Performance Analysis of South East Bank Limited

IntroductionLoans comprise the most important asset as well as the primary source of earning for the banking financial institutions On the other hand, this (loan) is also the major source of risk for the bank management. A prudent bank management should always try to make an appropriate balance between its return and risk involved with the loan portfolio. An unregulated banking financial institution might be fraught with unmanageable risks for the purpose of maximizing its potential return. In such a situation, the banking financial institutions might find itself in serious financial distress instead of improving its financial health. Consequently, not only the depositors but also the general shareholders will be deprived of their money from the bank. The deterioration of loan quality will also affect the intermediation efficiency of the financial institutions and thus the economic growth process of the country. This establishes the fact that banks should provide increasing emphasis on various analytical tools and techniques for screening proposals and loan decision taking. Credit Worthiness Analysis is one of the most important activities before sanctioning any credit to a new borrower as well as existing borrower to avoid any default risk and for improving the operational efficiency of nationalized and private sector commercial banks.Rationale of the StudyIn an economy banks play the crucial role of an intermediary that channel funds from the surplus units to the deficit economic units. Banks can lend up to 81% of its total deposit. The rest 19% is kept as Statutory Liquidity Reserve (SLR) out of which 6% is kept for Cash Reserve Requirement (CRR).Obviously the fundamental and most important task of any commercial bank is to sanction credit to the borrowers as per requirement of safeguarding the interests of its depositors.South East Bank Limited (SEBL) is one of the most reputed Non-government Commercial Banks in Bangladesh. It falls in satisfactory or B class bank according to CAMELS rating in Bangladesh. This rating has been done in consideration with good fundamentals, such as- good profitability, best asset quality, diversified product line, experienced top management etc. financial institutions rated in this category are judged to offer adequate safety for timely payment of financial obligations.In this study the main focal points were the credit appraisal & credit management procedure, monitoring of credit and to identify different quantitative and qualitative aspects of the Credit Risk Grading System of South East Bank Limited. Though the bank falls in satisfactory or B class banks according to CAMELS rating but it does not necessarily mean that credit management is not prudent in this bank. A sudden shift in non performing loan in the year 2010 may have contributed to this problem. However treasury was told to take proper action to improve this situation.Origin of the StudyInternship Program is a prerequisite for acquiring BBA degree. For the completion of the degree a student must undergo internship program. Internship Program is a perfect blend of the theoretical and practical knowledge. It gives the opportunity to handle the real business situation and to work in the organizational framework. This report is prepared on the basis of the authors experience of Internship Program in South East Bank Limited (SEBL), Mohammadpur Brach.The report on Performance Analysis of SEBL with an emphasis on credit has been prepared under the supervision and guidance of Ms. Nadira Sultana, Department of Banking, Faculty of Business Studies, University of Dhaka.Objectives of the StudyMain Objective The main objective of the study is to find out the trend in SEBLs performance over the last 5 years.Specific Objectives The usual practices of the Bank for sanction of a credit, management of credit and to monitor them have been identified. A comparative analysis has been done to find out the competitive position of the Bank with consideration of its peer group. To find out the associations of the Numeric grade assigned to a borrower with the different Risk Scores for identifying which Risks factors dominate over other risk factors influencing the Numeric Grade of the CRG. The factors that have greater influence on the aggregate score of CRG and the nature & extent of the relationship of the persuasive factors on the aggregate score have also been identifiedSources of Data & Methodology of the StudySources of Data: Sources of Primary DataPrimary data has been collected from SEBLs Mohammadpur branch officials under whom I completed my internship program. Primary data sources used are very few as it is very hard to find primary data.Sources of Secondary Data Different statements and documents of the South East Bank Limited, Mohammadpur branch. Annual Reports of mutual trust bank Annual Reports of pubali bank limited Different Newspapers and Journals published in the Internet.Analysis of Data :Different graph and charts has been used to analyze the data. And some ratios and different statistical measure has also been used where necessary.LimitationsIn spite of the highest level of effort to prepare a well organized and comprehensive report some limitations were yet present there- A period of only 6 weeks was not enough to collect and understand the insights of Credit Operations and Credit Management. Banks policy did not permit to disclose various data and information related to credit operation in the bank. Data for conducting analyses on the Credit Risk Grading system of South East Bank Limited has been collected from only Mohammadpur Branch. Concentration & portfolio of credit varies from branch to branch, as a result the conclusion drawn about the CRG of the Bank as a whole based on these analyses may differ from the real scenario. Recent data was not published about many of the important indicator of credit management.Literature Review:The performance of the banking sector is a subject that has received a lot of attention in recent years. However there are a very few studies that have been done on the performance analysis of banks of developing nations like Bangladesh. Sufian, Fadzlan, Habibullah, Muzafar Shah (September-1- 2009) measured the performance of commercial banks in Bangladesh from year 1997-2004 by analyzing return on average assets (ROAA), return on average equity (ROAE), and/or net interest margins (NIM) which is usually expressed as a function of internal and external determinants. Rivard and Thomas (1997) suggest that bank profitability is best measured by ROAA in that ROAA is not distorted by high equity multipliers and ROAA represents a better measure of the ability of the firm to generate returns on its portfolio of assets. Since returns on assets tend to be lower for financial intermediaries, most banks utilize financial leverage heavily to increase return on equity to a competitive level (Hassan and Bashir 2003). Credit performance analysis is one of the main indicator the banks overall performance measurement. Edward I. Altman, Brooks Brady, Andrea Resti and Andrea Sironi (March 2003) showed empirical evidence of a banks performance with credit rating, capital requirements, credit risk, recovery rate, default, procyclicality etc. M. Raquibuz Zaman Ithaca College and Hormoz Movassaghi Ithaca College (2011) performed a detailed study of performance analysis of different islamic banks in world. A detailed study regarding the performance of Islamic banks and its difference with conventional banking was done by Dr. Waheed Akhter , Ali Raza , Orangzab, Muhammad Akram by using analysis tools like Ratios, Trend Analysis etc. However this study was done for the banks in Pakistan only. The research paper that helped me most in completing this paper is the Comparative Analysis of Korean Banks Performance by Hong S. Pak & Sung-Kyoo Huh which compared the performance of Korean Banks with American Banks and also with the average performance of other Asian banks based on different performance measurement tool like Ratio of core capital to total assets, Interest spreads, Ratio of noninterest income to average assets, Ratio of overhead expenses to average assets, Domestic loan growth ratio, Ratio of domestic loans to deposits, Ratio of net charge-offs to average loans, Ratio of nonperforming loans to gross loans etc. Some performance measurement technique used for banks are described in the research paper which was written by August Aarma, Jaan Vainu (2002).Performance Analysis Techniques For A bank:In this chapter some performance analysis techniques has been described which are helpful in evaluating the banks performance. These techniques have been used in the analysis part to evaluate the performance especially credit performance of SEBL. Most of the techniques used here were learnt through the completion of my B.B.A program. The purpose of this chapter is to give a clearer idea about why those techniques are useful in evaluating a banks performance.Trend analysis:Trend analysis is the most commonly used technique in evaluating performance over a specific period of time for any type of business organization. The most attractive part of trend analysis is that it is very easy to understand and it gives an actual picture of a banks performance which has changed over a period of time. Another attractive feature of trend analysis is that you can evaluate a banks performance based on virtually any variable because there is no preset formula for analyzing the trend and trend analysis can also be presented in graph which will present the data more attractively. To evaluate a banks performance trend in different sectors may be used, like Trend in loan Trend in sector wise loan disbursement Trend in loan for NPL Trend in loss loan, etc.Different types of statutory requirement compliance:Banks being a large financial institution are subject to different statutory requirement as required by the superior authority. By analyzing if the bank had compliance with the statutory requirement the performance of the bank can be measured because most of these requirement are designed to improve the banks overall performance and to reduce the banks performance. Some of the statutory requirement that the banks in Bangladesh are required to maintained are as follows:CRR: Cash reserve requirement are set by the central bank to maintain liquidity. Scheduled bank are required to keep a certain percentage of their total deposit in cash with the account in Bangladesh Bank to maintain a strong position in liquidity. So by analyzing how bank has maintained their CRR we can have an idea about how the banks liquidity position. However this is not a perfect measurement of the banks liquidity. At present the CRR rate is 6%.SLR: Statutory Liquidity Requirement is total statutory reserve that a bank has to maintain with Bangladesh Bank. Some portion of the SLR is to be kept in cash (CRR) and some portion of the SLR is kept by buying govt. securities and bonds. SLR gives us a clearer picture of a banks liquidity position because it indicates the maximum amount that bank can use out of its deposit. at present SLR is 19%.CAR: Capital Adequacy Ratio is a ratio that regulators in the banking system use to watch banks health, specifically banks capital to its risk. CAR ratio is set by Bangladesh Bank CAR ratio calculates how much capital a bank have relative to banks risk weighted assets. So it will tell us about how prudently the banks fund are managed,These are the main types statutory requirement. These data are published in a timely manner in the balance sheet.Repricing Gap Analysis:In repricing gap analysis measures the difference between assets whose interest rate will be changed or repriced over some future period and liabilities whose interest rate will be repriced or changed over some future period. A negative gap explains that the bank is exposed to refinancing risk and a positive gap indicates that the bank is exposed to reinvestment risk.repricing gap are calculated as follows Repricing gap = rate sensitive assets rate sensitive liabilities.Ret sensitive assets are those assets which could be repriced or changed over a one year horizon and which are not fixed in nature.Rate sensitive liabilities are those liabilities which can be repriced or changed over the next one year horizon and which are not fixed in nature.If, the repricing gap are positive then it is assumed that a decrease in interest rate will reduce the value of the holding of the bank. So if the manager thinks that interest rate will decrease while repricing gap is positive he should increase the rate sensitive liabilities or decrease the risk sensitive assets so that the repricing gap be positive or vice versa.. Similarly if the manager thinks that the interest rate will increase in the future he will either increase the risk sensitive assets or reduce the rate sensitive liabilities. Repricing graph can also be analyzed as a percentage of total loans. It will tell us what percent of the total asset are exposed to repricing gap.GAP ratio =Du Pont Analyses:Du Pont analysis is one of the most effective predictor of a banks performance. Du Pont analysis starts with rate of return on equity, ROE.ROE =This consists of three components Pull-through, UAU = Financial leverage, LEVLEV =Return on total assets, ROAROA = All these financial ratios are widely used for a bank performance analysis. Pull-through (U) shows success of the bank tax management policy as it may be interpreted as one minus the average corporate tax rate. The financial leverage ratio (LEV) measures how many Estonian crowns (EEK) of assets the bank has per EEK of equity and may be interpreted as a banks gearing. Return on total assets (ROA) is one of the most frequently used financial ratios by financial analysts. ROA measures the ability of bank management to generate income after all financial and non- financial costs and expenses for owners.Changes in ROA are usually the cause of the most important changes in banks performance and need a more detailed analysis. The other financial ratios such as components of ROE, pull through (U) and financial leverage (LEV), reflect tax treatment and capitalization rate, and they usually change less. ROA may be divided into the following components:Bank burden = Earning assets ratio, EAREarning assets ratio, EAR =Net interest margin, NIMNIM = Burden (B) measures a bank managements control of operating expenses. The burden for banks is negative to show the fact that non- interest revenue (fees, earned commissions, other operating income) does not cover labor and other administrative or non- interest expenses. Earning assets ratio (EAR) is usually not an important factor of changes in ROA but it may be interesting to make comparisons between various banks because EAR characterizes different development strategies. Net interest margin (NIM) is a more important and widely used financial ratio in the factor ROA. NIM reflects the interest spread between assets and liabilities. For a more detailed analysis, NIM may be divided into three following components like Return on earning assets Cost of liabilities and Liabilities to earning assets ratio.Average Spread Between Lending and Deposit Rate:Since lending is one of the main source of income for banks and deposit is one of the main source of fund for banks so the average spread may give a comprehensive picture of a banks performance. Moreover a banks average spread between the lending and deposit rate may be compared over the spread may be compared with the spread maintained by other competitor bank to complete a comparative analysis among them. Spread maintained by the banks in different years is also useful in determining the operating profitability of the bank in different years.Ratio analysis:Ratios very smartly represent the data that can be used to reach to a judgment about the performance of a bank. Ratios are widely used by different analyst to reach to a judgments about a banks performance. Some of the important ratios that can be used to evaluate the banks performance are Snap Liquidity ratio: The snap liquidity ratio indicates a banks ability to meet up to its external liabilities from its liquid assets. It shows the banks ability to pay for liabilities over a short term period. Short term Borrowing / liquid assets: The ratio indicates Banks dependency on short term borrowing in comparison to its liquid assets. A short term borrowing to liquid asset ratio which is more than 1 indicates that the bank had more short term borrowing than its assets which could be liquidated to pay of its debt Volatility Liability/total assets: Banks volatility liability to total assets indicates banks volatile or rate sensitive liability against its total assets. There is no standard of this ratio rather it depends on the risk management policy of the bank. Interest earning assets/ total assets: : This ratio indicates banks holding of interest earning assets into total assets. It indicates a banks position in revenue generating assets. Net Interest Margin: This ratio indicates banks total interest income relative to banks total interest earning assets. This ratio is one of the main indicators of a banks operating performance as interest is one of the main source of income for banks. Investment risk: The ratio indicates Banks investment in Government approved securities and other shares and bonds in respect to its capital. It expresses about how much investment a bank has against banks total capital which in turn indicates a banks exposure to investment riskStatistical analysis:Different types of statistical tools cam also be used to evaluate a banks performance. However correlation and regression analysis are one of the most commonly used statistical tool because of their ability to present the result in a usefull maneer.Correlation: Correlation shows the degree of relationship within two variables. The correlation model can be used to statically prove the relationship between various factors like loan to operating profit, total loan to total nonperforming loan etc. And by analyzing the statistical software like SPSS we can determine if the correlation is really significant between the variables.Regression analysis: Regression analysis shows the relation of a dependent variable with two or more independent variables. This analysis can be used in evaluating a banks performance like how total income is affected by other types of income or how total provision for losses is affected by total amount of nonperforming loan etc. By using SPSS some more data can be inferred which may be useful in determining the banks actual performance.Risk Index:Risk index was originally developed by Hannan and Hanweck and later it was renewed by various economists. Risk index are used to analyze the big picture effect of credit risk on overall banks risk. Risk Index gauges the thickness of a book value cushion a bank has available to absorb accounting losses. Risk index is used using following formula RI = [ E(ROA) + CAP ] / SROAThe resulting risk index is a measure, expressed in units of standard deviations of ROA about how much a banks accounting earning can decline until it has a negative book value. The higher the value of ri is the less likely is the chance that the bank will become financially unstable.Risk index can also be expressed as a percentage probability of book value insolvency. In many instances it significantly differs from market value insolvency. This model was also develpoped by Hannan and Hanweck. The probability of book value insolvency is computed by the following formula P ( B.V