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Camels Rating System for Banking Industry in Pakistan

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CAMELS RATING SYSTEM FOR BANKING INDUSTRY IN PAKISTAN Does CAMELS system provide similar rating as PACRA system in assessing the performance of banks in Pakistan? Authors: Haseeb Zaman Babar Gul Zeb Supervisor: Catherine Lions Students Umea School of Business Spring Semester 2011 Master Thesis, One-Year, 15hp II Abstract Financial sector of an economy plays an important role in its economic development and prosperity of the country. Banking industry serves as the backbone of the financial sector that accumulates saving from surplus economic units in the form of deposits and provides it to deficit economic units in the form of advances. Banking industry provides support to economy and industries in specific in the time of recessions and economic crisis. But when banks are at the heart of economic recession or banks are the cause of financial crisis like the recent past financial crisis 2007-09, it makes the situation worst for economic recovery. So it is of great importance to keenly observe the performance of the banks and their compliance with the regulatory requirements. Performance of the banks is measured at two levels, one is at the management and regulatory level of the banks and another is at external rating agencies. Purpose of regulatory and supervisory rating systems is to measure the bank performance at internal level and its compliance with regulatory requirements to keep the bank on right track. These ratings are highly confidential and are only available to the bank management. External credit rating agencies examine and evaluate the banks and issue ratings for the general public and investors in particulars. It is of great importance that both these ratings present the same results about the condition of the banks to provide clear information to investors and management. In past several banks suffer from bankruptcy that was the failure of both internal rating systems and credit rating agencies. CAMELS is the supervisory and regulatory rating system implemented by State Bank of Pakistan. It takes into account six important components of a bank when it evaluates performance of the bank. These components are Capital, Assets, Management, Earning, Liquidity and Sensitivity to market risk. Ratings is assigned to theses components on the scale of 1 to 5 and that is a base for composite rating that also ranged from 1 to 5. PACRA rating agency is the dominant credit rating agency of Pakistan that performs ratings for most banks and industries in the country. In our research we examine the similarities in the results generated by CAMELS rating system and PACRA rating agency. For that purpose we sample seventeen commercial banks of Pakistan Banking industry. We observed that results generated by sample banks do not show any similarities with each other. This might be an indication of the banks that went on to bankruptcy in past three to four years or a future threat to financial sector of Pakistan. Key words: Capital Assets Management Earning Liquidity Sensitivity (CAMELS) rating system, Pakistan Credit Rating Agency (PACRA), Supervisory and regulatory Banks, Banking industry of Pakistan. III Acknowledgement We want to convey our deep hearted thanks to our supervisor, Professor Catherine Lions. We feel very lucky to have her supervision and nonstop encouragement, valuable suggestions, assistance and always on time feedback make it possible for us to complete our thesis on time. We humbly acknowledge the assistance and moral support of our friends who directly and indirectly helped us in completion of our thesis. Finally, it would be impossible to say enough about our dear parents and loved ones in our home country who supported, motivated and prayed for us. Haseeb Zaman Babar Gul Zeb IV TABLE OF CONTENTS ABSTRACT ..................................................................................................................... II ACKNOWLEDGEMENT ................................................................................................. IV CHAPTER 1: INTRODUCTION: ....................................................................................... 1 1.1 CREDIT RATING AGENCIES AND FINANCIAL MARKET STABILITY...........................................1 1.2 CRA'S AND CURRENT FINANCIAL CRISES............................................................................2 1.3 BANKING SECTOR OF PAKISTAN........................................................................................2 1.4 CAMELS RATING SYSTEM: ....................................................................................................... 4 1.5 PACRA RATING AGENCY..................................................................................................4 1.6 PROBLEM BACKGROUND: ........................................................................................................ 5 1.7 RESEARCH QUESTION............................................................................................................6 1.8 PURPOSE OF THE STUDY.........................................................................................................6 1.9 LIMITATION.....................................................................................................................6 1.10 DISPOSITION.................................................................................................................6 CHAPTER 2: RESEARCH METHODOLOGY: .................................................................... 8 2.1 THEORETICAL METHODOLOGY: ................................................................................................... 8 2.1.1 RESEARCH PHILOSOPHY: ......................................................................................................... 8 2.1.2 RESEARCH APPROACH:......................................................................................................... 10 2.1.3 RESEARCH STRATEGY: .......................................................................................................... 11 2.1.4 NATURE OF RESEARCH: ........................................................................................................ 13 2.1.5 RESEARCH DESIGN:.............................................................................................................14 2.2 PRACTICAL METHODOLOGY: ................................................................................................... 15 2.2.1 SELECTION OF THE RESEARCH TOPIC: ....................................................................................... 15 2.2.2 PRECONCEPTION: ............................................................................................................... 15 2.2.3 PERSPECTIVE:..................................................................................................................... 15 2.2.4 DATA COLLECTION METHOD: ................................................................................................ 15 2.2.5 LITERATURE STUDIED: .......................................................................................................... 16 2.2.6 SAMPLING: ........................................................................................................................ 16 CHAPTER 3: THEORETICAL FRAMEWORK:................................................................ 18 3.1 CREDIT RATINGS AND ITS IMPORTANCE AN ECONOMIC GROWTH……………………………………18 3.2 Why Performance measurement of banking sector?........................................................... 19 3.3 BANK REGULATORY REQUIREMENTS AND SUPERVISORY RATING: .................................................... 20 3.4 OFF-SITE SUPERVISORY RATING SYSTEMS: .................................................................................. 22 3.4.1 ORAP RATING SYSTEM: ....................................................................................................... 22 3.4.2 PATROL RATING SYSTEM: .................................................................................................... 23 3.4.3 CAMELS RATING SYSTEM: ................................................................................................... 23 V 3.5 COMPOSITE RATING:.............................................................................................................. 36 3.6 RATINGS FROM EXTERNAL AGENCIES: ........................................................................................ 37 3.6.1 PACRA (PAKISTAN CREDIT RATING AGENCY): .......................................................................... 37 3.6.2 STANDARD AND POOR´S: ...................................................................................................... 41 3.6.3 ANALYTICAL HIERARCHY PROCESS (AHP): ................................................................................ 42 3.7 OUR THEORETICAL FRAMEWORK: ............................................................................................. 43 CHAPTER 4: BANKING SECTOR OF PAKISTAN: ........................................................ 45 4.1 ECONOMY OF PAKISTAN: ........................................................................................................ 45 4.2 FINANCIAL SECTOR OF PAKISTAN:............................................................................................. 45 4.3 BANKING DEVELOPMENT IN PAKISTAN: ..................................................................................... 46 4.3.1 COMMERCIAL BANKING SYSTEM (1947-1973): ........................................................................ 46 4.3.2 NATIONALIZATION OF BANKS (1974-1978): ...........................................................................
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