International Journal of Accounting and Financial

Management Research (IJAFMR)

ISSN 2249-6882
Vol. 3, Issue 2, June 2013, 55-60
TJPRC Pvt. Ltd.

ALTMAN MODEL AND FINANCIAL SOUNDNESS OF INDIAN BANKS

NISHI SHARMA & MAYANKA
University Institute of Applied Management Sciences, Panjab University, Chandigarh, India

ABSTRACT
Financial soundness of banking sector is undoubtedly a backbone of every economy. Failure of giant banks may
traumatize not only the domestic economy but can also put the globe at stake. Collapse of Lehman brothers is recent
evidence to this contagious effect. In this context, it is very crucial to analyse the financial soundness of domestic banks. At
present there are various methods which may be helpful to analyse financial position of banks like capital adequacy ratio,
profitability, liquidity or hybrid model like CAMEL rating. An important model to analyse financial soundness / distress of
any corporate house is Altman Z score model. But unfortunately it was least explored by researchers while studying
financial soundness of banks. In this reference the present study attempts to apply Altman model to Indian banking
industry. The study found that with only two exceptions the financial position of Indian banks found satisfactory. The two
banks found somehow in distress position are Canara bank among public sector banks and Kotak Mahindra bank among
private sector banks. However, capital adequacy ratio of both of these banks was sound enough as compared to its peer
banks. The study suggests the use of hybrid model to make any conclusive remark to the soundness of any company.

KEYWORDS: Altman Model, Financial Position, Hybrid Model, Private Sector Banks and Public Sector Banks
INTRODUCTION
Global financial crisis blessed with growing inflation, currency depreciation, fiscal uncertainty, high level of
interest rates and subdued industrial production was strong enough to break down the resilience of financial sector. The
collapse of financial giants Lehman brothers and Merrill Lynch bought distress to many financial institutions across the
globe. There are different methods of measuring this distress like capital adequacy ratio, profitability, liquidity or hybrid
model like CAMEL rating. An important model to analyse financial soundness / distress of any corporate house is Altman
Z score model. The model scores the financial soundness of corporate house in terms of Z values. Z score has originally
been devised by Edward Altman to signal the possibility of financial bankruptcy of manufacturing units. But since then it
has been frequently updated to make it applicable to private companies, non-manufacturers and entities indulge in
emerging credit. The model claims for more than 70% accuracy in predicting corporate bankruptcy. But unfortunately it
was least explored by researchers while studying financial soundness of banks. In this context, the present study tests the
efficacy of Altman model in Indian banking sector.

REVIEW OF RELATED LITERATURE

The study of financial soundness / distress of banking sector is totally inevitable to ensure economic growth but
the issue could not get extensive anatomisation. Though there are studies in this field applying capital adequacy ratio,
profitability, liquidity or hybrid model like CAMEL rating, yet the distress position has not extensively studied.
Particularly there is a great dearth of studies applying Altman financial distress model to banking industry which has
already shown significant result for manufacturing sector. Some of the studies conducted in the arena may be discussed as
further. A study conducted by Chaitanya (2005) measured financial distress of IDBI using Altman Z-Score Model. The

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Nishi Sharma & Mayanka

model reported that the financial position of the bank was not satisfactory and it also gave indications about the possible
bankruptcy of the bank. Blank et., al. (2009) conducted a study on German banks. The study established the relationship
between size distribution and financial stability of the banks.
Carapeto (2010) attempted to devise most accurate, consistent & simple accounting measure that can be used to
distinguish between healthy & financially unsound institutions. The study took a sample of 1175 banks and exposed the
ratio of non-performing loans to total loans as the most appropriate accounting measure of distress is the ratio of nonperforming loans to total loans.
Nayak and Nahak (2011) studied the performance of Indian public sector banks during post-liberalization period.
The study devised performance index for banks based upon the financial ratios of profitability, financial efficiency,
operational efficiency and financial soundness. The paper applied Principal Component Analysis method to construct index
and ranked different banks over the last 10 years using Edward Altman Model. The study ranked State Bank of India
continues at first position to be followed by other banks like Punjab National Bank, Canara Bank, Bank of India and Bank
of Baroda etc.
Husna and Rahman (2012), attempted to predict possible bankruptcy of Islamic Banks through the CAMEL
rating. The study examined asset quality, liquidity ratios, ratio of volatile liability to total source of funds, ratio of primary
capital to average assets and current-quarter ratio. Subramnayam and Venkateswarlu (2012) found that the percentage to
total of public sectors banks share is decreasing year to year and foreign sector banks share is fluctuating. The study
reported that the operating profit percentage of public sector banks to total has decreased from 72.69 percent to 67.20
percent during 2001-02 to 2010-11. The operating profit percent to total percent of private sector banks has increased from
15.52 percent to 21.92 percent during 2001-02 to 2010-11 and the operating profit percent to total of foreign banks
fluctuated during 2001- to 2010-11 period.
Mishra et., al. (2013) studied the stability of Indian banking sector. The study applied Value at Risk measures,
Grangers Causality test and Regression analysis. The results reveal the symptoms of moderate rise in instability in the
banking sector in coming periods due to the instability in the asset quality.
As shown from the review, Altman model has not been much applied by the researchers. Alternatively capital
adequacy ratios, assets quality, ratio of non-performing assets, liquidity, and profitability have been opted as suitable
measures to depict the financial soundness. However, after the lessons from recent financial crisis, the study of survival /
insolvency probability should be of paramount concern for all related parties. In this context, the present paper attempts to
analyse the financial distress of Indian banks through testing the Altman model.

RESEARCH METHODOLOGY
The present study estimates Z score for 36 Indian commercial banks for a period of five years from 2007-12.
These banks comprise of 20 Indian public sector banks and 16 Indian private sector banks. The study applies Altman Z
score model to Indian banking industry. This model is a hybrid model which calculates Z score for the corporate house on
the basis of four variables viz., working capital, retained earnings, earnings before interest and tax, book value of equity,
total liability and total assets. The data used in the study is a secondary data collected from economics times and Reserve
bank of India. The calculation of Z score has been done with the help of following equation:
Z = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4
Where,

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Altman Model and Financial Soundness of Indian Banks

X1 is the ratio of Working Capital to Total assets. It estimates company's ability to cover financial obligations.
X2 is the proportion of Retained Earning to Total Asset. This ratio measures cumulative profitability over time as
a proportion of total assets. X3 is the ratio of Operating profit to Total Assets. It depicts the managerial efficiency in terms
of profitability of the business. Earnings before interest and tax (EBIT) have been used as a proxy to operating profit.
X4 is the ratio of Book value of equity to Total Liabilities of the corporate house. It expresses the financial
leverage i.e. the proportion of equity. A high value of ratio depicts firms aggressiveness in financing its growth with debt.
If the cost of the debt financing outweighs the return that the company generates on the debt, it could even lead to the
possible bankruptcy.
Altman model suggests that if a financial institute secure more than 2.6 score, it should be placed in safe zone. But
if it is unable to secure even 1.1 Z score it should be assumed in distress zone and it is more prone to bankruptcy. If the
value of Z score is in between 1.1 and 2.6, it should be treated in grey zone. The present study computes Z score for all 36
banks during a period of 5 years from 2008-12. It assigns ranks to public and private sector banks separately. The study
also ranks these banks on the basis of liquidity, profitability and capital adequacy ratio so as to analyse whether the hybrid
model has an edge over the others or it produces the same results.

RESULTS AND FINDINGS

Table 1 depicts the descriptive statistics of different variables used in the study.
Table 1: Descriptive Statistics
Particulars

Working
Capital

Number of Observations
Mean
Maximum
Minimum

100
126514.9
691433.8
10120.1

Number of Observations
80
Mean
46377.37
Maximum
247307.3
Minimum
4550.618
Source: Authors Calculation

Retained
EBIT
Earnings
Public Sector Banks
100
100
10006.01
5434.15
63731.91 23852.96
1996.244
641.812
Private Sector Banks
80
80
7092.453 2123.024
51493.93 10840.78
415.36
39.232

Market
Equity

Total
Assets

Total
Liability

100
639.6037
1737.262
145.316

100
188663.3
967613.5
52454.58

100
165688.5
903240.1
15313.35

80
270.6173
1269.624
37.056

80
80697.35
377334
6807.348

80
72844.75
324570.5
6070.274

The descriptive statistics of selected public sector and private sector bank reveal that average liquidity (ratio of
working capital to total assets) of Bank of Baroda is highest at 0.774 and lowest for Canara bank at 0.038. In case of
private banks it is highest for city Union Bank at 0.732 and worst for Kotak Mahindra at 0.122. The profitability
(percentage of EBIT to total assets) is highest in case of Allahabad Bank at 8.65% and 4.19% of Axis Bank of respectively
for public sector and private sector banks. Average Profitability ratio is lowest for Syndicate Bank at 1.05% in case of
public sector and 0.58% for DCB in case of private sector banks. Table 2 and 3 demonstrate the Z score of Indian
commercial banks.
Table 2: Z Score of Public Sector Banks
S.No.
1
2

Public Sector Banks

Allahabad
Andhra Bank

2012

2011

2010

2009

2008

5.31
5.26

5.29
5.36

5.07
5.56

5.12
5.46

5.33
5.36

Average
Z Score
5.23
5.40

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Nishi Sharma & Mayanka

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19

Bank of Baroda
Bank of India
Bank of Maharashtra
Canara Bank
Corporation bank
Dena Bank
IDBI
Indian bank
Indian overseas bank
Oriental Bank of Commerce
Punjab and Sind Bank
Punjab National Bank
State Bank of India
Syndicate bank
UCO
Union Bank of India
United Bank of India

Table 2:Contd.,
5.58
5.48
5.25
5.11
4.95
4.67
0.42
0.43
4.84
4.76
5.01
4.99
4.83
4.89
5.00
4.89
5.02
4.88
4.81
5.03
4.83
4.86
5.02
5.10
5.22
5.08
5.21
5.23
5.01
4.92
5.16
5.06
4.80
4.70

5.57
5.41
4.96
0.78
4.71
4.87
4.91
5.25
4.74
5.00
4.60
5.05
4.92
5.11
4.54
4.85
4.35

5.48
5.55
4.83
1.07
4.82
4.90
5.07
5.31
4.95
5.43
4.70
5.01
5.08
5.07
5.25
5.21
4.95

5.06
5.16
5.24
0.76
5.11
5.15
5.25
4.71
4.84
5.42
4.90
4.87
4.94
4.87
5.14
5.15
4.56

5.43
5.30
4.93
0.69
4.85
4.98
4.99
5.03
4.88
5.14
4.78
5.01
5.05
5.10
4.97
5.09
4.67

20

Vijaya bank

4.71

4.65

5.03

5.22

4.96

4.91

4.81

4.77

4.77

4.92

4.84

4.82

Average Annual Z score

Source: Authors Calculation

Altman model assigns least rank to Canara bank and put it in distress zone. However, other public sector banks
were found to be in safe zone as they secured more than 2.6 score. Z score of Bank of Baroda was highest which was
followed by Andhra Bank. Z score was best in the year 2009 and was least in 2010 and 2011. This may probably be due to
the later repercussions of global financial crisis. But even in that phase, public sector banks were found capable enough to
get way from any financial distress.
Table 3: Z Score of Private Sector Banks
S.No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16

Private Sector Banks

Axis bank
City union bank
Dhanlaxmi Bank
Development credit bank
Federal Bank
HDFC BANK
ICICI
IndusInd Bank
ING Vsysya bank
Jammu Kashmir Bank
Karnataka Bank
Karur Vsya Bank
Kotak Mahindra Bank
Laxmi Villas Bank
South Indian Bank
Yes Bank
Average Annual Z score
Source: Authors Calculation

2012
4.7222
5.2003
4.5846
4.7343
5.0371
4.8854
4.7489
4.8924
5.0052
4.4665
4.4481
4.9984
1.0174
4.8862
5.1937
4.2274
4.5655

2011
4.8968
5.2376
5.0009
4.5562
5.0651
5.1468
4.7879
4.2620
4.8143
4.2462
4.3773
5.0443
0.9177
4.9595
4.9181
4.6996
4.5581

2010
5.1108
4.9883
5.3002
4.3148
4.9937
5.0785
4.7982
3.8118
4.6085
4.6859
4.2612
4.8702
0.8468
4.8341
4.9241
5.0222
4.5281

2009
5.0289
5.1323
5.2930
4.8110
4.9063
4.5312
5.0480
3.4716
4.6841
5.3207
4.1788
5.0368
0.8162
5.6470
4.7945
4.5791
4.5800

2008
5.0219
5.6844
5.1957
4.8322
4.8936
4.2390
5.3951
3.5234
5.2860
5.4106
4.7597
5.6450
1.0865
5.3870
5.3731
5.1728
4.8066

Average Z Score
4.9561
5.2486
5.0749
4.6497
4.9792
4.7762
4.9557
3.9922
4.8796
4.8260
4.4050
5.1189
0.9369
5.1428
5.0407
4.7402
4.5655

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Altman Model and Financial Soundness of Indian Banks

The financial position of Kotak Mahindra bank was found to be in distress zone by Altman Z score model. The
model also reported that soundness of Indusind bank has shown remarkable improvement after 2009. The model ranked
City Union Bank as the best performer which was followed by Laxmi Vilas bank. Table 4 and Table 5 provides brief
description of ranking of public sector and private sector banks respectively on the basis of profitability, liquidity, capital
adequacy ratio and Z score.
Table 4: Ranking of Public Sector Banks
S.No

Bank

1
Allahabad Bank
2
Andhra Bank
3
Bank of Baroda
4
Bank of India
5
Bank of Maharashtra
6
Canara bank
7
Corporation bank
8
Dena Bank
9
IDBI
10
Indian bank
11
Indian overseas bank
12
OBC
13
Punjab and Sind Bank
14
Punjab National Bank
15
SBI
16
Syndicate bank
17
UCO
18
Union Bank of India
19
United Bank of India
20
Vijaya bank
Source: Authors Calculation

Profitability Based
Ranks
1
2
9
11
6
7
17
16
5
4
19
8
18
15
13
20
12
10
14
3

Liquidity
Based Ranks
17
2
1
4
14
20
15
6
16
13
11
10
12
7
8
3
9
5
19
18

CAR Based
Ranks
11
10
1
17
3
2
4
19
16
5
8
12
6
9
7
20
18
13
15
14

Z Score Based
Ranks
4
2
1
3
14
20
17
12
11
9
16
5
18
10
8
6
7
13
19
15

Poor working capital ratio to total assets and Z score of Canara bank place it on the last position. However the
same put on second rank on the basis of capital adequacy ratio. Profitability and capital adequacy ratio ranked Syndicate
Bank on last position. Bank of Baroda has been ranked first on the basis of liquidity, capital adequacy ratio and Z score.
Allahabad bank has been ranked first on the basis of profitability. Andhra Bank has been ranked second on the basis of
three categories viz., profitability, liquidity and Z score. However, capital adequacy ratio assigns tenth rank to it.
Table 5: Ranking of Private Sector Banks
Bank
Axis bank
City Union bank
Dhanlaxmi Bank
Development Credit Bank
Federal Bank
HDFC bank
ICICI Bank
IndusInd Bank
ING Vsysya bank
JK bank
Karnataka bank
Karur Vysya bank
Kotak Mahindra bank
Laxmi Vilas Bank

Profitability
Based Ranks
1
7
12
16
13
10
5
3
4
2
14
9
15
6

Liquidity
Based Ranks
9
1
4
8
6
10
11
15
7
12
14
5
16
3

CAR Based
Ranks
9
14
16
8
1
5
3
10
15
7
12
11
2
13

Z score
Based Ranks
7
1
4
13
6
11
8
15
9
10
14
3
16
2

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Nishi Sharma & Mayanka

South Indian Bank

Yes Bank
Source: Authors Calculation

11
8

Table 5: Contd.
2
13

6
4

5
12

Axis bank was ranked highest on the basis of profitability. Liquidity and Z score both criteria have ranked City
Union bank the best performer. Kotak Mahindra bank could not secure good position on the basis of profitability, liquidity
and Z score. However its capital adequacy ratio was good enough to enable it to have second position among private sector
banks.

CONCLUSIONS
The study concluded that with only two exceptions the financial position of Indian banks found satisfactory as per
the Altman model. The two banks found somehow in distress position are Canara bank among public sector banks and
Kotak Mahindra bank among private sector banks. However, capital adequacy ratio of both of these banks was sound
enough as compared to its peer banks. This analysis also derive a very important conclusion that capital adequacy ratio
cannot be treated as a whole sole indicator of financial soundness and should be considered along with other parameters.
The study is expected to provide good framework to policymakers as well as bank managers while designing their
investment outlay.

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Carapeto et., at. (2010). Distress Classification Measures in the Banking Sector. Mergers and Acquisitions
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1-30,

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http://citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.175.7259
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Nayak B. and Nahak C (2011). Benchmarking Performance of Public Sector Banks in India. The IUP Journal of
Bank Management, IUP Publications, 2, 57-76.

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Blank et., al. (2009). Shocks at large banks and banking sector distress: The Banking Granular Residual. Journal
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Husna and Rahman (2012). Financial Distress- Detection Model for Islamic Bank. International Journal of Trade
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Subramnayam and Venkateswarlu M.(2012). Financial performance of scheduled commercial banks in India-a
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Chaitanya (2005). Measuring Financial Distress of IDBI Using Altman Z-Score Model. IUP Journal of Bank
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Mishra, Majumdar and Bhandia(2013). Banking Stability- A Precursor to Financial Stability. Department of
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