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The Financial Soundness of Selected Banks in South Africa

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The Financial Soundness of Selected Banks in South Africa THE FINANCIAL SOUNDNESS OF SELECTED BANKS IN SOUTH AFRICA: A CAMELS RATING SYSTEM APPROACH Rushil Manga 211079359 Treatise submitted in partial fulfilment of the requirements for the degree of Master of Commerce in Economics (Course Work and Research) in The Faculty of Business and Economic Sciences at Nelson Mandela University Port Elizabeth April 2019 Supervisor: Dr H. Khobai DEPARTMENT OF ACADEMIC ADMINISTRATION EXAMINATION SECTION SUMMERSTRAND NORTH CAMPUS PO Box 77000 Nelson Mandela University Port Elizabeth 6013 Enquiries: Postgraduate Examination Officer DECLARATION BY CANDIDATE FULL NAME: RUSHIL MOHAN MANGA STUDENT NUMBER: 211079359 QUALIFICATION: Master of Commerce in Economics (Course Work and Research) TITLE OF THESIS: THE FINANCIAL SOUNDNESS OF SELECTED BANKS IN SOUTH AFRICA: A CAMELS RATING SYSTEM APPROACH DECLARATION In accordance with Rule G4.6.3, I declare that this treatise titled ‘The financial soundness of selected banks in South Africa: A CAMELS rating system approach’ is my own work, that all the sources used or quoted have been identified and acknowledged by means of appropriate referencing, and that I have not previously su0bmitted this dissertation for assessment to another university or for any other qualification. Signature: Date: 30 November 2018 0ABSTRACT Bank failure continues to feature in South Africa and although it is not uncommon, nor limited to any single country, it has the potential to have significant systemic risks. It is, therefore of the utmost importance to mitigate bank failure where possible. Bank supervision plays a key role in ensuring that individual banks, and the banking sector, remain sound. This study analysed seven selected banks in South Africa namely, ABSA, African Bank, Capitec Bank, FirstRand Bank, Nedbank, Standard Bank and VBS Mutual Bank. The CAMELS rating system was applied to evaluate the component and composite ratings for each selected bank. The empirical evidence exhibited that the CAMELS model has been used world-wide and proved valuable in its simplicity and reliability. The results showed that all banks achieved a rating of three or fair, with the exception being African Bank. African Bank, rated four or marginal, continues to struggle to regain market confidence since its cu0ratorship and restructuring. The study further showed that among the selected banks, management quality and liquidity were two components that consistently showed critical weaknesses, which posed concerns for formal supervision. The study utilised One-way ANOVA (Analysis of Variance) to analyse the results of the CAMELS model. It was found that there was no significant difference in the financial soundness of the selected banks as a measure of the CAMELS model. The study further recommended that the banks invest and focus on developing human resource departments to attain and retain high quality managers in terms of qualifications and experience. The banks’ internal policies need to align, not only with the company’s business targets, but also the personal contentment and fulfilment of employees and managers. This will help reduce frictional unemployment in the banking sector. It must be noted that Capitec was the only bank to avoid a marginal or weak rating in the management quality component. To address the poor rating awarded to the liquidity component in all selected banks, it is recommended that senior management, regulators and supervisors need to work together to implement sound liquidity management practices. ii The CAMELS model presents a clear depiction of the financial soundness of a bank and can be comparable to other competitive banks within a country. For this reason, the model would be easily understandable, not only to supervisors and senior management, but also investors, stake-holders, their customers and the general population. It is therefore recommended that the SARB publishes a detailed annual report, which analyses all banks in South Africa by way of the CAMELS model. KEYWORDS CAMELS model, CAMELS ratings system, banks, South Africa, ANOVA, Basel, supervision, financial soundness, risk, ratings iii DEDICATION This treatise is dedicated to my loving parents, Giles and Manjoo Manga, for giving me the opportunity to further my studies. None of this would have been possible without your love and support. iv ACKNOWLEDGEMENTS I would like to express my sincere gratitude to the following individuals who contributed and supported me: • My supervisor, Dr H. Khobai, for his support, guidance and understanding throughout my research paper. Your input has made my treatise a success and enjoyable, for which I am grateful. • My parents, Giles and Manjoo Manga, for their love and support throughout my academic career and giving me the opportunity to grow, develop and follow my dreams. • My brother, Ashvin Manga, for supporting and motivating me. • My girlfriend, Davanitha Moodley, whose love, patience and words of encouragement kept me focused and motivated throughout my candidature. I further extend my gratitude to you for assisting me with the layout and presentation of my work. • Dr B. Ismail, for his guidance and support during the initial phase of my research. • Mr F. Geel and Mr R.G. Doraswami, for their diligence and time in the editing of my work. • My friends and colleagues, Merioboroghene Mowoe and Joseph Mhango, for their friendship and support throughout my studies. I would also like to express my gratitude to the Nelson Mandela University Research Capacity Development for awarding me the Postgraduate Research Scholarship to fund my studies. v TABLE OF CONTENTS Page DECLARATION i ABSTRACT ii DEDICATION iv ACKNOWLEDGEMENTS v TABLE OF CONTENTS vi LIST OF TABLES ix LIST OF FIGURES xi LIST OF ABBREVIATIONS xii CHAPTER ONE INTRODUCTION 1.1 Background to the study 1 1.2 Problem statement 2 1.3 Objectives of the study 4 1.4 Purpose of the study 4 1.5 Research hypotheses 5 1.6 Research methodology 6 1.7 Significance of the Study 7 1.8 Organisation of the study 7 1.9 Summary 8 CHAPTER TWO OVERVIEW OF BANK SUPERVISION AND THE SELECTED BANKS OF THE STUDY 2.1 Introduction 9 2.2 Bank supervision 9 2.2.1 On-site bank inspection 10 2.2.2 Off-site bank inspection 12 2.3 Basel Accords- Basel Committee on Banking Supervision (BCBS) 13 2.3.1 Basel I 13 2.3.2 Basel II 14 2.3.3 Basel III 14 vi 2.3.4 Basel IV 15 2.4 Strategic overview of the selected banks 17 2.4.1 Absa Bank Limited (ABSA) 17 2.4.2 African Bank Limited 17 2.4.3 Capitec Bank Limited 19 2.4.4 FirstRand Bank Limited 20 2.4.5 Nedbank Limited 20 2.4.6 Standard Bank 21 2.4.7 VBS Mutual Bank 21 2.4.8 Summary of total assets and other indicators 22 2.5 Summary 22 CHAPTER THREE LITERATURE REVIEW 3.1 Introduction 24 3.2 Fundamentals of the CAMELS rating system 24 3.2.1 The CAMELS rating system 24 3.2.2 Capital adequacy 27 3.2.3 Asset quality 29 3.2.4 Management quality 31 3.2.5 Earning ability 32 3.2.6 Liquidity 34 3.2.7 Sensitivity to market risk 35 3.2.8 Summary of the CAMELS component ratings system approach 36 3.3 Stress Testing 37 3.4 The significance of the CAMELS rating system approach 38 3.5 Empirical evidence of previous studies 39 3.6 Summary 43 CHAPTER FOUR RESEARCH METHODOLOGY 4.1 Introduction 44 4.2 Research design 44 4.3 Research method 45 4.4 Data collection 47 4.5 Data analysis 47 vii 4.5.1 The CAMELS model 47 4.5.2 One-way ANOVA 48 4.5.3 Hypotheses of the study 49 4.6 Summary 51 CHAPTER FIVE EMPIRICAL FINDINGS 5.1 Introduction 52 5.2 The CAMELS rating system model 52 5.3 Analysis of Variance, ANOVA 64 5.3.1 Capital adequacy ratio 64 5.3.2 Asset quality ratio 65 5.3.3 Cost to income ratio 66 5.3.4 Return on assets ratio 67 5.3.5 Return on equity ratio 67 5.3.6 Total loans to total deposits ratio 68 5.3.7 Total securities to total assets ratio 69 5.3.8 Financial soundness of selected banks 69 5.4 Summary of hypotheses testing 71 5.4.1 Null hypotheses decisions 71 5.4.2 Alternative hypotheses decision 72 5.5 Summary 73 CHAPTER SIX CONCLUSION AND RECOMMENDATIONS 6.1 Introduction 76 6.2 Conclusion 76 6.3 Recommendations 79 6.4 Limitations of the research 81 6.5 Scope for further research 81 REFERENCES 83 viii LIST OF TABLES Table 1.1 List of failed banks 3 Table 2.1 Generic features of on-site bank inspections 11 Table 2.2 Generic features of off-site bank inspections 13 Table 2.3 Total assets and other indicators for Absa Bank 17 Table 2.4 Total assets and other indicators African Bank 18 Table 2.5 Total assets and other indicators Capitec Bank 19 Table 2.6 Total assets and other indicators FirstRand 20 Table 2.7 Total assets and other indicators Nedbank 21 Table 2.8 Total assets and other indicators Standard Bank 21 Table 2.9 Total assets and other indicators VBS Bank 22 Table 2.10 Summary of total assets and other indicators for all selected banks 22 Table 3.1 The CAMELS composite rating interpretation 27 Table 3.2 Capital adequacy ratios 28 Table 3.3 Asset quality ratios 30 Table 3.4 Management quality ratios 31 Table 3.5 Earning ability ratios 33 Table 3.6 Liquidity ratios 34 Table 3.7 Sensitivity to market risk ratios 35 Table 3.8 Summary of the CAMELS component rating system approach 37 Table 4.1 Number of banks in South Africa 485 Table 4.2 Breakdown of the CAMELS model 47 Table 4.3 Criteria and ratios ratings 48 Table 5.1 Banks’ sratios for 2015 (%) 54 Table 5.2 Banks’ sratios for 2016 (%) 55 Table 5.3 Aggregate banks’ sratios for 2015 and 2016 (%) 56 Table 5.4 Aggregated CAMELS component ratings for 2015 and 2016 (%) 59 Table 5.5 Summary of best and worst performing banks for each ratio 60 Table 5.6 Banks’
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