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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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Are Indian Banks Heading Towards ‘Financial Embarrassment’?