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Are Indian Banks Heading Towards ‘Financial Embarrassment’?

Are Indian Banks Heading Towards ‘Financial Embarrassment’?
– Kiran Kumar K V

Box 1:The Economic Times 27-June-2015

The manner in which US Federal & other central banks of advanced countries are shaping their monetary policies in order to avoid another economic downturn, is going to precisely result in that – claimed Mr. Raghuram Rajan, RBI Governor at LBS last week[1](Refer Box-1). The practice of zero-lower-bound interest rates of Fed and ECB in order to fuel industrial growth is unconventional and exposing other markets as well to the macro-economic risks. While saying this, Mr. Rajan

also ensures to sound confident on the prospects of India and Indian Banks despite the external influences like these.

While the Central Bank and the Government will dwell upon to ensure the external risks of the above-kind, the banks per se, operating in India need to ensure that they are operationally covered to sustain themselves. Ceteris paribus, especially the external risks, how do the Indian banks cope with distress?
Objective of this Analysis: This analysis aims to test the possibility of Commercial Banks in India going bankrupt in the next 2-3 years, purely based on their operational efficacy.

Box 2: Altman Z-Score Formula

Methodology: Various ready-made methods of bankruptcy prediction are available, that take the form of survival approach, option-valuation, neural-network models and other sophisticated approaches. These methods focus on risks emanating from externalities as well as internal affairs of a firm. As the aim of this study is to predict possibility of financial distress caused by operational dimensions of the firm, Altman’s Z-Score Model is applied. Edward I. Altmanpublished his Z-Score formula in 1968[2], which uses multiple financial ratios of the firm to predict the bankruptcy chances in the next two years. Altman had- applied multiple discriminant analysis to a set of public manufacturing firms and arrived at coefficients for different ratios, those when summed,  give a score, based on which one can derive conclusions on the state of distress. Over a period of time, the formula has been modified to suit different set of firms, viz., public-owned companies, privately-owned firms, non-manufacturing firms, firms from emerging markets etc. This analysis uses the Z-Score formula proposed to be suitable for non-manufacturing firms in emerging markets, which is presented in Box-2.
Analysis & Results: Constituents of BSE Bankex Index were taken as sample (12 banks), data pertaining to their financials were collected from their respective annual reports for the year ended 31-March-2015 and requisite ratios and Z-Score are computed. The data and their computations are presented in the below table (Box-3)
(Figures In)
Total Assets
Working Capital
Retained Earnings
Earnings
Equity
Total Liabilities

TA
NWC
RE
EBIT
EQ
TL
Bank Of India
In Lakhs
62528474

502170
3185720
754949
3252285
4009869
Axis Bank
In Crores
467243
60163
44475
7358
44950
84394
Bank Of Baroda
In Crores
676114
11076
37416
4931

37847
36976
Canara Bank
In Crores
553152
-26040
26611
2703
27086

25763
Federal Bank
In Crores
82908
-2474
7529
1012
7700
2393
HDFC Bank

In Crores
607097
37433
62653
10216
63154
59478
ICICI Bank
In Crores
826079

109891
83537
11175
84697
211252
Indusind Bank
In Lakhs
10911592
1767533

1010103
309822
1063048
2061806
Kotak Mahindra Bank
In Crores
148561
42639
21752
3065

22138
31415
Punjab National Bank
In Crores
636011
19757
42217
3341
42588

59205
State Bank Of India
In Crores
2700110
51323
160641
17517
161388
244663
Yes Bank

In Crores
136170
14279
11262
1997
11680
26220
                                                                      Box 3: Financial Data of BSE Bankex Constituents
Altman’s Z-Scores computed for the respective banks, along with the zone they fall,
are presented in the below chart (Box-4)
Box 4: Altman Z-Score for BSE Bankex Constituents
Kotak Mahindra Bank and Federal Bank were found to be in safe zone. Canara Bank and State Bank of India are in distress zone. All other banks are in the grey zone. Going by Altman’s model we may predict distress zone banks to go into bankruptcy in the near future; grey zone banks need to exercise caution and relook into their operational strategies; whereas banks in safe zone need to maintain status quo.
In the context of a probable economic downturn, as discussed above and when considered as a whole, it can be observed that most of the banks in India fall under grey zone, which is not so immune state to be in, (even though it’s not a distress state).
Conclusion:The above results need to be viewed with caution, as Altman model is developed primarily on manufacturing firms and applicability of the same on non-manufacturing firms, especially banking and financial firms are yet to be proven by researchers[3]. Lack of literature on the same is a big limitation for this analysis. As an academic attempt, this study can remain as a record and unfolding of the future can lead to further research in the area and development of a model meant for banking companies.
There is no evidence to suggest computation of a Z-Score is a better means of analysing long-term solvency. Rather, it can be asserted that use of these ratios as predictors of distress is best in complementing a rigorous analysis of financial statements. Evidence from literature does suggest the Z-Score is a useful screening, monitoring and attention-directing device.[4]
Going by the results, it can be concluded that banks of India, have as an undercurrent, a not-so-satisfactory operational efficacy, and unless these are fixed for better, financial embarrassment – in the event of Mr. Rajan’s prediction coming true – is something that could be a reality.


[1] (Economic Times Mumbai Bureau, 2015)
[2] (Altman E. I., 1968)
[3] (Altman Z-Score, 2015)
[4] (Wild, Subramanyam, & Halsey, 2007)
Altman Z-Score. (2015). Retrieved from Wikipedia – The Free Encyclopedia: https://en.wikipedia.org/wiki/Altman_Z-score
Altman, E. (2000). Predicting Financial Distress of Companies: Revisiting the Z-Score and ZETA Models.
Altman, E. I. (1968). Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy. Journal of Finance.
Economic Times Mumbai Bure
au. (2015, June 27). Rajan Rings the Alarm Bell: Chances of Global Depression. The Economic Times, p. 1. Retrieved from http://epaperbeta.timesofindia.com/Article.aspx?eid=31815&articlexml=Rajan-Rings-the-Alarm-Bell-Chances-of-Global-27062015001030
Wild, J. J., Subramanyam, K. R., & Halsey, R. F. (2007). Credit Analysis. In J. J. Wild, K. R. Subramanyam, & R. F. Halsey, Financial Statement Analysis (pp. 540-541). Tata Mc-Graw Hill.
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