FY 2068/69 and
minimum positive variance of 0.43% in FY 2067/68.

In general, both HBL & EBL were able to maintain CAR above the minimum NRB
standard efficiently during the study period however the banks require to increase
their capital fund either through internal sources or decrease risky assets investment
in the coming future.

4.2 ASSETS QUALITY

Assets quality indicates what types of advances the bank has made to generate
interest income. Here, out of the several indicators of Asset Quality; Asset

72
composition, Non-performing loss ratio, Loan loss provision ratio and Loan loss
coverage ratio are taken in order to examine the asset quality of both banks.

4.2.1 ASSETS COMPOSITION

The assets portfolio of the bank represents the varied nature and consequence of the
bank's function and investment policies. Usually every banker seems to arrange their
assets appearing in balance sheet in descending order of liquidity. The capital and
liabilities of banks are invested in various assets in the form of Cash & Bank Balance,
Investments, Bills purchase, Loans and advances, fixed assets, other assets etc. Of
these, Loans and advances usually make the largest portion of all the assets. As they
are the least liquid form of assets, Loans and Advances contain the high proportion
of potential risk to the bank's capital.

Table - 4.3
BANKS' ASSETS COMPOSITION
(Rs. In Million)
HBL
PARTICULARS 2064/65 2065/66 2066/67 2067/68 2068/69
Cash Balance 278.18 473.76 514.22 632.05 951.33
Balance with NRB 935.84 2,328.41 2,604.79 1,390.63 3,979.16
Balance with Banks/FIS 234.12 246.36 747.48 941.98 1,431.80
Money at Call or Short Notice 518.53 1,170.79 308.84 734.00 264.60
Investments 13,340.18 8,710.69 8,444.91 8,769.94 10,031.58
Loans, Advances & Bills
19,497.52 24,793.16 27,980.63 31,566.98 34,965.43
Purchase
Fixed Assets 726.07 952.20 1,061.87 1,187.49 1,305.36
Non Banking Assets 10.31 22.69 - - -
Other Assets 634.79 622.26 1,054.38 1,513.14 1,435.15
EBL
PARTICULARS 2064/65 2065/66 2066/67 2067/68 2068/69
Cash Balance 822.99 944.70 1,091.50 1,049.00 1,700.99
Balance with NRB 1,080.91 4,787.16 5,625.11 4,706.32 8,159.75
Balance with Banks/FIS 764.07 432.51 1,102.20 367.54 502.56
Money at Call or Short Notice 346.00 - - - -
Investments 5,059.56 5,948.48 5,008.31 7,743.93 7,863.63
Loans, Advances & Bills
18,339.09 23,884.67 27,556.36 31,057.69 35,910.97
Purchase

73
 Fixed Assets 360.51 427.16 463.09 460.26 547.93
Non Banking Assets - - - - -
Other Assets 376.22 492.17 536.19 851.47 1,127.30
(Source: Annual Reports of HBL & EBL)

Asset composition of HBL and EBL like in every banks remained largely in Loans and
Investment during the last five financial years. They occupied a large portion in their
respective balance sheet however EBL has occupied comparatively less portion than
HBL. That means HBL has high potential risk to the bank’s assets than EBL. As shown
in the above table, cash and bank balance (which form the most liquid of all assets)
continues to increase with the highest amount in FY 2068/69. Similarly, proportion of
fixed assets and other assets of the respective banks are also in increasing trend
during the period.

4.2.2 LOANS AND ADVANCES

The fact that the Loans and advances usually form the largest of the asset items and
can carry the greatest amount of potential risk to the bank's capital account. The
primary factor effecting overall asset quality is the quality of the loan portfolio.
Assets with inherent credit weaknesses categorized into non-performing assets
components: Substandard, Doubtful and Loss grades are examined, as per minimum
criteria laid down by NRB based on the overdue period of the advances. These
graded loans require provisioning of 25%, 50% and 100% respectively in order to safe
guard the interest of the stakeholders. The quality of loans and advances of both HBL
& EBL is assessed based on their Loan Classification and Loan Loss Provision mix.

4.2.3 NON-PERFORMING LOAN (NPL) RATIO

The default in repayment of interest or principal within the stipulated time frame,
the performing loan turns into non-performing loan. As per NRB directives, all Loans
and Advances must be classified in order of Principal default aging into Pass (past

74
due upto 3 months), Sub-standard (past due between 3-6 months), Doubtful (past
due between 6-12 months) and Loss (past due over 1 year). NPL forms an aggregate
of Substandard, Doubtful and Loss loans. The ratio of NPL to Total loans and
advances shows the percentage of NPL in total loan. The lower the ratio the better is
the proportion of performing loans and risk of default.

Table - 4.4
NON PERFORMING LOAN RATIO
(Rs. In Million)
HBL EBL
PERIOD TOTAL LOANS NPL TOTAL LOANS NPL
NPL NPL
& ADVANCES RATIO & ADVANCES RATIO
2064/6
477.23 20,179.61 2.36 121.00 18,836.43 0.64
5
2065/6
551.31 25,519.52 2.16 117.99 24,469.56 0.48
6
2066/6
1,024.83 29,123.75 3.52 43.71 28,156.40 0.16
7
2067/6
1,391.75 32,968.27 4.22 108.51 31,611.84 0.34
8
2068/6
751.16 35,968.47 2.09 307.49 36,616.83 0.84
9
Mean 2.87 0.49
Standard Deviation(S.D.) 0.85 0.69
Coefficient of Variation(C.V.) 0.30 1.40
(Source: Annual Reports of HBL & EBL)

The above Table - 4.4 presents the NPL Ratio of the banks. The NPL ratio of HBL is in
decreasing trend for first two years of the study period, slightly increased in third and
fourth year and decreased in the final year with maximum ratio of 4.22% in FY
2067/68 and minimum ratio of 2.09% in FY 2068/69. Whereas NPL of EBL is in
decreasing trend for first three years of the study period and slightly increased in last
two years with maximum ratio of 0.84% in FY 2068/69 and minimum ratio of 0.16%
in FY 2066/67.

The above presented table represents that both banks have been able to decrease
their non-performing loan in order to strengthen their asset quality. The average of
NPL ratio of HBL is 2.87% which is very higher than 0.49% of EBL, however both have

75
maintained their NPL ratio below 5% as per NRB requirement. This shows that the
asset quality of EBL is much better than HBL as it has average NPL less than 1%. Since
the CV of HBL 0.30 is less than 1.40 of EBL, HBL is more uniform and consistent with
respect to loans and advances than EBL.

FIGURE - 4.3
Graphical representation showing Non Performing Loan Ratio between HBL and EBL

4.00

3.00 HBL
EBL

2.00

1.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

As shown in the above Figure - 4.3, the non-performing loan ratio of HBL has been
found very fluctuating. Whereas the non-performing loan ratio of EBL found below
the minimum requirement of NRB during study period. It has very low non-
performing loan ratio in comparison with ratio of HBL which shows that EBL has less
potential risk to the bank’s assets.

4.2.4 LOAN LOSS PROVISION RATIO

The Loan Loss Provision ratio indicates adequacy of allowance for loans, the
performance in loan portfolio and also describes the quality of assets that a bank is
holding. It provides useful insight into the quality of a bank’s loan portfolio and bad
debts coverage, and the adequacy of loan loss provisions. This ratio shows the
possibility of loan default of a bank and also indicates how efficiently it manages its
loans and advances and makes effort for the recovery of loan. Greater loan loss
provision is required to allow in income statement if high loss is expected. Loan loss
provision on the other hand signifies the cushion against future contingency created

76
 by the default of the borrowers. The high ratio signifies the relatively more risky
assets in the volume of loans and advances. The high provision for loan loss shows
the recovery of loan to be difficult and irregular and the age of the loan is increasing.

Table - 4.5
LOAN LOSS PROVISION RATIO
(Rs. In Million)
HBL EBL
LOAN LOSS
PERIOD TOTAL LOANS PROVISION TO LOAN LOSS TOTAL LOANS PROVISION TO
PROVISIO
& ADVANCES TOTAL LOAN PROVISION & ADVANCES TOTAL LOAN
N
2064/6
682.09 20,179.61 3.38 497.35 18,836.43 2.64
5
2065/6
726.36 25,519.52 2.85 584.88 24,469.56 2.39
6
2066/6
1,143.13 29,123.75 3.93 600.04 28,156.40 2.13
7
2067/6
1,401.29 32,968.27 4.25 604.15 31,611.84 1.91
8
2068/6
1,003.04 35,968.47 2.79 705.86 36,616.83 1.93
9
Mean 3.44 2.20
Standard Deviation(S.D.) 0.58 0.32
Coefficient of Variation(C.V.) 0.17 0.15
(Source: Annual Reports of HBL & EBL)

The above Table - 4.5 exhibits the loan loss provision ratio of HBL for the study
period is in decreasing trend for the first two year, slightly increases in the third and
fourth year and decreases in the final year. The ratio ranges from 2.85% in FY
2065/66 to 4.25% in FY 2067/68.

In case of EBL, the loan loss provision ratio for the study period is in continuous
decreasing trend for first four years and slightly increases in the final year. The ratio
ranges from 1.91% in FY 2067/68 to 2.64% in FY 2064/65.

The above presented table represents that both banks have been able to decrease
their loan loss provision ratio with the decrease in their non-performing loan. The
average of LLP ratio of HBL is 3.44% which is higher than 2.20% of EBL. This shows
that the asset quality of EBL is much better than HBL. CV of HBL is 0.17 whereas CV of

77
EBL is 0.15. Since the CV of EBL is less than that of HBL, EBL is more uniform and
consistent with respect to LLP than HBL.

FIGURE - 4.4
Graphical representation showing Loan Loss Provision Ratio between HBL and EBL

4.00

3.00
HBL
EBL
2.00

1.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.4 shows the observed value of LLP ratio of both banks which are
in decreasing trend over the study period. The LLP ratio of HBL has been found very
fluctuating than EBL. The asset quality of EBL is seems better as it has low ratio in
comparison with ratio of HBL. This shows that EBL has less potential risk to the
bank’s assets and more uniformity plus consistency with respect to LLP ratio than
that of HBL.

4.2.5 LOAN LOSS COVERAGE RATIO

The loan loss coverage ratio is an indication of the adequacy of bank’s loan reserve to
cover or absorb possible future contingent loan losses. It shows how well the bank is
in maintaining the reserves that could cover potential loan losses. Greater loan loss
coverage is required to allow in income statement if high loss is expected. Higher
ratio implies higher portion of non-performing loan portfolio.

Table - 4.6
LOAN LOSS COVERAGE RATIO
(Rs. In Million)

78
 HBL EBL
LOAN LOAN
PERIOD LOSS LLP TO LOSS LLP TO
NPL NPL
PROVISIO NPL PROVISIO NPL
N N
2064/6
682.09 477.23 142.93 497.35 121.00 411.02
5
2065/6
726.36 551.31 131.75 584.88 117.99 495.72
6
2066/6
1,143.13 1,024.83 111.54 600.04 43.71 1,372.91
7
2067/6
1,401.29 1,391.75 100.69 604.15 108.51 556.76
8
2068/6
1,003.04 751.16 133.53 705.86 307.49 229.55
9
Mean 124.09 613.19
Standard Deviation(S.D.) 15.54 415.51
Coefficient of Variation(C.V.) 0.13 0.68
(Source: Annual Reports of HBL & EBL)

The above Table - 4.6 exhibits the loan loss coverage ratio of HBL for the study period
is in continuous decreasing trend for the first four years and increased in the final
year. The ratio for HBL ranges from 100.69% in FY 2067/68 to 142.93% in FY 2064/65.
In case of EBL, the loan loss coverage ratio for the study period is in increasing trend
for first three years and decreased in last two years. The ratio ranges from 229.55%
in FY 2068/69 to 1372.91% in FY 2066/67.

The above presented table represents that both banks have been able to maintain
the reserve for covering contingent loan losses that may occur at any time in future.

The average ratio of HBL is 124.09% and EBL is 613.19%. This shows that the EBL is
very much cautious about future happening regarding the loan losses and thus has
been able in maintaining for future losses. Since, the CV of HBL with 0.13 is less than
that of EBL with 0.68 HBL is more uniform and consistent with respect to loan loss
coverage than EBL.

79
 FIGURE - 4.5
Graphical representation showing Loan Loss Coverage Ratio between HBL and EBL

1,200.00

900.00
HBL
EBL

600.00

300.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.5 shows the observed value of loan loss coverage ratio of both
banks. The loan loss coverage ratio of HBL is low than EBL which is in increasing trend
over the study period whereas EBL is found to have fluctuating condition.

The assets quality of EBL seems better as it has maintained the reserve more than
required for future contingent loan losses. This shows that EBL is more cautious
about future happening regarding the loan losses.

4.3 MANAGEMENT QUALITY

Management role is very important in the performance of FIs. The key distinct areas
that reflect the overall quality of management are governance, general
management, human resource policy, management information system, internal
control and audit strategic planning and budgeting.

There is one measure that is relevant to management is the ratio of Total expense to
Total income. Since the profitability of an institution is determined by the gap of
Total Income and Total Expense which are well in direct control and monitoring of
the management, it is used to represent the management quality. Another measure
that is also relevant to management is the ratio of earning per employee which is
used as a proxy of management quality.

80
4.3.1 TOTAL EXPENSES TO TOTAL INCOME RATIO

The ratio of total expenses to total income is used as a proxy measure of the
management quality. This ratio is calculated by dividing the total expense by total
income. A high level of expenditures in un-productive activities may reflect an
inefficient management. A high or increasing ratio of expense to total revenues may
give indication of inefficient operation. This can be, but necessarily due to
management deficiencies. In any case, it is likely to negatively affect profitability.

Commercial bank's earning originates from interest on Loans & advances,

Investments, Commissions & discounts, Foreign Exchange Rate gains & other
miscellaneous income. Conversely, it expends on Depositors' interest, Staff salary,
Provident fund allowances & other operating expenses like rent, water & electricity,
fuel expenses, audit fee expenses, management expenses, depreciation,
miscellaneous expenses, and all other expenses directly related to the operation of
bank.

Table - 4.7
TOTAL EXPENSES TO TOTAL INCOME RATIO
(Rs. In Million)
HBL EBL
PERIOD TOTAL TOTAL TOTAL TOTAL
TE/TI TE/TI
EXPENSES INCOME EXPENSES INCOME
2064/6
636.53 1,597.50 39.85 391.72 1,209.90 32.38
5
2065/6
759.30 1,988.05 38.19 478.93 1,544.97 31.00
6
2066/6
886.09 2,157.96 41.06 578.88 1,927.98 30.03
7
2067/6
1,099.80 2,586.74 42.52 676.24 2,192.94 30.84
8
2068/6
1,348.67 2,911.21 46.33 819.34 2,609.74 31.40
9
Mean 41.59 31.13
Standard Deviation(S.D.) 2.76 6.15
Coefficient of Variation(C.V.) 0.07 0.20
(Source: Annual Reports of HBL & EBL)

81
As shown in above Table - 4.7, the total expense (TE) to total income (TI) ratio of HBL
has been fluctuating during the study period with maximum of 46.33% in FY 2068/69
to minimum of 38.19% in FY 2065/66. In the case of EBL, total expense to total
income ratio ranges in between 30.03% in FY 2066/67 to 32.38% in FY 2064/65.

The above presented table represents that HBL has higher total expense to total
income ratio than EBL. During the study period, the average ratio of HBL is 41.59%
and EBL is 31.13% which shows that EBL has much success in managing operating
activities of the bank efficiently. Since, the CV of HBL with 0.07 is less than that of EBL
with 0.20 HBL is more stable and consistent than EBL.

FIGURE - 4.6
Graphical representation showing Total Expenses to Total Income Ratio between HBL and EBL

50.00

40.00

HBL
30.00 EBL

20.00

10.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.6 exhibits the observed TE to TI ratio of HBL and EBL within the
study period of last five years. As shown in the figure, the observed ratio of HBL
fluctuated up and downs but not more than 46.33%. In case of EBL, the ratio is not
more than 30.03% which indicates decreasing expenses with respect to income that
is credited to good management quality.

4.3.2 EARNING PER EMPLOYEE

82
Earning per employee is calculated by dividing net profit after taxes by number of
employees of respective banks. Low or decreasing earning per employee can reflect
inefficiencies as a result of overstaffing, with similar repercussions in terms of
profitability (IMF, 2000).

Table - 4.8
EARNING PER EMPLOYEE
(Rs. In Million)
HBL EBL
EARNING EARNING
PERIOD NET NO. OF NO. OF
PER NET PROFIT PER
PROFIT EMPLOYEES EMPLOYEES
EMPLOYEE EMPLOYEE
2064/6
635.87 591 1.08 451.22 449 1.00
5
2065/6
752.83 591 1.27 638.73 534 1.20
6
2066/6
508.80 577 0.88 831.77 568 1.46
7
2067/6
893.12 647 1.38 931.30 586 1.59
8
2068/6
958.64 793 1.21 1,090.56 625 1.74
9
Mean 1.16 1.40
Standard Deviation(S.D.) 0.17 0.21
Coefficient of Variation(C.V) 0.15 0.15
(Source: Annual Reports of HBL & EBL)

The above Table - 4.8 shows the Earning per employee of HBL & EBL in million rupees
during the study period. The ratio of HBL is in fluctuating trend throughout the study
period. It has maximum earning per employee with Rs.1.38 in FY 2067/68 and the
minimum with Rs. 0.88 in FY 2066/67. In case of EBL, earning per employee is in
continuous increasing trend during the study period with maximum of Rs.1.74 in FY
2068/69 and with minimum Rs.1.00 in FY 2064/65.

The above presented table represents that EBL has higher earning per employee
ratio than HBL. During the study period, the average ratio of HBL is Rs. 1.16 and EBL
is Rs. 1.40 which shows that EBL is much success in making earning of the bank
efficiently than HBL. Since, HBL and EBL both with positive CV of 0.15 they are
equally stable and consistent in this aspect.
83
 FIGURE - 4.7
Graphical representation showing Earning Per Employee between HBL and EBL

2.00

1.50
HBL
EBL
1.00

0.50

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.7 shows the observed Earning per Employee of HBL & EBL. The
ratio of HBL is in fluctuating trend throughout the years of study whereas the ratio of
EBL is in continuous increasing trend over the period of study. Though the number of
employees of EBL is in increasing trend, the earning per employee ratio is also
increasing which shows that the bank is very much efficient in earning in terms of
profitability of the bank.

4.4 EARNING QUALITY

The earning quality lays importance on how a bank earns its profit. This quality also
explains the sustainability and growth of bank in terms of earnings in the future.

Earning represents the first line of defense against capital depletion resulting from
shrinkage in asset value. Earnings performance also allows the bank to remain
competitive by providing the resources. The main objective of bank is to earn profit
and their level of profitability is measured by Profitability ratios. Profitability ratios
measures the efficiency of banks, higher profit ratios indicate higher efficiency and
vice-versa.

4.4.1 RETURN ON EQUITY (ROE) RATIO

84
ROE is measure of the rate of return flowing to the bank's shareholders. ROE is the
profit as a percentage return on the owner's stake. Computed as the ratio of net
income to the equity, it reflects the income earned from its internal sources. Return
on equity reveals how well the bank uses the resources of owners. The higher ratio
represents sound management and efficient mobilization of the owner's equity and
vice-versa. ROE of 15% is treated as standard and banking industry are desired to
have higher ratio than this standard.

Table - 4.9
RETURN ON EQUITY RATIO
(Rs. In Million)
HBL EBL
RETURN RETURN
PERIOD NET SHAREHOLDER'S NET SHAREHOLDER'S
ON ON
PROFIT EQUITY PROFIT EQUITY
EQUITY EQUITY
2064/65 635.87 2,512.99 25.30 451.22 1,921.24 23.49
2065/66 752.83 3,119.88 24.13 638.73 2,203.63 28.99
2066/67 508.80 3,439.21 14.79 831.77 2,759.14 30.15
2067/68 893.12 3,995.48 22.35 931.30 3,113.55 29.91
2068/69 958.64 4,632.01 20.70 1,090.56 4,177.30 26.11
Mean 21.46 27.73
Standard Deviation(S.D.) 3.68 3.84
Coefficient of Variation(C.V.) 0.17 0.14
(Source: Annual Reports of HBL & EBL)

As shown in above Table - 4.9, the ROE of HBL with 14.79% minimum in FY 2066/67
and maximum of 24.13% in FY 2065/66. The ratio decreases for the first two years of
study period, decreases in the third year, increases in the fourth year and thereafter
decreases in the final year. On the other hand, ROE of EBL is maximum with 30.15%
in the FY 2066/67 and minimum of 23.49% in FY 2064/65. The ratio is in increasing
trend during the period of study upto third year and thereafter decreasing upto final
year.

The above presented table represents the return of equity ratio of HBL & EBL. During
the study period, the mean ratio of HBL is 21.46% and EBL is 27.73%. In most years of
study period and obviously the mean ratio is above the 15% benchmark, ROE ratio of
85
both the banks seems to be sound. However, the ROE of EBL is much better than
HBL. Since, CV of HBL with 0.17 is higher than that of EBL with 0.14, EBL is more
stable and consistent than HBL.

FIGURE - 4.8
Graphical representation showing Return on Equtiy Ratio between HBL and EBL

30.00

24.00

HBL
18.00 EBL

12.00

6.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

As shown in above Figure - 4.8, the return on equity ratio of HBL is fluctuating over
the years of study period. The observed values of the ratio are fluctuating over study
period. In case of EBL, the ratio is in increasing trend. The average ratios of both the
banks are above the benchmark of 15%. The increasing trend of ratios implies that
earning quality of bank is getting better. While comparing the ratio, EBL is much
better than HBL in making the earnings in terms of profitability.

4.4.2 RETURN ON ASSETS (ROA) RATIO

ROA is a measure of profitability linked to the asset size of the bank which
determines the net income produced per rupee of assets. It is primarily an indicator
of managerial efficiency that indicates how capably the management of the bank has
been converting the institution's assets into net earnings. ROA is a popular tool to
measure how well their assets are utilized in generating profit. It measures the profit
earning capacity of bank by utilizing available resources i.e. total assets. Return will
be higher if the banks resources are well managed and efficiently utilized. Generally,
the return on assets ratio should be 1% and higher is desired to the banking industry.

86
 Table - 4.10
RETURN ON ASSETS RATIO
(Rs. In Million)
HBL EBL
RETURN RETURN
PERIOD NET TOTAL NET TOTAL
ON ON
PROFIT ASSETS PROFIT ASSETS
ASSETS ASSETS
2064/6
635.87 36,175.53 1.76 451.22 27,149.34 1.66
5
2065/6
752.83 39,330.13 1.91 638.73 36,916.85 1.73
6
2066/6
508.80 42,717.12 1.19 831.77 41,382.76 2.01
7
2067/6
893.12 46,736.20 1.91 931.30 46,236.21 2.01
8
2068/6
958.64 54,364.43 1.76 1,090.56 55,813.13 1.95
9
Mean 1.71 1.87
Standard Deviation(S.D.) 0.27 0.15
Coefficient of Variation(C.V.) 0.16 0.08
(Source: Annual Reports of HBL & EBL)

As shown in above Table - 4.10, the return on assets ratio of HBL is minimum in FY
2066/67 with 1.19% and maximum in FY 2065/66 and FY 2067/68 with 1.91%. The
ratio has been in fluctuating trend during the period of study. In case of EBL, the
return on assets ratio is maximum with 2.01% in FY 2066/67 and FY 2067/68 and
minimum with 1.66% in FY 2064/65. Except in FY 2068/69, the ratio has been in
increasing trend during the period of study.

The above presented table represents the return of assets ratio of HBL & EBL. During
the study period, the ROA ratio of HBL has been fluctuating whereas the ROA ratio of
EBL is in continuous increasing trend which shows the quality of assets and their
efficiency to generate return is increasing. The mean ratio of HBL is 1.71% and EBL is
1.87%. In all the years of study period and obviously the mean ratio is above the 1%
benchmark, ROA ratio of both the banks seems to be sound. However, the ROA of
EBL is better than HBL. Since, CV of HBL with 0.16 is slightly higher than that of EBL
with 0.08 EBL seems to be more stable and consistent.

87
 FIGURE - 4.9
Graphical representation showing Return on Assets Ratio between HBL and EBL

2.00

1.50
HBL
EBL
1.00

0.50

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

As shown in above Figure - 4.9, the observed values of return on assets ratio of HBL
are fluctuating over study period. In case of EBL, the ratio is in increasing trend. The
average ratios of both the banks are above the benchmark of 1%. The increasing
trend of ratio implies the better quality of assets and their efficiency to generate
return per asset is getting better. While comparing the ratio, EBL is better than HBL in
making the earnings per asset.

4.4.3 EARNING PER SHARE (EPS)

The profitability of a firm from the point of view of the ordinary shareholders is the
Earning per Share. It measures the profit available to the equity shareholders as per
share basis. The earnings per share of an organization give the strength of the share
in the market. The higher the EPS is supposed to be a best comparing between two
banks.

Table - 4.11
EARNING PER SHARE
(Rs. In Million)
PERIOD HBL EBL

88
 EARNING EARNING
NET NUMBER OF NET NUMBER OF
PER PER
PROFIT SHARES PROFIT SHARES
SHARE SHARE
2064/6
635.87 10,135,125 62.74 451.22 8,314,000 54.27
5
2065/6
752.83 16,000,000 47.05 638.73 10,304,673 61.98
6
2066/6
508.80 20,000,000 25.44 831.77 12,796,075 65.00
7
2067/6
893.12 24,000,000 37.21 931.30 13,915,704 66.92
8
2068/6
958.64 27,600,000 34.73 1,090.56 17,611,264 61.92
9
Mean 41.44 62.02
Standard Deviation(S.D.) 12.68 11.75
Coefficient of Variation(C.V.) 0.31 0.19
(Source: Annual Reports of HBL & EBL)

The above Table - 4.11 reveals that EPS of HBL is in decreasing trend for the first
three years, increases in the fourth and again decreases in the final year of the
review period. EPS is minimum in FY 2066/67 with Rs.25.44/share and maximum in
FY 2064/65 with Rs.62.74/share. Whereas, in case of EBL, EPS of the bank has been
in increasing trend for first four years and thereafter decreases in the final year of
the study period. The EPS of the EBL ranges between Rs. 54.27/share in FY 2064/65
and Rs.66.92/share in FY 2067/68.

The above presented table represents the earning per share of HBL & EBL. During the
study period, the ratio in terms of rupees of HBL has been ups and down whereas the
EPS of EBL is in continuous increasing trend which shows the quality of earning and
their efficiency to generate return per share is increasing. The mean ratio of HBL is
Rs. 41.44/share and CV of the bank is 0.31 which shows less consistent more volatile
whereas the mean ratio of EBL is Rs. 62.02/share and CV is 0.19 which shows more
consistent and less volatile during the study period.

89
 FIGURE - 4.10
Graphical representation showing Earning Per Share between HBL and EBL

70.00

56.00

HBL
42.00 EBL

28.00

14.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.10 shows the EPS of HBL fluctuated downwards for the initial
three years, upwards for fourth year and again downwards for the final year whereas
the ratio of EBL is in increasing trend continuously which shows that the trend of
earning per share is increasing and their efficiency to generate return is increasing
over the study period

4.5 LIQUIDITY ANALYSIS

The level of liquidity influences the ability of a banking system to withstand shocks.
Liquidity risk arises when an FI's liability holders like depositors demand immediate
cash for the financial claims they hold with an FI. The most liquid form of asset is
cash, which FIs can use directly to meet liability holders' demand to withdraw funds.
Day to day withdrawals by liability holders are generally predictable and large FIs can
expect to borrow additional funds on the money and financial markets to meet any
sudden shortfalls of cash. At times FIs face a liquidity crisis due to either a lack of
confidence on the FIs problem or some unexpected need for cash, the liability
holders may demand larger withdrawals than usual. This turns the FIs’ liquidity
problem into a solvency problem and causes it to fail.

90
4.5.1 CASH AND BANK BALANCE RATIO

The ratio of cash and bank balance to total deposit ratio measures the levels of liquid
assets available with the bank to meet short term obligations. It measures overall
liquidity position. The higher ratio implies the better liquidity position and lower ratio
shows the inefficient liquidity position of the bank.

Table - 4.12
CASH AND BANK BALANCE RATIO
(Rs. In Million)
HBL EBL
CASH AND CASH AND
CASH AND CASH AND
PERIOD TOTAL BANK BALANCE TOTAL BANK BALANCE
BANK BANK
DEPOSIT TO TOTAL DEPOSIT TO TOTAL
BALANCE BALANCE
DEPOSIT DEPOSIT
2064/6
1,966.67 31,843 6.18 3,013.97 23,976 12.57
5
2065/6
4,219.32 34,682 12.17 6,164.37 33,323 18.50
6
2066/6
4,175.33 37,611 11.10 7,818.82 36,932 21.17
7
2067/6
3,698.65 40,921 9.04 6,122.86 41,128 14.89
8
2068/6
6,626.90 47,731 13.88 10,363.31 50,006 20.72
9
Mean 10.47 17.57
Standard Deviation(S.D.) 2.66 3.17
Coefficient of Variation(C.V.) 0.25 0.18
(Source: Annual Reports of HBL & EBL)

The above Table - 4.12 shows that the cash and bank balance to total deposit ratio of
HBL & EBL. The ratio of HBL is in fluctuating trend in the review period. It is maximum
in FY 2068/69 with 13.88% and minimum with 6.18% in FY 2064/65.

Whereas, in case of EBL, except in FY 2067/68 the ratio of the bank has been in
increasing trend over the study period. The ratio of the bank ranges between 12.57%
in FY 2064/65 and 21.17% in FY 2066/67.

The above presented table represents the cash and bank balance to total deposit
ratio of HBL & EBL. During the study period, the ratio of HBL has been ups and down

91
whereas the ratio of EBL is in continuous increasing trend except in FY 2067/68 which
shows that the bank is efficient to maintain the liquidity position. The mean ratio of
HBL is 10.47% and CV of the bank is 0.25 whereas the mean ratio of EBL is 17.57%
and CV is 0.18 which shows EBL is more consistent and less volatile than HBL during
the study period.

FIGURE - 4.11
Graphical representation showing Cash and Bank Balance Ratio between HBL and EBL

20.00

16.00
HBL
EBL
12.00

8.00

4.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.11 exhibits the cash and bank balance to total deposit ratio of
HBL & EBL. The ratio of HBL has been ups and down which indicates that the bank
has switched to investing on more profitable assets. The ratio of EBL is in continuous
increasing trend which implies that the bank is efficient in maintaining liquidity
position of the bank but more liquidity impacts profitability in decreasing trend.

4.5.2 NRB BALANCE TO TOTAL DEPOSIT RATIO

To ensure adequate liquidity in the commercial banks, to meet the depositors'

demand for cash at any time and to inject the confidence in depositors regarding the
safety of their deposited funds, NRB has put the directives to maintain certain
percent of total deposit in NRB by the commercial banks. Total Deposit means
Current, Savings and Fixed Deposit Account as well as Call account deposit and
certificates of deposit. For the purpose, deposits held in convertible foreign currency,
employees guarantee amount and margin account will not be included.

92
 Table - 4.13
NRB BALANCE TO TOTAL DEPOSIT RATIO
(Rs. In Million)
HBL EBL
TOTAL DEPOSIT TOTAL DEPOSIT
PERIOD NRB NRB
LESS MARGIN CRR LESS MARGIN CRR
BALANCE BALANCE
DEPOSIT DEPOSIT
2064/65 1,448.14 31,198 4.64 2,667.97 23,755 11.23
2065/66 3,048.53 28,021 10.88 6,164.37 33,031 18.66
2066/67 3,866.49 36,664 10.55 7,818.82 36,556 21.39
2067/68 2,964.65 39,701 7.47 6,122.86 40,718 15.04
2068/69 6,362.30 46,760 13.61 10,363.31 49,554 20.91
Mean 9.43 17.45
Standard Deviation(S.D.) 3.08 3.62
Coefficient of Variation(C.V.) 0.33 0.21
(Source: Annual Reports of HBL & EBL)

The above Table - 4.13 shows that NRB balance to total deposit ratio of HBL & EBL.
The ratio of HBL is in fluctuating trend in the review period. The ratio is maximum in
FY 2068/69 with 13.61% and minimum with 4.64% in FY 2064/65. This shows that the
bank has been failed to maintain the amount in NRB as per the requirement of 5.5%
in FY 2064/65. Whereas, in case of EBL, except in FY 2067/68 the ratio of the bank
has been in increasing trend over the study period. The ratio of the bank ranges
between 11.23% in FY 2064/ 65 and 21.39% in FY 2066/67. This implies that the bank
has been able to meet the compliance of NRB requirement of 5.5% during the study
period.

The above presented table represents the NRB balance to total deposit ratio of HBL
& EBL. During the study period, the ratio of HBL has been ups and down whereas the
ratio of EBL is in continuous increasing trend except in FY 2067/68.

The mean ratio of HBL is 9.43% and EBL is 17.45% which shows that both of the
banks are able to meet the compliance of NRB standard requirement. However, the
above calculation is based on year end volumes of deposit and NRB balance whereas
NRB calculates CRR on weekly average balances. Hence, this is a limitation of the

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study. Since, CV of EBL is 0.21 lesser than that of HBL with 0.33, so EBL is more stable
and consistent.

FIGURE - 4.12
Graphical representation showing NRB Balance to Total Deposit Ratio between HBL and EBL

20.00

15.00
HBL
EBL

10.00

5.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.12 shows the NRB balance to total deposit ratio of HBL & EBL
within the study period of last five years. The ratio of HBL has been ups and down,
however has been able to fulfill the compliance of NRB standard requirement of
5.5% except in FY 2064/65. The ratio of EBL is in continuous increasing trend which
implies that the bank is efficient in maintaining cash reserve position in NRB more
than requirement in order to meet the depositors' demand for cash at any time in
future.

4.5.3 INVESTMENT IN GOVERNMENT SECURITIES RATIO

Cash and bank balance is the highest liquidity and safety among all assets.
Investment in government securities are the second most liquid asset of any bank.
Banks all over the world invest a significant amount of their total deposit on the
government securities in their respective central banks to meet the liquidity
shortages in the banks in case of huge unanticipated withdrawals. As per NRB, only
investments made in government securities are considered liquid asset. Banks are
highly encouraged to invest in the government securities because it is as good as
liquid assets and there is no risk in government securities.

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 Table - 4.14
INVESTMENT IN GOVERNMENT SECURITIES RATIO
(Rs. In Million)
HBL EBL
PERIOD INVESTMEN TOTAL INVESTMEN TOTAL
RATIO RATIO
T DEPOSIT T DEPOSIT
2064/6
7,471.67 31,843 23.46 4,821.60 23,976 20.11
5
2065/6
4,212.30 34,682 12.15 5,146.05 33,323 15.44
6
2066/6
4,465.37 37,611 11.87 4,354.35 36,932 11.79
7
2067/6
6,407.36 40,921 15.66 7,145.02 41,128 17.37
8
2068/6
9,162.22 47,731 19.20 6,068.88 50,006 12.14
9
Mean 16.47 15.37
Standard Deviation(S.D.) 4.40 2.97
Coefficient of Variation(C.V.) 0.27 0.19
(Source: Annual Reports of HBL & EBL)

The above Table - 4.14 shows that Investment in government securities to total
deposit ratio of HBL & EBL. The ratio of HBL has been decreasing for the first three
years during the study period and thereafter increasing for final two years with
maximum of 23.46% in FY 2064/65 and minimum of 11.87% in FY 2066/67. Whereas,
in case of EBL, the ratio of the bank has been in continuous decreasing trend over the
study period except for the FY 2067/68. The ratio of the bank ranges between
11.79% in FY 2066/67 and 20.11% in FY 2064/65. This indicates that the banks have
switched to investing on more profitable assets rather than investing in government
securities.

The above presented table represents the Investment in government securities to

total deposit of respective banks. During the study period, the ratio of HBL has been
in decreasing trend for the initial three years and thereafter increased continuously
following the year. In case of EBL, the ratio is in continuous decreasing trend except
for FY 2067/68. The mean ratio of HBL is 16.47% and EBL is 15.37%. Since, CV of EBL
is 0.19 is slightly less than HBL with 0.27 EBL is more stable and consistent.

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 FIGURE - 4.13
Graphical representation showing Investment in Government Securities Ratio between HBL and EBL

25.00

20.00

HBL
15.00 EBL

10.00

5.00

0.00
2064/65 2065/66 2066/67 2067/68 2068/69

The above Figure - 4.13 shows the Investment in government securities to total
deposit ratio of HBL & EBL during the study period of last five years. The ratio of HBL
has been ups and down, however the ratio of EBL is in continuous decreasing trend
which implies that the bank has switched to investing on more profitable assets
rather than investing in government securities.

4.6 SENSITIVITY TO MARKET RISK

Sensitivity to market risk refers to the risk that causes due to the changes in market
conditions which would adversely affect the earnings and/or capital. One of the
market risks is the interest rate risk also called price risk. It is the risk that is caused
by changes in market interest rate. A bank may have different types of assets and
liabilities. Some assets and liabilities are sensitive to changes in interest rate. Such
assets and liabilities are called rate sensitive assets (RSA) and rate sensitive liabilities
(RSL).

The assets and liabilities having maturity less than a year need to be re-priced
periodically. Therefore, when a bank has more liabilities re-pricing in a rising rate
environment than assets re-pricing, the net interest margin decreases. Conversely, if
the bank is asset sensitive in a rising interest rate environment, net interest margin
will increase because the bank has more assets re-pricing at higher rates.

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There are various methods of measuring interest rate risk. Such as gap analysis,
simulation analysis, duration analysis etc. This study focuses on the gap analysis
which simply measures the net quantity of assets or liabilities re-pricing within a
given period to estimate the likely impact that changes in interest rates. With a view
to minimize the IRR NRB requires the banks to use gap analysis for minimization of
liquidity risk.

4.6.1 MEASURING INTEREST RATE SENSITIVITY

The interest rate sensitivity (IRS) is used to determine whether changes in interest
rate positive or negatively affect the bank's net interest margin or profitability. It can
be computed by expressing cumulative GAP as a percentage of total risk sensitive
assets (RSA).

Table - 4.15
INTEREST RATE SENSITIVITY
HBL
YEAR 1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS
2064/6
38.29 144.49 251.75 121.56 -
5
2065/6
29.58 71.90 122.13 46.78 -
6
2066/6
41.76 149.19 131.84 (24.17) 0.00
7
2067/6
8.18 50.48 78.75 (73.52) 0.00
8
2068/6
1.28 23.93 29.51 (61.64) -
9
Mean 23.82 88.00 122.79 1.80 0.00
EBL
YEAR 1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS
2064/6
65.16 318.76 396.73 426.47 131.39
5
2065/6
32.83 283.05 233.70 222.81 63.55
6
2066/6
43.19 310.00 399.85 381.40 56.31
7
2067/6
6.85 31.93 (48.62) (71.72) 0.67
8
2068/6
27.10 212.01 346.60 241.82 9.85
9
Mean 35.03 231.15 265.65 240.16 52.36

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 (Source: Annual Reports of HBL & EBL)

The above Table - 4.15 shows the interest rate sensitivity as measured by cumulative
gap divided by total rate sensitive asset for HBL & EBL. The mean gap indicated a
positive difference between RSA and RSL. It indicates a positive increase in bank's net
interest margin with an increase in interest rate. For HBL in the fourth quarter of FY
2066/67, FY 2067/68 and FY 2068/69 there have been found a sign of negative gap. It
indicates that during this time bucket, asset coming due are insufficient to cover
liabilities due. However, average figure showed a positive gap indicating that asset
are sufficient enough to satisfy liabilities.

For both banks, during all time buckets, the mean gap is positive. A positive mean
gap indicates an increase in interest rate will lead to a positive increase in bank's net
interest margin. In sample period of five years, the mean gap for these two banks is
always positive. It indicates that assets coming due in all period are sufficient to
cover liabilities due. Therefore, if the banking company had been analyzed on a
quarterly or yearly basis, no liquidity problem would be evident.

FIGURE - 4.14
Graphical representation showing Interest Rate Sensitivity between HBL and EBL

250.00

200.00

HBL
150.00 EBL

100.00

50.00

0.00
1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS

The above Figure - 4.14 shows that the gap of EBL is always greater than that of HBL.
It indicates that the net interest margin or the profitability of HBL is more sensitive to
interest rate changes than EBL.

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4.6.2 GAP RATIO

GAP ratio is used to examine whether bank's rate sensitive assets (RSA) are sufficient
enough to cover its rate sensitive liabilities (RSL). It is calculated as the ratio between
RSA and RSL. It is computed by expressing RSA divided by RSL.

Table - 4.16
GAP RATIO
HBL
YEAR 1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS
2064/65 1.62 1.28 1.01 0.57 0.61
2065/66 1.42 0.86 1.28 0.57 0.86
2066/67 1.72 1.04 0.69 0.38 1.07
2067/68 1.09 1.43 1.10 0.34 1.16
2068/69 1.01 1.26 0.92 0.52 1.18
Mean 1.37 1.17 1.00 0.47 0.97
EBL
YEAR 1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS
2064/65 2.87 1.13 1.75 2.36 0.17
2065/66 1.49 1.83 2.24 5.12 0.25
2066/67 1.76 1.42 1.21 1.15 0.38
2067/68 1.07 1.02 0.48 0.73 1.09
2068/69 1.37 0.96 0.75 0.90 0.93
Mean 1.71 1.27 1.29 2.05 0.56
(Source: Annual Reports of HBL & EBL)

The above Table - 4.16 shows the gap ratio as measured by rate sensitive assets
divided by rate sensitive liabilities for different time period or bucket. The ratio of
greater than 1 indicates a positive gap i.e. RSA is greater than RSL. Similarly, ratio of
less than 1 indicates a negative gap i.e. RSA is lesser than RSL. Both of these
situations are considered as the gap mismatch. However, the ratio of 1 indicates a
perfect match.

The mean gap ratio of HBL for three quarters is greater than 1 indicating a positive
gap. For all liabilities maturing within three quarters, bank has sufficient amount of
assets. However, for liabilities maturing at third quarter of a year, bank's assets are

99
not sufficient indicating a negative gap. This result indicates that bank's liquidity
position for satisfying liabilities maturing above third quarter of a year seems poor.

Similarly, the mean gap ratio of EBL for all four quarters is greater than 1 indicating a
positive gap. However, it is negative for assets maturing above a year which indicates
that bank's liquidity position for satisfying liabilities maturing above a year seems
poor. But in average the liquidity position is sound.

FIGURE - 4.15
Graphical representation showing Gap Ratio between HBL and EBL

2.00

1.50
HBL
EBL
1.00

0.50

0.00
1-90 DAYS 91-180 DAYS 181-270 DAYS 271-365 DAYS OVER 365 DAYS

The above Figure - 4.15 shows that EBL has greater gap ratio than HBL for the first
four quarter with more than 1, however HBL has greater gap ratio than EBL for the
assets maturing above a year but below 1. This result implies that both of the bank's
liquidity position for satisfying liabilities maturing above a year seems poor.

4.7 MAJOR FINDINGS

 The Core capital ratio of HBL was maximum in FY 2064/65 with 9.64% and
minimum ratio of 8.68% in FY 2066/67 whereas the ratio of EBL was maximum in
FY 2068/69 with 9.61% and minimum ratio of 7.73% in FY 2065/66. The average
CCR of HBL 9.12% shows higher than EBL with 8.65% and exceeds the statutory
requirement of NRB which means that it is able to utilize its capital in better ways
than EBL. The CV of HBL is 0.05 and EBL is 0.07 which means that both the banks
are very consistent to each other.
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 Capital adequacy ratio of HBL was maximum in FY 2064/65 with 12.70% and
minimum of 10.68% in FY 2067/68. In case of EBL, the ratio was maximum in FY
2064/65 with 11.44% and minimum of 10.43% in FY 2067/68. The reason of this
decrease was due to comparatively high increase of RWA. The average of CAR of
HBL is 11.23% which is slightly higher than EBL with 10.84% and exceeds the
statutory requirement of NRB. The CV of HBL is 0.07 and EBL is 0.03 which means
that both the banks are very consistent to each other.
 Asset composition of HBL and EBL like in every banks remained largely in Loans
and Investment during the last five financial years. They occupied a large portion
in their respective balance sheet however EBL has occupied less portion than HBL.
That means HBL has high potential risk to the bank’s assets than EBL.
 The NPL ratio of HBL is in decreasing trend for the first two years of study period,
increased in third and fourth year and decreased in the last year with maximum
ratio of 4.22% in FY 2067/68 and minimum ratio of 2.09% in FY 2068/69.
Whereas, NPL of EBL is in decreasing trend for the first three years of study
period and increased in the final two years with maximum ratio of 0.84% in FY
2068/69 and minimum ratio of 0.16% in FY 2066/67. The average of NPL ratio of
HBL is 2.87% which is very higher than 0.49% of EBL, however both have
maintained their NPL ratio below 5% as per NRB requirement. This shows that the
asset quality of EBL is much better than HBL as it has average NPL less than 1%.
Since the CV of HBL 0.30 is less than 1.40 of EBL, HBL is more uniform and
consistent.
 The loan loss provision ratio of HBL is in decreasing trend for the first two year,
slightly increased in the third and fourth year and decreased in the final year. The
ratio ranges from 2.85% in FY 2065/66 to 4.25% in FY 2067/68. In case of EBL, the
loan loss provisioning ratio is in continuous decreasing trend for first four years
and slightly increases in the final year. The ratio ranges from 1.91% in FY 2067/68
to 2.64% in FY 2064/65. The average of LLP ratio of HBL is 3.44% which is higher
than 2.20% of EBL. This shows that the asset quality of EBL is much better than

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 HBL. CV of HBL is 0.17 whereas CV of EBL is 0.15. Hence, EBL is more stable and
consistent.
 The loan loss coverage ratio for HBL ranges from 100.69% in FY 2067/68 to
142.93% in FY 2064/65. In case of EBL, the ratio is in increasing trend for first
three years and decreased in last two years. The ratio ranges from 229.55% in FY
2068/69 to 1372.91% in FY 2066/67. The average ratio of HBL is 124.09% and EBL
is 613.19%. This shows that the EBL is very much cautious about future happening
regarding the loan losses and thus has been able in maintaining for future losses.
Since the CV of HBL with 0.13 is less than EBL with 0.68, HBL is more uniform and
consistent.
 The total expense to total income ratio of HBL has been fluctuating with
maximum of 46.33% in FY 2068/69 to minimum of 38.19% in FY 2065/66. In case
of EBL, the ratio ranges in between 30.03% in FY 2066/67 to 32.38% in FY
2064/65. The average ratio of HBL is 41.59% and EBL is 31.13% which shows that
EBL is very much success in managing operating activities of the bank efficiently.
Since the CV of HBL with 0.07 is less than EBL with 0.20, HBL is more stable and
consistent.
 The ratio of Earning per employee of HBL is in fluctuating trend throughout the
study period. It has maximum ratio with Rs.1.38 in FY 2067/68 and minimum with
Rs. 0.88 in FY 2066/67. In case of EBL, earning per employee is in continuous
increasing trend with maximum of Rs.1.74 in FY 2068/69 and minimum Rs.1.00 in
FY 2064/65. The average ratio of HBL is Rs. 1.16 and EBL is Rs. 1.40 which shows
that EBL is much success in making earning of the bank efficiently than HBL. Since
the HBL and EBL both have positive CV of 0.15, they are equally stable and
consistent.
 The ROE ratio of HBL with 14.79% minimum in FY 2066/67 and maximum of
24.13% in FY 2065/66. The ratio decreases for the first two years of study period,
decreases in the third year, increases in the fourth year and thereafter decreases
in the final year. On the other hand, ROE ratio of EBL is maximum with 30.15% in

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 the FY 2066/67 and minimum of 23.49% in FY 2064/65. The ratio is in increasing
trend during the period of study upto third year and thereafter decreasing upto
final year. The mean ratio of HBL is 21.46% and EBL is 27.73% which is above 15%
benchmark hence ROE ratio of both the banks seems to be sound. Since the CV of
HBL with 0.17 is slightly higher than that of EBL with 0.14, EBL is more stable and
consistent.
 The ROA ratio of HBL is minimum in FY 2066/67 with 1.19% and maximum in FY
2065/66 and FY 2067/68 with 1.91%, the ratio has been in fluctuating trend
during the period of study. In case of EBL, the ratio is maximum with 2.01% in FY
2066/67 and FY 2067/68 and minimum with 1.66% in FY 2064/65. Except in FY
2068/69, the ratio has been in increasing trend which shows the quality of assets
and their efficiency to generate return is increasing. The mean ratio of HBL is
1.71% and EBL is 1.87% which is above 1% benchmark hence ROA ratio of both
the banks seems to be sound. Since the CV of HBL with 0.16 is slightly higher than
that of EBL with 0.08, EBL seems to be more stable and consistent.
 The EPS of HBL is in decreasing trend for the first three years, increases in the
fourth and again decreases in the final year with minimum of Rs.25.44/share in FY
2066/67 and maximum of Rs.62.74/share in FY 2064/65. Whereas, in case of EBL,
EPS of the bank has been in increasing trend for first four years and thereafter
decreases in the final year. The EPS of EBL ranged between Rs. 54.27/share in FY
2064/65 and Rs.66.92/share in FY 2067/68 which shows the quality of earning
and their efficiency to generate return per share is increasing. The mean ratio of
HBL is Rs. 41.44/share and CV of the bank is 0.31 which shows less consistent
more volatile whereas the mean ratio of EBL is Rs. 62.02/share and CV is 0.19
which shows more consistent and less volatile during the study period.
 The cash and bank balance to total deposit ratio of HBL is in fluctuating trend. It is
maximum in FY 2068/69 with 13.88% and minimum with 6.18% in FY 2064/65.
Whereas, in case of EBL, except in FY 2067/68 the ratio of the bank has been in
increasing trend. The ratio of the bank has ranged between 12.57% in FY 2064/65

103
 and 21.17% in FY 2066/67 which shows that the bank is efficient to maintain the
liquidity position. The mean ratio of HBL is 10.47% and CV of the bank is 0.25
whereas the mean ratio of EBL is 17.57% and CV is 0.18 which shows EBL is more
consistent and less volatile.
 The NRB balance to total deposit ratio of HBL is in fluctuating trend. The ratio is
maximum in FY 2068/69 with 13.61% and minimum with 4.64% in FY 2064/65.
This shows that the bank has been failed to maintain the amount in NRB as per
the requirement of 5.5% in FY 2064/65. Whereas, in the case of EBL, except in FY
2067/68, the ratio of the bank has been in increasing trend. The ratio of the bank
has ranged between 11.23% in FY 2064/ 65 and 21.39% in FY 2066/67. This
implies that the bank has been able to meet the compliance of NRB requirement.
The mean ratio of HBL is 9.43% and EBL is 17.45% which shows that both of the
banks are able to meet the compliance of NRB standard requirement. However,
the above calculation is based on year end volumes of deposit and NRB balance
whereas NRB calculates CRR on weekly average balances. Hence, this is a
limitation of the study. Since the CV of EBL is 0.21 lesser than that of HBL with
0.33, so EBL is more stable and consistent.
 The Investment in government securities to total deposit ratio of HBL has been
decreasing for the first three years and thereafter increasing for final two years
with maximum of 23.46% in FY 2064/65 and minimum of 11.87% in FY 2066/67.
Whereas, in case of EBL, the ratio of the bank has been in continuous decreasing
trend. The ratio of the bank has ranged between 11.79% in FY 2066/67 and
20.11% in FY 2064/65. This indicates that the banks have switched to investing on
more profitable assets rather than investing in government securities. The mean
ratio of HBL is 16.47% and EBL is 15.37%. Since the CV of EBL is 0.19 is slightly less
than HBL with 0.27, EBL is more stable and consistent.
 The interest rate sensitivity for HBL in the fourth quarter of FY 2066/67, FY
2067/68 and FY 2068/69 has been found a sign of negative gap. It indicates that
during this time bucket, asset coming due are insufficient to cover liabilities due.

104
 However, average figure showed a positive gap indicating that asset are sufficient
enough to satisfy liabilities. For both banks, during all time buckets, the mean gap
is positive. It indicates that assets coming due in all period are sufficient to cover
liabilities due. Therefore, if the banking company had been analyzed on a
quarterly or yearly basis, no liquidity problem would be evident.
 The mean gap ratio of HBL for three quarters is greater than 1 indicating a
positive gap. For all liabilities maturing within three quarters, bank has sufficient
amount of assets. However, for liabilities maturing at third quarter of a year,
bank's assets are not sufficient indicating a negative gap. This result indicates that
bank's liquidity position for satisfying liabilities maturing above third quarter of a
year seems poor. Similarly, the mean gap ratio of EBL for all four quarters is
greater than 1 indicating a positive gap. However, it is negative for assets
maturing above a year which indicates that bank's liquidity position for satisfying
liabilities maturing above a year seems poor. But in average the liquidity position
is sound.

CHAPTER V

SUMMARY, CONCLUSION AND RECOMMENDATION

5.1 SUMMARY

Structural Adjustment Program (SPA) initiated during the period of 1980’s and
political change during the period of 1990’s has opened door to the large numbers of
commercial banks, numerous development banks, finance companies and
cooperatives. Since the provision of WTO allows more foreign banks to operate in

105
the country from 2010, banking sector are sure to face toughest competition in its
history. As the numbers of banks are increasing, given the limited size of the market,
the banks survival depend upon how well it can manage its resources and deliver the
best desired quality services to its customer. As commercial banks are now
introducing complex and innovative banking products, they are exposed to many
risk, hence naturally the bank’s activities require intensive supervision for their
success. There are many techniques to judge the financial performance and
management efficiency of the banking sector, one of the latest and widely popular
techniques has been CAMELS.

The research study is focused on CAMELS analysis of Himalayan Bank Limited (HBL)
and Everest Bank Limited (EBL) comparatively in the framework of CAMELS
Components accordance to BASEL accord. The study scrutinizes the financial
performance of the sampled commercial banks as regards to their capital adequacy,
asset composition and quality of loan assets, management of revenues and
expenses, level and trend of earnings, liquidity position, and sensitivity to market
risk. Various materials were reviewed in order to build up the conceptual foundation
and reach to the clear destination of research. During the research the areas that
formed part of the research review were; Functions of Commercial Bank, Concept of
Bank Supervision, Concept of CAMEL and component evaluation system, Basel
Capital Accord, NRB guidelines. Besides these, review of research papers, work
papers, dissertations and related reports were conducted.

The research was conducted within the framework of descriptive and analytical
research design. Himalayan Bank Limited and Everest Bank Limited were chosen as
study units. The required data and information were collected from secondary
sources. Data regarding the financial performances of these banks have been
collected from the banks’ audited annual reports from the period of FY 2064/65 to FY
2068/69 and are the primary source of information and are treated as authentic.

106
Researcher has used different financial ratios, simple mathematical and statistical
tools to get the meaningful result of the collected data and to judge the financial
performance of these banks. CAMELS analysis shows the mixed results. Some
indicator shows that one bank is better while the another indicator indicates other is
better. The statutory requirement of CCR has been 6% and CAR has been 11% for
initial one year of study period and 10% for rest of the years as per the NRB
standards. The capital adequacy ratios of both the banks undertaken for study are
generally above than NRB standard in all the years which leads to conclude that the
bank is running with adequate capital and can be considered as good. EBL has least
non performing loan in comparison with HBL. The management quality indicator
shows that EBL is better than HBL. The ratio of EPS shows that EBL has higher earning
per employees than HBL also leads in earning quality indicator ROE and ROA.

Again the indicators of the liquidity show that EBL is better than HBL. From overall
comparison between HBL and EBL, EBL seems to be performing better and more
stable & consistent than HBL. The Gap ratio of rate sensitive assets and rate sensitive
liabilities re-priced over one year maturity bucket of HBL & EBL for all four quarters is
greater than 1 indicating a positive gap. However, for liabilities maturing above a
year, banks’ assets are not sufficient indicating a negative gap. In average the
liquidity position is sound. The composite ratings of HBL & EBL under CAMELS rating
system shows “1” (see annex xviii) which indicates that both the banks are sound in
every aspects of banking activities.

5.2 CONCLUSION

Banking has become highly sophisticated. Changes are taking place in the banking
environment around us each and every day. These changes have brought about risks
and opportunities, which have direct bearing on the operation of the banks. Banks
play an important role in the economic upliftment of the country. Central bank, as
the sole monetary authority of the country, is responsible for the total financial
stability of the country. It undoubtedly needs to be capable of supervising the banks
107
and other financial institutions. Thus it will ensure their sound financial health and
help towards checking any undesirable financial crisis.

As can be seen, some banks in Nepal are going downhill, not to forget the global
banking crisis. This is due to volatility of the banking business, wherein they are
subjected to market failures arising from asymmetries of information. The
mismanagement of credit operations, imprudent investment and lack of
transparency in operation are the factors that may have lead to the declining health
of the financial institutions. As commercial banks are now introducing complex and
innovative banking products, they are exposed to many risks and therefore have
amplified as well as diversified the functions performed by the Bank Supervision
Department of NRB for efficient supervision of financial institutions.

Besides the internal management of the banks, the external environments also
equally affect the health of the bank. One of them is competition. With the opening
up of new banks and non-bank finance institutions competition in the financial
services industry is getting very intense with margins decreasing by the day.

The two commercial banks undertaken for the study has passed most of the CAMELS
standard and hence from this aspect we can say that both of them are financially and
commercially sound. From the study it shows that the bank having good
management quality has good earnings and the banks which comply with the
CAMELS and NRB standard fully will sure to have good results than other banks.

But since large numbers of financial institutions are already operating in the country
and many are ready to enroll in the market, the banks efficiency may not just be
reflected by the CAMELS indicators. As large banking institution of developed
countries following the CAMELS standard going bankrupt, we cannot just rely on
CAMELS to measure the financial soundness and health of our banking institution.

Proper socio-economic analysis, competitors analysis, changing perspective of the

people, customer oriented quality service, transparency and fulfillment of corporate

108
social responsibility might be key issues for the success of the banking institution in
coming days. As the banks of 21 st century are facing lots of challenges, their strategy
should be to develop customer loyal, dynamic and competent management team
who can foresee and address the emerging problems and challenges before their
competitors.

Based on the findings, the performance of HBL and EBL in the framework of

CAMELS Components is concluded as under:

 The both banks' Core capital ratio variated positively and met NRB standard
during the review period. The Capital adequacy ratio is above NRB norms. This
means the banks have adequately maintained its internal sources during the past
five years. The banks are running with adequate capital and the capital fund of
the banks is sound and sufficient to meet the banking operation as per NRB
standard.
 Assets composition of both banks like in every banks remained largely in the
loans and investment. The decreasing trend of non-performing loans and
advances ratio of both banks helps to conclude that the banks are aware of
nonperforming loans and adopting the appropriate policies to manage this
problem and to increase the quality of asset. The NPL ratio trend of both bank are
well in control and below international standard of 5% in general. It can
therefore, concluded that banks have placed efficient credit management and
recovery efforts. The decreasing trend of loan loss provision ratio also speaks of
good quality loans are increasing.
 The both banks are managed and operating efficiently since the total expenses to
total income ratios are in decreasing trend. This could be, but not limited to
management efficiencies. In any case, the decreasing trend will positively affect
the bank's profitability in future. The increasing trend of earning per employee of
HBL & EBL depicts management capacity to control overhead expenses. Overall it

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 can be concluded that the management decisions related to operation and
investment have assisted in controlling over the recovery of bad debt.
 The ROE ratio of HBL & EBL is in increasing trend and above the universal
benchmark of 15% during the past five years of study period. The increasing trend
of ROE shows that the return per unit of equity invested by the shareholders is
increasing year by year. The ROA ratio of these banks is also above the 1%
benchmark. The banks’ ROA is in continuous increasing trend. The earnings per
share held by the shareholders are also increasing year by year. Based on these
findings it can thus be concluded that banks are able to establish investor's and
public faith. They have good quality of assets and efficient enough to generate
increasing return in future.
 The cash & bank balance ratio of HBL is in decreasing stage for initial three years
and thereafter increases during the study period. NRB balance is also fluctuating
ups and down, however has maintained its requirement. The decreasing stage
indicates that the bank has switched into more profitable but high risk assets.
Whereas the ratio of EBL is in increasing trend and NRB balance to TD ratio is also
above the NRB standard. Thus the banks are able to maintain the minimum NRB
requirement of 5.5% to satisfy the short-term obligation that might create the
financial crunch in the bank at any time. However the calculations are based on
year end balances whereas NRB takes average weekly balances for NRB balance
calculation which is a limitation of the study.
 The interest rate sensitivity of HBL & EBL is positive during the entire time bucket.
This indicates an increase in interest rate will lead to a positive increase in banks'
net interest margin. The gap ratio for all quarters during a year shows a positive
gap. Therefore there is no liquidity problem during one year maturity bucket.
However, for liabilities maturing above a year, banks’ assets are not sufficient
indicating a negative gap. In average the liquidity position is sound.
 The composite ratings of HBL & EBL under CAMELS rating system show “1”. Banks
in this group are basically sound in every aspects of banking activities. Thus, any

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 deficiencies are minor and can be handled in a routine manner by the
management of the respective banks.

5.3 RECOMMENDATION

As per the study conducted, the following recommendations are made based on the
conclusions as regard to financial performance of HBL and EBL.

 Both of the banks have higher CAR and CCR than the standards set by NRB; hence
banks can lower these ratios and make more capital available for investment in
more profitable assets.
 Non-performing loan of HBL is in continuous decreasing for initial four years of
study period and thereafter increased in the last year. So, HBL is advised to give
more attention to decrease this level. The non-performing loan ratio of EBL is in
decreasing trend during the five years of study period which is a sign of good
performance of the bank.
 Both of the banks have higher provision coverage for loan loss than required.
Higher provision to loan loss means less capital for investment. Hence, banks are
suggested to keep provision enough as per requirement of NRB only to cover for
non performing loans and rest of the capital use for investment purpose.
 The total expenses to total income ratio of both the banks are fluctuating ups and
downs. The banks need to generate additional operating income in the coming
years and to maintain the current level. Earnings per employee of EBL is in the
range of 11 lakhs, while HBL lies below this range, hence these banks are
suggested to increase the productivity of their employees for high return.
 Generally Return on Equity of greater than 15 percent is considered good. During
the study of five years period, ROE of EBL ranges between 23% to 30% whereas
HBL ranges between 14% to 26%. So, HBL is suggested to increase the better
utilization of its Capital fund in more profitable assets and EBL is also suggested to
maintain this level. Hence both of the banks are recommended to adopt the

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 further more corrective actions in order to enhance the earnings and further
control the operating expenses which would cushion in competitive environment.
 Generally Return on Assets of greater than 1 percent is considered good. Though
both of the banks have ROA more than 1 percent during the study period, they do
not seem to be at satisfied level. So, they are suggested to increase their assets
utilization capacity or dispose of unnecessary assets.
 Financial institution's liquidity and solvency are directly affected by portfolio
quality which should be carefully analyzed on the basis of collectability and loan-
loss provisioning. As liquidity has inverse relationship with profitability, financial
institution must strike a balance between liquidity and profitability.
 Hence, banks are suggested to keep cash and bank balance ratio and NRB balance
ratio at minimum level requirement and explore excess capital in less risky areas
for the proper utilization of the idle liquid assets where returns are higher.
 Both banks' short term net financial assets are highly sensitive to interest rate
risk. Since positive CGAP is beneficial when interest rates expected to rise and
conversely negative CGAP is beneficial when interest rates are expected to fall,
the bank should minimize the mismatch of short term risk sensitive assets in
order to minimize sensitivity prevailing falling interest rates scenario.

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