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Analysing the Financial Soundness of the Commercial Banks in Romania: an Approach Based on the Camels Framework

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Analysing the Financial Soundness of the Commercial Banks in Romania: an Approach Based on the Camels Framework Available online at www.sciencedirect.com ScienceDirect Procedia Economics and Finance 6 ( 2013 ) 703 – 712 International Economic Conference of Sibiu 2013 Post Crisis Economy: Challenges and Opportunities, IECS 2013 Analysing the Financial Soundness of the Commercial Banks in Romania: An Approach Based on the Camels Framework Angela Romana,*,Alina Camelia a aFaculty of Economics and Business Administration / Department of Finance, Money and Public Administration, "Alexandru Ioan Cuza" Abstract The Romanian banking system has undergone through tremendous changes in the last decade, its financial soundness and performance being paramount in the achievement of a stable and sustainable economic growth. Thus, the aim of our research is to comparatively analyse the financial soundness of the commercial banks that operate in Romania. In order to achieve this we have used one of the most popular methods for the analysis of the financial soundness of banks, namely the CAMELS framework. The obtained results highlight the strengths and the vulnerabilities of the analysed banks, underlining the need to strengthen the concerns of the decision makers from banks to improve and increase their soundness. © 2013 The Authors. PublishedPublished by by ElsevierElsevier B.V. B.V. Selection and peer-review underunder responsibility responsibility of of Faculty Faculty of of Economic Economic Sciences, Sciences, Lucian Lucian Blaga Blaga University University of Sibiu.of Sibiu. Keywords: banks, financial soundness, performances, CAMELS framework, Romania 1. Introduction In order to ensure a healthy, solid and stable banking sector, the banks must be analysed and evaluated in a way that will allow the smooth correction and removal of the potential vulnerabilities. In this way, one of the most popular methods for the analysis and evaluation of the banks soundness is represented by the CAMELS framework. The aim of our research is to analyse the financial soundness of the commercial banks that operate in Romania. In order to achieve this aim our methodology is based on the CAMELS framework. This framework, firstly known * Corresponding authors Roman Angela ; E-mail address: [email protected] argu Alina Camelia; E-mail address : [email protected] 2212-5671 © 2013 The Authors. Published by Elsevier B.V. Selection and peer-review under responsibility of Faculty of Economic Sciences, Lucian Blaga University of Sibiu. doi: 10.1016/S2212-5671(13)00192-5 704 Angela Roman and Alina Camelia Şargu / Procedia Economics and Finance 6 ( 2013 ) 703 – 712 under the name of CAMEL, has been created in 1979 in USA by the bank regulatory agencies, and afterwards its use has been extended, being considered a useful tool for the supervisor authorities from different countries in order to assess the soundness of the financial institutions. The acronym CAMEL derives from the five main segments of a bank operations: Capital adequacy, Asset quality, Management quality, Earnings ability and Liquidity. Since 1996, out of the desire to stronger focus on risk, to the five components was added the sixth component "S", so that the CAMEL approach became the CAMELS approach, w parameters are relevant indicators for assessing the financial soundness of a bank, being recommended also by the IMF and the World Bank (2005), grouping, moreover, the financial soundness indicators of the banking sector, according to the six key areas of potential vulnerability, in the CAMELS approach. The reminder of the research is organised as follows: part two presents a review of the academic literature on the subject, part three is dedicated to the data and the methodology used, part four concerns the analysis and discussion of the selected banks soundness and part five contains the concluding remarks. 2. Review of the academic literature The insurance of a healthy, solid and stable banking sect the economic life, from depositors, stakeholder, employees and throughout the economy in its whole. Starting from this appreciation, the national and international regulatory and supervision authorities and also the academic researchers have deepened their interest on the evaluation and analysis of the soundness and performances of the financial system in general and implicitly of the banking sector. The first studies undertaken on the subject of banks performance have appeared in the late 1980s and the early 1990s, employing one of the two model types: the Market Power (MP) model or the Efficiency Structure (ES) model (Mensi et Zouari, 2010). With the development of the analysis methods, the studies on banks profitability and soundness have evolved from the ones previous mentioned to more sophisticated analysis models based on empirical evidence that were focused both on the banks performance and its determinants. Most of these studies underline that the bank size plays a significant role in the determination of a bank performances and soundness, its role however being still a subject of intense debate. There is large body of academic literature that underlines a positive link between the size of a banking institution and its determinants (e.g. Molyneux and Seth, 1998; Pilloff and Rhoades, 2002; Sufian, 2009). In recent years one of the most used models for the estimation of a bank performances and soundness is represented by the CAMELS framework (Baral, 2005). This system is used also as a bank supervision instrument by the regulatory authorities (Gilbert et al, 2000; Hays et al, 2009) and also as a main model for the evaluation of the banks performances (Evan et al., 2000; Derviz et Podpiera, 2008 One of the most comprehensive studies on banks soundness in the new European Union member states that employs CAMELS is represented by the research of Derviz et Podpiera (2008) on the Czech Republic banking sector. The study underlines the evolution of the financial soundness for the five largest Czech banks in the pre and post privatisation period, namely 1999 to 2005. ased on CAMEL framework to analyse the performances of the Northern Cyprus banking sector. The research is focused on the five largest banks in the post 2001 period. The results suggest that the profitability and the management quality of the analysed banks have improved during the analysed period of time, while a deterioration has been registered in the capital adequacy and liquidity level. Despite being such a popular analysis tool, the CAMEL framework has been used to a lesser extend for the analysis of the Romanian banking sector performances and soundness, among the most representative researches being those of Albulescu et Coroiu (2009) and Dardac et Moinescu (2009). Thus, our research intends to fill this gap by providing an analysis of the financial soundness for the Romanian banking sector in the pre and post crisis period. 3. Data and methodology The data used in our research are obtained from the unconsolidated financial and annual reports of the banks from our sample and from the Bureau Van Dijk Bankscope database. The sample is composed by 15 commercial Angela Roman and Alina Camelia Şargu / Procedia Economics and Finance 6 ( 2013 ) 703 – 712 705 banks that operate in Romania, that together own over 78.10% of the total banking assets. In order to evaluate and analyse the soundness of the commercial banks that operate in Romania we have chosen one of the most popular methods for analysis used in this type of research namely the CAMELS framework. The variables used in our research and the way that are computed are presented in table 1. We have computed the average separately for each of the indicators used and each parameter from the CAMELS framework for the analysed period of time (2004 - 2011). The obtained averages have been used in order to rank the banks. The best score obtained by a bank got the rank one followed up to rank fifteen using a step of one. If we have obtained the same average for two or more banks the respective banks were assigned the average rank. Based on the components of the CAMELS framework we estimate the financial soundness of the commercial banks from our sample. Capital adequacy (C) is one of the most important indicators for the financial health of the banking sector because it guarantees the capacity of this sector to absorb the eventual losses generated by the manifestation of certain risks or certain significant macroeconomic imbalances. Most of the studies used for the measurement of the capital adequacy the capital ratio that is compounded as a ratio of total capital to total assets. The measurement of capital adequacy is done, also through other significant ratios like: the ratio of total equity to total asset, the ratio of equity to net loans or the ratio of equity to debts. Asset quality (A) is a significant element that measures the strength of a bank and is directly linked with the capital adequacy because most of the times the solvency risks are determined by the depreciation of the assets (IMF and World Bank, 2005, p. 26). In the case of the banking institutions, the quality of the assets is determined especially by the quality of the loans because this category of assets represents a significant share in the overall balance sheet of a bank. Most of the times, the quality of the loans is measured through the ratio of non-performing loans to total loans, that reflects the share of non-performing loans in total loans that a bank has. Another significant indicator in the evaluation of the assets quality is the ratio of total loans to the total assets. Normally, in the case of a bank, the loans represent the most important part of the assets, but a high ratio reflects also an assets structure more sensitive to loan losses like: loan loss reserves to total assets, loan loss provisions to total loans and the ratio of loan loss provision to net interest revenue. Table 1. CAMELS parameters and their calculation method CAMELS variables Ratios Calculation method Capital Adequacy Capital adequacy ratios Total Capital Ratio Equity / Total Assets Asset Quality Impaired loans ratio Impaired Loans / Gross Loans The coverage of non-performing loans Loan Loss Provisions / Net Interest Revenues The ratio of the total loans to total assets.
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