Do Banks Are Financially Viable? a Study Of

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Do Banks are financially Viable? A Study of

Indian Commercial Banks*

Abstract

The present study addresses the problem of financial viability in Indian commercial banks. Financial viability means the ability of the bank to survive successfully in the market. The study has analyzed the financial viability of 47 Indian commercial banks for the period of 2005-06 to 2010-11by measuring the actual and minimum sufficiency level of different financial viability indicators (IMF,2006). The study found that public sector banks are highly financially viable as comparison to the old and new private sector banks. Further study recommends the immediate steps by banking authority to cope up with financial non viability especially in private sector banking in India.

Keywords: Commercial Banks, Financial Viability, Financial Performance, Economic Crisis

I Introduction

Banks are sensitive to economic shocks and sudden changes in the economic activity make them prone to failure not only during the periods of crisis, but on later years also (Hutchison & McDill, 1999). Large number of banks failed in the world during crises of 2008, only in U.S. 252 large and small banks lost their existence with the total assets of US $ 159 billion (BIS, 2009). Insolvency of several banks in the world economy has shown its impact on the different country’s economy separately and adds to the crisis in general. It has made the banking sector vulnerable and resulted in to remarkable changes which are apparent to be uncertain in nature.

The recent crisis has shown the weakness of the global banking industry. Now the bank regulators are compelled to devise and transform the banking structure in such a way so that they can survive smoothly even in the period of financial turmoil. Financial viability in case of banks is defined as the ability of the bank to generate sufficient incomes to meet operating payments, debt commitments and also to allow growth while maintaining service levels. Evaluation of financial viability is becoming crucial condition for maintaining sufficient level of financial viability for the sustainable development, solvency and low probability of bankruptcy.

As per the report on trends and progress of the banks in India (RBI, 2012), developed countries like U.S., U. K have return on assets below 1 percent while it is above than 1 percent in emerging and developing economies during the crisis period. Indian commercial banks also have 1 percent return on equity during 2008-09 to 2010-11. Despite the financial crisis, Indian banks are financially healthy and performing soundly. Indian banking industry stayed somewhat insulated largely due to RBI’s proactive step to check reckless lending to the housing sector by stipulated of stringent credit assessment, higher provisioning for standard assets and higher margin requirement (Ganapure and Gaikwad, 2011). But still this global melt down has posed a challenge to Indian commercial banks to ensure their smooth functioning. Therefore, keeping the importance of financial viability, the present study is an attempt in evaluate the financial viability of Indian commercial banks.

The paper has been organized into six sections. Section I gives a brief introduction of the paper. Section II scans the relevant literature on the banking sector. Section III outlines the objectives and section IV elaborates the methodology adapted to analyze the issue. In section V the data analysis is carried out, results are discussed and inferences drawn. Lastly section VI concludes the paper.

II Review of Literature

Various studies are available on banking industry in India and abroad. Some of the relevant studies are reviewed as under: -

Financial viability of the banks is related to the consistent performance of the banks that ensures the long term survival of the banks. Before the financial sector reforms Indian banks were not operationally competent and commercially fragile (Sangami and Nazir, 2010). Poor recovery of loans, growing operating expenditures and low volume of business were the main hurdles for the viability of Indian banks in rural areas (Satish and Gopalkrishan, 1997 and Pati, 2002). Basu (2003) assessed the causes of bank failures in India and found that high credit risk caused banks to collapse especially when borrowers default on loans. Reserve Bank of India made several efforts to improve the survival ability of the Indian banks. Performance of public sector banks had not improved in response to deregulation measures as compared to private sector banks as revealed by the study of Kumbhakar and Sarkar (2003). A Close relationship is observed between the size, efficiency and soundness of the banks (Das and Ghosh, 2006 and Kumar and Gulati, 2008).

Casu et al (2010) examined ownership and cost-efficiency relationship of Indian banks during the financial sector reforms. The study found that deregulation and re-regulation had increased the competition and cost technology process. Barros et al (2010) analyzed the factors affecting the performance of the banks with a sample of 1384 EU commercial banks to determine the characteristics of best and worst bank. The study found that smaller banks with high loan intensity had higher probability of best performance. Lace and Koleda (2012) concluded that lack of financial viability and low potential for sustainable development is the major reason of bankruptcy for Latvian service companies. Singh and Makkar (2013) identified the major financial health indicators of Indian banking industry which significantly affected their performance. The study concluded that Indian banks are financially healthy and sound. But Confederation of Indian Industry (2013) in its survey on 15 Indian banks pointed out that banks are expected to face increased pressure on their financial health owing to stricter regulatory requirement as per Basel III.

In the light of reviewed literature, it is found that no attempt has been made to analyze the financial viability of commercial banks. There is dearth of viability studies especially in Indian context. So there exists a literature gap that needs to be fulfilled. The present study is an attempt in this direction through evaluating the financial viability of Indian commercial banks.

III Objectives

1)To measure and evaluate the financial viability indicators for the Indian commercial banks.

2)To compare the financial viability of different group of commercial banks in India.

On the basis of above objectives following hypothesis has been outlined:

H0: There is no significant difference in the financial viability indicators (debt equity ratio, return on equity, return on assets, return on business and interest coverage ratio) of different groups of commercial banks in India.

IV Research Methodology of the Study

The study is analytical in nature and based on secondary data. The data is collected from RBI publications, annual reports of different banks and from the websites of different banks. The sample of the study comprises of 47 Indian commercial banks including 26 public sector banks and 21 private sector banks. The study is carried out for the period of 6 years (2005-06 to 2010-11). The most frequently used indicators of financial viability are debt to equity ratio, profitability (return on equity, return on assets and return on sales/business) and interest coverage ratio(Table 1). Financial viability of commercial banks is measured by calculating the actual and permissibale value of above mention financial indicators of banks. (IMF, 2006) The comparison of actual value of financial viability indicators with the permissible value of financial viability indicatorsenables a bank to evaluate the risk of loss of solvency.

The permissible values of financial viability indicators provide such general level of financial viability that is minimal but sufficient for operating a bank without the risk of bankruptcy (Table 2). The degree of sufficiency of financial viability is determined through the ratios of actual value of indicators to the permissible value of indicators. The actual sufficiency level of banks financial viability indicators reveals the economic conditions of the bank. It indicates the financial position of the bank as there may be lack of development funds in the bank, its insolvency and bankruptcy but surplus viability may hinder the development, burdening a bank with excessive cash and reserves at hand.

The reserve or lack of financial viability is calculated through the difference of actual sufficiency level of the indicators and the minimum sufficiency level (i.e. equal to 100). If the actual sufficiency value of financial viability indicators is more than the minimum sufficiency values, then there is surplus of financial viability in the bank. The bank is financially strong and capable of carrying out its operations independently. If the actual sufficiency value of financial viability indicators is equal to the minimum sufficiency value then the financial viability of the bank is 100 percent sufficient. The bank has to maintain this level of its indicators to make it financial viable otherwise there may be serious problems on the existence of the bank.

If the actual sufficiency value of financial viability indicators is lower than the minimum sufficiency value then the bank is at the risk of loss of financial viability and prone to bankruptcy. Further Uni-variate ANOVA is used to compare the financial viability indicators of different bank groups of India. It will help to assess the soundest and healthiest bank group among the different bank groups of India.

V Results and Discussion

Financial viability indicators help to assess the performance of the commercial banks on each dimension. Therefore, the results and findings of the study are discussed as follow:

5.1 Financial Viability Indicators of Indian Commercial Banks

The strength and weakness of Indian commercial banks as measured through financial viability indicators is as follows:

(Insert Table 3)

Debt-Equity Ratio (DE): This ratio indicates the proportion of external funds and the internal funds used in the bank. It indicates the leverage capacity of the bank how efficiently bank is substituting the different sources of finance. Debt equity ratio is found more or less around 5 percent for state bank group and nationalized bank group while debt equity ratio of both new and old private sector banks lies between a wide range of 5 to 20 percent. There are some banks in private sector group those have used the maximum of debt along with equity as they has highest debt-equity ratio i.e. 19.22 percent by Ratnakar Bank followed by Jammu & Kashmir bank (17.92 percent) and SBI Comm.and Int. bank (17.91 percent). Therefore these banks are required to reduce their D-E ratio to reduce the risk involved in their capital structure as high dependency on debt enhance the riskiness of banks.

Return on Equity (ROE): ROE indicates the efficiency of the bank in utilizing the shareholders fund. This ratio reveals the earning capacity of the bank in terms of shareholders fund. Table 3 reveals that Syndicate bank (34.83 percent) has the highest ROE followed by Punjab and Sind Bank (24.33 percent) and Dena Bank (23.67 percent). State Bank of India (14.42 percent) stood at 28th position as compare to 47 Indian commercial banks in terms of ROE. Development credit bank is not utilizing the shareholders fund efficiently as it has negative returns on equity (-11.34 percent).

Return on Assets (ROA): It measures the profitability of bank which a bank earns through efficiently utilizing its assets. Higher the ratio good it is for the sound financial health of the bank. Laxmi Vilas bank (15.15 percent) has earned highest return on their assets followed by Karur Vyas bank (14.72 percent). SBI and Development Credit Bank have earned same returns on their assets i.e. 6.19 percent. ICICI bank (0.11 percent) not efficiently utilized its assets as it has lowest ROA followed by HDFC bank (0.82 percent).

Return on Business (ROB): ROB reveals the efficiency of the bank in earning profits through its business. Here business of the bank means sum of its advances and deposits. Table 3 shows that Laxmi Vilas bank (10.28 percent) has gained highest return over its business followed by Karur Vyas bank (9.82 percent) and SBI international bank (6.04 percent). State bank of India and State Bank of Mysore are enjoying same amount of return (i.e. 4.61 percent). While banks namely ICICI bank (0.10 percent), HDFC bank (0.63 percent) and ING Vysya bank (0.88 percent) has suffering from lowest return.

Interest Coverage Ratio (INT): Interest coverage ratio indicates the ability of the bank to pay its interest charges. It reveals the capacity of the bank to pay interest charges as well as its total amount of the loans. SBI international and commercial bank (3.13 percent) has highest interest coverage ratio followed by Karur Vyas bank (2.93 percent). SBI bank has 1.45 percent debt service coverage ratio. ICICI bank has lowest capacity to pay interest charges as it has minimum ratio (0.024 percent) among the 47 Indian commercial banks followed by South Indian bank (0.045 percent) and HDFC bank (0.223 percent).

5.2 Financial Viability of Different Groups of Commercial Banks in India

Financial viability indicators as shown in table 3 indicate the performance of the bank on individual parameter over the study period. In this section the financial viability of different groups of commercial banks in India is evaluated on the basis their actual sufficiency level and minimum sufficiency level (Refers to Methodology section). Actual sufficiency level of different financial viability indicators of bank is compared with their minimum sufficiency level (i.e. equal to 100) and then reserve or lack of financial viability is measured. The results are discussed as follow:

Financial Viability of State Bank Group

Table 4 depict that state bank of group has reserve of financial viability in its all financial viability indicators except the return on business. This indicates that the state bank group is efficiently utilizing its shareholders funds and assets as indicated by the positive balance of ROE and ROA. Interest coverage capability of the state bank group (39.35) is also positive which indicates the ability of this group in payment of its interest obligations in time.

Financial Viability of Nationalized Bank Group

More or less the financial viability indicators of nationalized banks group are also behaving like the indicators of state bank group as shown in table 5. The table reveals that nationalized bank group found financial viable in its all indicator except the return on business.

Further the table shows that debt equity ratio of nationalized bank group (150.94) is highest as compared to the other bank groups. This group also has excess reserve of return on equity (315.91) and also has higher returns on assets (10.63) as compared to the state bank group.

Financial Viability of New and Old Private Sector Bank Group

The table 6 exhibits the financial viability of new private sector banks. Table reveals that this group banks are neither financially sound nor viable as most of the indicators of financial viability are have negative value. The actual sufficiency value is found more than to minimum sufficiency value for these banks only in two indicators i.e., ROE & ROA.

Old private sector bank group is also lacking on the parameters of financial viability as shown in table 7. The table shows this most of the indicators of financial viability of this group banks has negative return value. The findings clearly indicate the need of immediate steps by the banking authority to cope up with this non viable situation of new and old private sector banks.

5.3 Comparison of Financial Viability Indicators of Different Bank Groups

To compare the financial viability indicators of different bank groups Uni-variate ANOVA (analysis of variance) is used and results are shown in table 8. Table reveals that there is a significant difference in the debt equity ratio (0.001) of four groups of commercial banks in India. On comparing the debt equity ratio, it is found that standard deviation is highest in old private sector bank group (4.968) followed by new private sector bank group (2.001). Due to high deviation of debt equity ratio from its mean value both the bank group has negative balance in this financial viability indicator. Table 8 indicates that there is a significant difference in the return on equity (0.010), return on assets (0.037) and return on business (0.078). Nationalized bank group is effectively utilizing the shareholders funds as it has highest return on equity ratio (16.758) followed by state bank group (15.106).

The low standard deviationof state bank group (3.021) among the entire bank groups indicates the consistency in its return on equity funds. State bank group is effectively utilizing their assets as this group has highest ROA (0.066) followed by nationalized bank group (0.063) andold private bank group (0.063). Return on business is maximum in old private sector bank group (0.052) followed by state bank group (0.046). New private bank group is required to improve the profitability as it has lowest returns on equity, return on assets and return on businessas compared to the other bank groups. The study found a significant difference in the interest coverage ratio (0.032) of different bank groups of India. Old private sector bank group has highest debt service capability (1.655) followed by state bank group (1.393).