Grow Through Proactive Risk Management
Background After the restoration of democracy, Nepal has adopted more liberal and open economic policies. The process of economic liberalization and reforms in the financial sector introduced in the early […]
After the restoration of democracy, Nepal has adopted more liberal and open economic policies. The process of economic liberalization and reforms in the financial sector introduced in the early 1980s has led to significant changes in the banking industry. The open and liberal policy of the government in the financial sector has helped in establishing many banks and financial institutions in the country. These banks have contributed towards the introducing new technology, new banking systems and efficient service delivery in the country. These banks have been contributing inline with the thrust of economic liberalization and financial sector reform, i.e., making the financial system more competitive, efficient and profitable. Therefore, performance review of banks is essential.
Banking industry was booming until a decade back. But, economic slowdown during that period started affecting their performance of commercial banks. This led to consolidation of banking industry resulting into merger between banks and merger of development banks and finance companies with commercial banks and development banks.
Banking sector in Nepal is highly fragmented, especially in comparison with other key economies. Competition in the banking industry is increasing with great intensity. The principle of ‘survival of the fittest’ will hold good under such a scenario. Therefore, a bank has to increase its efficiency to win the competition.
Efficiency of banks can be measured using different parameters. The concept of productivity and profitability can be applied while evaluating efficiency of banks. The term productivity refers to the relationship between the quantity of inputs employed and the quantity of outputs produced. The input in the banking industry can be referred to the costs involved in producing the products and services, e.g., interest expenses, staff costs, operating costs. As there is difficulty in measuring the quantity of output produced by banks, the amount of income can be used to measure output of banking products.
An increase in productivity means that more output can be produced from same inputs or same outputs can be produced from fewer inputs. Banking efficiency is mainly measured by following ratios:
ROA of the banks in FY 2018/019 is presented in the table below:
In terms of ROA, ADBL is the best bank with SCB and RBB standing at second and third position respectively. This ratio is mainly guided by interest rate spread followed by earnings of non-interest income and cost efficiency. Interest rate spread of these bans are 4.5% and above. Although interest rate spread of NIC (5.02%) is the highest in the industry, it ranks below average in terms of ROA mainly due to lower ratio of other income and higher operating costs.
ROE of the banks in FY 2018/019 is presented in the table below:
Computation of ROE is important on two ground. First, an increase in earnings available to shareholders leads to increase in shareholders’ value. Second, in well-functioning competitive markets, the maximization of shareholders’ value will lead to efficient allocation of capital.
In terms of ROE, RBB is the leader with NIC standing at second bank position. The reason for NIC achieving second position despite lower ROA is its high degree of leverage. Civil Bank is at the bottom.
Leverage of a bank shows how much business it is able to generate with given abound of capital. This ratio is computed by dividing total assets by total equity. The degree of leverage shows degree of risk within the bank. Banks perceive highly levered bowers as risky. Similarly, the regulators and customers of a bank also perceive highly levered banks as risky.
Leverage of the banks in FY 2018/019 is presented in the table below:
NIC bank has the highest leverage ratio. Hence this bank is the riskiest one in the market. Low levered banks (e.g., NBL, SCB, NB Bank and ADBL) have potential of increasing profitability by taking more risk.
To measure the efficiency of banks in detail, banks generally use following five parameters:
The table below shows these parameters for Nepalese banks:
In terms of this ratio, SCB is the best bank whilst NBB stands at second position. On the other hand, CCBL and Civil are at the bottom of the 18 banks. NBB has been able to secure second position mainly due to bank guarantee business in significant volume. Banks with higher ratio can be considered efficient, but also vulnerable in the sense that a reduction in other income will hit the profitability.
Interest expenses to interest income ratio shows the efficiency of banks in mobilising resources at lower costs and investing in high yielding assets. In other words, it reflects the efficiency in the use of funds. Two of the public sector banks – RBB and NBL are most efficient banks under this parameter while Citizens is the most inefficient bank.
NCC has the highest ratio which signifies worst performance in the industry. Conversely, NIBL and PCBL are at the top in terms of staff efficiency.
Civil has the highest ratio signifying worst performance. This could be probably due to recent mergers yet to achieve synergy perceived by the management. NBL and PCBL are efficient banks since they have the lowest ratio in the industry. Despite being late entrant in the industry, Sanima has excellent ratio because of which the bank has been able to achieve top performance amongst its peers.
The operating profit to total income ratio helps in assessing whether banks are doing the right things internally. In this front, RBB and SCB are the best bank. Conversely, CCBL is the worst bank.
The analysis of operational efficiency of banks will help one in understanding extent of the vulnerability of banks under the changed scenario and in deciding whom to bank upon. This may also help the inefficient banks upgrade their efficiency and be winner in the situations developing due to slowdown in the economy. The regulators should also be concerned on the fact that the banks with unfavourable ratios may bring catastrophe in the banking industry.
LD Mahat is a Chartered Accountant, Financial Adviser and Risk Management Specialist possessing over 29 years of diverse experience across several sectors covering a wide spectrum of assurance, business advisory and taxation disciplines. LD is a committed, highly motivated and result-oriented professional, consistently developing and nurturing client relationship and building long-lasting relationships with diverse clients. He has the ability to define issues, propose customized solutions that significantly add value and contribute to client’s success.
LD has got master’s in risk management form New York University, Stern Business School. He has undergone executive education at Harvard Business School and Insead Business School. He was risk management specialist in several Asian Development Bank Funded projects. He has provided risk management advisory services in various Nepalese corporate sectors.
LD has worked on large projects jointly with big 4 international accounting firms ~ PwC, Deloittee, Ernst & Young and KPMG in the field of Assurance, Diagnostic Review, Capacity Building, e-Government Procurement, e-Governance, Special Review, Investment Climate, and IFRS Implementation.
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