Professional Documents
Culture Documents
Internship Report
Comparative Study on “Impact of Operational Efficiency, Liquidity,
and Risk upon Profitability of PSBs in Nepal”
As part of the requirement for MBA Program
Internship Program Code: PWM 703
Internship Employer
Nepal Bank Ltd.
Work Supervisor: Mr. Arjun Lal Joshi
Address: New road, Kathmandu
Intern
Bishal Sarraf (KU Reg. No. 012882-11)
Pragalv Neupane (KU Reg. No.012876-11)
22ndSeptember, 2013
DECLARATION
This report has been completed and analysis is done through an extensive research
and is an original work which has been completed through consultation with college
and work supervisors. We state that, we will not be liable for any consequences of the
decisions and actions taken by the use of information contained in this report.
Signature
………………….... ….………………
Pragalv Neupane Bishal Sarraf
1
ACKNOWLEDGEMENT
We would like to express our sincere gratitude towards Kathmandu University School
of Management and its esteemed faculties for guiding us with excellently designed
academic modules.
We would like to thank Nepal Bank Ltd. for providing us with an opportunity to
practice our academic knowledge in a professional environment. It was a privilege to
be a part of one of the oldest company and the overall experience was worthwhile.
Our special thanks go to Mr. Arjun Lal Joshi, Senior Manager and Ms. Yesodha
Shrestha (Amatya), Senior Assistant for their constant guidance and motivation. Our
research would not have been possible without the support staffs along with the staffs
in Department.
We are extremely grateful to Mr. Niranjan Phuyal, our academic supervisor, for his
invaluable insight, guidance and constructive feedback. We are also indebted to Asst.
Prof. Sabin Panta, our internship coordinator, for his help, support and understanding.
Special thanks to family and friends, Mr. Prasanna Poudel, Mr. Narendra Prasad
Pokharel, Mr. Bijay Chaudhary for their tireless support, inspiration and their efforts
to keep us upright for the entire three months.
Bishal Sarraf
Pragalv Neupane
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EXECUTIVE SUMMARY
Nepal Bank Ltd is the oldest bank of Nepal with highest branch networks in the
country. One of the government undertaking banks apart from the other two, it is
thriving to deliver quality banking to its customers of different segments.
Research illustrated that Net Interest Income is one of the factor that possess high
impact on profit of bank at both industrial and individual level, with inference of high
interest rate sensitivity in PSBs. The other factor such as deposit, credit, and LLP also
had impact upon their profitability. The result contradicted with previous findings
where credit had negative whereas LLP has positive impact on profit. Insignificance
of liquidity and investment (except with negative impact for NBL) on profit illustrates
inadequacy in investment environment in both capital and money market tool.
Least CDR and high NPL ratio according to industrial benchmark suggest poor
operational efficiency had high risk position of PSBs in Nepal. No impact of CDR on
profitability measurement, further strengthen the findings of report. Banks have
recovered a significant amount out of their past NPL, has made risk factor having
positive impact upon profitability of PSBs in Nepal.
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Contents
Part One....................................................................................................................................1
INTRODUCTION....................................................................................................................1
1.1 Background.....................................................................................................................1
1.2 Goals/objectives of Internship.........................................................................................2
1.3 Roles/Jobs performed in the internship...........................................................................3
Part Two....................................................................................................................................5
INTRODUCTION OF INDUSTRY AND COMPANY............................................................5
2.1 Evolution of Banking Industry in Nepal.........................................................................5
2.2 Introduction to Nepal Bank Ltd......................................................................................5
2.3 Product Services of NBL................................................................................................7
2.4 Organizational Strategies................................................................................................7
2.5 Organization’s general and competitive environment.....................................................8
2.5.1 Internal environment....................................................................................................8
2.5.2 External Environment..................................................................................................8
Part Three...............................................................................................................................11
Presentation of Major Project Undertaken..............................................................................11
3.1.1 Introduction to the Project..........................................................................................11
3.1.2 Problem Statement.....................................................................................................12
3.1.3 Objective of project....................................................................................................12
3.1.4 Scope and Limitation of project.................................................................................13
Section II: Literature Review & Conceptual Framework........................................................15
3.2.1Literature Review.......................................................................................................15
3.2.1(a) Performance of PSBs and their profitability..........................................................17
3.2.1(b) Impact of Sources and USES of fund on profitability of bank...............................18
3.2.2 Impact of Liquidity on profitability of bank...............................................................19
3.2.3 Impact of Investment on Profitability of bank............................................................20
3.2.4 Impact of Riskiness on Profitability of Bank.............................................................20
3.2.5 Ratio to measure and compare banking performance.................................................21
3.2.6 Conceptual framework...............................................................................................22
3.2.7 Hypothesis development............................................................................................24
Section III: Methodology........................................................................................................25
3.3.1 Research Design........................................................................................................25
3.3.2 Empirical model.........................................................................................................25
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3.3.3 Data............................................................................................................................26
3.3.4 Population and sample...............................................................................................26
3.3.5 Variable Specification: Dependent variable...............................................................26
3.3.6 Variable Specification: Independent variable.............................................................27
Section IV: Presentation and analysis of the project...............................................................28
3.4.1 Descriptive analysis for Variables..............................................................................28
3.4.2 Correlation analysis...................................................................................................29
3.4.3 Regression analysis (variable)....................................................................................30
3.4.5 Regression analysis (ratios)........................................................................................33
3.4.6 Test for Normality and autocorrelation......................................................................36
3.4.7 Empirical Findings.....................................................................................................36
Section V: Conclusion and recommendation..........................................................................39
3.5.1 Conclusion for Public sector banks............................................................................39
3.5.2 Conclusion for Individual PSB..................................................................................39
3.5.3 Recommendations......................................................................................................40
3.5.4 Action plan.................................................................................................................44
Part four: Reflection of Internship..........................................................................................46
Bibliography...........................................................................................................................48
Annexes..................................................................................................................................51
LIST OF TABLE
5
Table 1 Work Schedule at internship program................................................................................3
Table 2 SWOT matrix...................................................................................................................11
Table 3Summarized descriptive analysis of banking variables.....................................................29
Table 4Summarized DESCRIPTIVE ANALYSIS OF BANKING ratios......................................29
Table 5 CorrelatioTable 6n analysis of banking variables.............................................................30
Table 7 Correlation analysis of ratios with ROE...........................................................................31
Table 8 Correlation analysis of ratios with roa..............................................................................31
Table 9 Summarized regression output for banking variables.......................................................32
Table 10 Summarized stata output for panel data regression of variables.....................................33
Table 11SUMMARIZED REGRESSION OUTPUT FOR ratio with ROE as dependent.............34
Table 12 SUMMARIZED REGRESSION OUTPUT FOR RATIO WITH ROA AS
DEPENDENT...............................................................................................................................36
Table 13: Marketing plan..............................................................................................................43
LIST OF FIGURE
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Figure 1 Conceptual framework on impact of variables upon profitablity of PSB........................23
Figure 2: Conceptual framework on impact of ratio on profitability of PSB................................24
Figure 3 Organizational structure of nbl.......................................................................................52
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LIST OF ACRONYMS
ADBL: Agricultural Development Bank Limited
ATM: Automated Teller Machine
ARVA: Average Rate of Variable Assets
ARVL: Average Rate of Variable Liabilities
BFI: Banking and Financial Institutions
CA: Capital Adequacy
CB: Central Bank
CAR: Capital Adequacy Ratio
CDR: Credit to Deposit Ratio
CFD: Central Finance Department
EA: Earning Assets
FOREX: Foreign Exchange
FY: Fiscal Year
GDP: Gross Domestic Product
HR: Human Resource
IDFC: Infrastructure Development Finance Company
IRD: Inland Revenue Department
JVB: Joint Venture Bank
LC: Letter of Credit
LLP: Loan Loss Provision
MBA: Master’s in Business Administration
NBL: Nepal Bank Limited
NII: Net Interest Income
NIM: Net Interest Margin
NPA: Non Performing Assets
NPL: Non-Performing Loan
NRB: Nepal Rastra Bank
PDB: Private Domestic Bank
P/L: Profit/Loss
PEST: Political, Economic, Social, and Technological analysis
PSB: Public Sector Bank
RBB: Rastriya Banijya Bank
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ROA: Return on Assets
ROE: Return on Equity
RWA: Risk Weighted Assets
SMS: Short Message Service
SSA: Sub-Saharan Africa
SWIFT: Society of Worldwide Interbank Financial Telecommunication
SWOT: Strength, Weakness, Opportunities, and Threats
TL: Total Loan
TT: Telegraphic Transfer
URL: Uniform Resource Locator
VRA: Variable Rate Assets
VRL: Variable Rate Liabilities
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Part One
INTRODUCTION
1.1 Background
This report is prepared as part of our internship credit requirement of MBA program
at Kathmandu University School of Management. It reflects the understanding of the
organization, its operation through research, information search, and task performed
in Central Finance Department of Nepal Bank Limited.
MBA program provides platform to learn theories along with practical exposure at
both ‘on’ and ‘off’ the scenario. The academic learning is exposed practically, being a
part of the organization in this internship program. This provides students with
platform to further explore organizational environment, strengthen the classroom
theories, and identify ones area of interest and expertise. This program can be
stepping stone for students to explore and understand professional environment and
work setting.
We worked at the Central Finance Department, Head Office of Nepal Bank Ltd for
twelve weeks (three months). Being specialized in financial management, we choose
this department to understand operation in financial system at organizational
environment with aim to provide a blend of practical exposure to our theoretical
knowledge. This shall further help us to identify our competencies and focus upon our
academic expertise.
Along with the technical and practical knowledge, this experience also helped us in
developing interpersonal and communication skills, proving that exposure to
corporate environment is the best way to build such skills in oneself. Along the
internship period, we gained an invaluable firsthand experience of working with
coworkers across varied ages and cultures and lessons in effectively communicating
one’s thoughts to the supervisor.
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1.2 Goals/objectives of Internship
The goals/objectives of internship program are divided into three major categories as:
personal goals, academic goals, and professional goals.
Personal Goals
Effective communication, analytical and problem solving and strong initiative and
leadership are the three most important skills required while managing an
organization. The following are our personal goals of this internship program.
Academic Goals
The goal here is to use theoretical knowledge gained through the formal studies and
further improve our knowledge base and blend our theoretical knowledge with the
practical implementation. Further the goals can be stated as:
Professional Goals
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Gain relevant experience in a career field of interest and develop networking and
professional relation with the employees of the organization.
Basic of Finance
Department
Agency Accounts
NRB Accounts
Reconciliation
SWIFT Operation
Remittance
TABLE 1 WORK SCHEDULE AT INTERNSHIP PROGRAM
The detailed description of our roles and assigned jobs are as follows:
Reconciliation
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We were assigned the task of Vostro account reconciliation at NRB including account
for Central Finance Department and Note Chest. As part of the clearing process, funds
of entire NBL transaction were done through this account at NRB. The account seems
to have enormous pending balance that was not reconciled from Baishak 2070.
Further, merge of three accounts of Kathmandu Banking Office, Government
Transaction, and Central Finance department on 15thBaishak, 2070 has created
additional pending amount on these accounts. During our three month tenure, we
reduced pending balance amount by approx. thirty five billion, developing new model
for note chest reconciliation, and reconciliation as a whole.
Voucher
We were assigned task of voucher preparation for various banking transactions like:
Banking Schedule, ATM transfer, TT, Fund Transfer from one bank to other and to
NRB. Vouchers were prepared manually by using paper based format at beginning.
We initiated electronic preparation of voucher by programming it in MS-Excel. This
was implemented in our department upon approval by chief manager, and has eased
most of the operations in CFD. (Specimen of voucher is included in Annex)
Remittance
We were assigned for preparation of schedule and vouchers for remittance through
agency banks. Here, we learned about the procedure of inward remittance and made
vouchers/schedules to transfer it to other banks, branches as per requirement.
Apart from these tasks, we monitored dealer’s operation on dealing with different
foreign banks to buy and sell foreign currency based upon negotiation of bid-ask
prices, SWIFT operations on transferring funds from different local and international
banks and its executing procedures, and capital restructuring process. We just
monitored these processes as they are sensitive in nature and require concerned
authorities to perform the task under their consent.
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Part Two
INTRODUCTION OF INDUSTRY AND COMPANY
The use of money was not much regulated at that time which made the economy
vulnerable to fluctuations in currency value. Nepal Rastra Bank was created in 1956
as the central bank to address this issue. The function of NRB was to supervise
commercial banks and to guide the basic monetary policy of the nation. Its major
functions were to regulate the issue of paper money; secure countrywide circulation of
Nepalese currency and achieve stability in its exchange rates; mobilize capital for
economic development and for trade and industry growth; develop the banking
system in the country, thereby ensuring the existence of banking facilities; and
maintain the economic interests of the general public.
Due to the new policy of the government to liberalize the Nepalese economy, the
private sector rushed into the banking and financial industry after the restoration of
democracy in 1990. Many commercial banks like Himalayan Bank, Everest bank, etc
were established during this decade. At present there are 31 commercial banks in
Nepal.
His Majesty King Tribhuvan inaugurated Nepal Bank Limited on Kartik 30, 1994
which marked the beginning of an era of formal banking in Nepal. Until then all
monetary transactions were carried out by private dealers and trading center. It was
5
formed under the principle of Joint venture (Joint venture between govt. & general
public). The authorized capital of NBL was Rs. 10 million & issued capital Rs. 2.5
million of which paid-up capital was Rs. 842 thousand with 10 shareholders.
During the start of formal banking with NBL, very few understood or had confidence
in this new concept of formal banking. Rising equity shares were not easy and
mobilization of deposits even more difficult. This was evident when the bank floated
equity shares worth NRs. 2,500,000, but was successful only in raising NRs. 842,000.
The total deposits for the first year was NRs. 17,02,025 where current deposits was
about NRs. 12,98,898 fixed was about NRs. 3,88,964 and saving was NRs. 14,163.
Loan disbursed and outstanding at the end of the first year was NRs. 1,985,000. From
the very conception and its creation, Nepal Bank Ltd, was as joint venture between
the government and the private sector. Out of 2500 equity shares of NRs. 100 face
value, 40% was subscribed by the government and the balanced i.e. 60% was offered
for the sale to private sector. (Organization hierarchy is included in Annex 1)
Vision Statement
Mission Statement
Network for inclusion: Use bank's network to increase its reach all over the country
from urban areas to rural areas and help in improving the lifestyle of rural population
and in turn become the bank of choice of corporate, medium businesses and rural
market.
Enhancing the value: To employees, shareholders, government and customers.
World class banking services: Provide world class banking services by achieving
excellence in customer service and adopting high level technology standards.
Values Statement
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Integrity: Uphold trustworthiness and business ethics in the business process.
Total banking solutions: To cater the need of all sections of society.
Objectives
To focus on building the positive net worth and meeting capital requirement over
the coming five years.
To focus on increasing the customer base and market share.
To maximize the potential efficiency of bank’s staff.
To minimize the risk associated with the business.
To focus on providing world class business solutions.
To focus on increasing profit.
* The vision, mission, values and objectives are extracted from Nepal Bank Website
NBL offers a range of banking services in terms of both deposits and loans. This bank
has wide network of branches throughout the nation, including E-channels of banking
as internet banking, SMS banking. Some of the deposit schemes at NBL are: fixed
deposit account, saving account, current account, premium saving account, and
Mahila Bisesh Account. Some of the loan products offered by NBL are: corporate
loan, retail/consumer loans, and small and medium enterprise loan.
Other than this, bank also facilitates international trade financing through LC. Fee and
charge structure for such services are one of the lowest among commercial banks in
Nepal, with wide range of branch network.
Market Development
From its establishment, the bank has targeted locations that were deprived of banking
operations. This led to huge branch network of branch (117 branches) throughout the
nation. The branch network is also used to facilitate NRB function of currency
circulation through note chest created within branches. The bank also focuses on rural
7
banking with small transaction center present in smaller and remote location with
motive to facilitate people rather earning profit.
Product Development
The bank focuses on new product for individual and corporate customers. Apart from
it, bank has also introduced special products to facilitate government transactions: like
pension fund of Nepal Army, different government schools. It also receives utility
fund on behalf of Nepal Telecom. NBL has also developed special banking product to
collection tax fund on behalf of IRD, to facilitate tax collection from big agents.
The internal environment of bank facilitates staff with a proper working environment.
The banking operation is mix of electronic and manual functions. Electronic functions
include posting transactions in banking software. Documentation is still done
manually. Overstaffing is one of the major sources of creating inefficiencies in
banking operation Moreover with the presence of trade unions affiliated to seven
political parties have made the internal environment of bank more politicized.
Economic factors: Nepal has not been able to achieve its targeted growth of 5.5% as
it ended up at a growth rate of only 3.6%. Similarly, national saving has decreased,
while every Nepali citizen’s per capita GDP has reached Rs.62500. These data shows
that in the coming future there may be competitive banking environment as the BFI
are merging which creates some large institutions in terms of capital and assets. Being
a PSB, the bank also must support agro based economy of country. More focus is
directed towards agro sector rather industrial sector for most of PSB. The recent
closure of accounts by foreign agency banks like Citi Bank, JP Morgan Chase Bank
and others because of money laundering issues has imposed problem in operations of
international financing and remittance. These factors have imposed direct challenge to
bank to operate among these economic variables. Nepal Bank has much to do to
compete.
Social factors: The factors such as demographic, culture, and population social status
determines various aspects which affect the banking as well. For example, emergence
of entrepreneurs mean more demand for loan, increase in income may lead to more
saving habit, more adult population may mean more economic activity. In case of our
country, agriculture is the backbone, supported by massive remittances because of
flow of labor force to other countries. Saving is prevalent in our country compared to
the western countries.
Technological factors: The rapid change in the technology is a symptom for the
organizations either to change and adapt to the changing technology or to fade away.
The banking sector is not an exception. Being the first bank of Nepal, there are still
many employees who are not adapted to the technology which is creating hurdles to
9
attain efficiency in the banking operations. Moreover, rapid development of new
banking software adds efficiency in daily operation and other analytical tasks. Banks
failing to adopt according to these technological changes lag far behind in business.
The banking operations must be updated accordingly with the technological changes,
to remain competitive through operational efficiency.
Strengths Weaknesses
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Part Three
Presentation of Major Project Undertaken
Section I: Introduction
3.1.1 Introduction to the Project
Banking and financial institutions have now become an integral part of economy. The
major function of financial system is to promote investment through financing
productive business opportunities, mobilizing savings, efficient allocating resources
and making easy the trade of goods and services[ CITATION Aco \l 1033 ]. A sound
banking withstands confrontational conditions and adds performance based value in
the financial system[ CITATION Ath08 \l 1033 ].Banking industry are integral part of
economy as it collects savings and funds from individual and institutional level, and
mobilize it as funding for other sectors. It transfers the excess fund from sectors
having excessive of it, to needy sector collectively from sum of deposits.
The history of financial services sector in Nepal was started with the establishment of
Nepal Bank Limited in 1937[ CITATION Bar \l 1033 ]. Since then, there are 31
commercial banks, including three public sector banks, and six joint venture banks,
and twenty two domestic private banks. Among them, public sector banks are the old
banks in history possessing substantial asset base and branch networks across the
country. The public sector banks of country includes: Nepal Bank Limited (NBL),
Rastriya Banijya Bank Limited (RBB), and Agricultural Development Bank Limited
11
(ADBL). The public sector banks are believed to be large in comparison to others in
terms of their operational size (deposits and credits), and branch network across the
country. [ CITATION Aco \l 1033 ].
This project aims at finding the factors that affect profitability of public sector banks
in Nepal. Since, public sector banks hold substantial market share, assets, and
business among BFI, profitability of such institutions have huge impact upon
economy of country. This study includes the impact of factors contributing towards
sources and uses of fund, liquidity, and riskiness for bank.
Some studies illustrated that there was 37.04% growth in net profit of commercial
banks compared to the corresponding quarter of the previous fiscal year. But
increment in deposit of FY 2069/70 increased by 17.62% compared to last fiscal year,
whereas loans and advances increased by 17.75%. On the other hand, net interest
income of banking industry increased by 37.19% compared to corresponding quarter
of FY 2068/69, where no significant changes in investment module. But still banks
have huge change in terms of profit including 300% plus change in profit of one of
the PSB.
The major problem statement identified for this report is: What are the major factors
that have accounted for profitability of PSB in Nepal and what are comparative
factors that have contributed for profitability of each PSB in Nepal?
12
This report aims at finding the impact of both external and internal determinants upon
profitability of public sector commercial banks in Nepal. The major objectives of this
project are listed as follow:
To determine internal factors affecting profitability of PSBs in Nepal.
To understand the position of individual PSB in comparison to others PSBs in
Nepalese market.
To understand financial position of individual PSB and PSBs on benchmark of
different banking standards defined by NRB.
To analyze position of PSBs and recommend different measures from academic
perspective to strengthen their position in future.
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The major limitations of this project are mentioned as follow:
The study has been limited because of availability of data. Quarterly data of all the
required variables were available from third quarter of FY 2003-2004 in case of
NBL and RBB, but in case of ADBL, data was available from fourth quarter of FY
2008-2009. This restricted the proper impact study among two PSB: NBL, and
RBB. Complete data would have strengthened scope of the study.
The limited availability of time has limited the scope of study that restricted us
from further detailing of project. This project can be a research topic that shall
detail the impact and comparative analysis of PSB, along with other JVB and
PDB.
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Section II: Literature Review & Conceptual Framework
3.2.1Literature Review
A Book by Shrestha & Bhandari (2008) states that “Commercial banks are one of the
major financial intermediaries, whose primary function is the transfer of monetary
resources from the savers to the users.”These institutes are leading financial entities
responsible for issuing of demand liabilities and making loan to business in as
tradition that goes back several years. This concept of banking at local level has now
advanced to cross border in order to facilitate import and export operation involved in
trade financing facilitated through different level of commercial banks [ CITATION
Eun11 \l 1033 ]. One of the literatures accumulates the functions of commercial banks
in broad category of primary and secondary functions. It writes, the primary function
of commercial banks include: acceptance of deposits, advancing loans, creation of
credit, clearing of cheques, financing foreign trade, and remittance of funds; whereas
secondary services are agency services (collection and payments of credit
instruments, purchase and sale of securities, collection of dividends on shares,
correspondents, income-tax consultancy, execution of standing orders, acting as
trustee and executor), and general utility services (lockers facility, traveller’s cheques
and credit cards, letter of credit, collection of statistics, acting referee, underwriting
securities, gift cheques, accepting bills of exchanges on behalf of customers, merchant
banking) that creates sources of incomes for banks as interest on loan, interest on
investments, discounts, commissions, and brokerages[ CITATION Scr13 \l 1033 ].
The book “Financial Markets & Institutions” by Shrestha & Bhandari (2008) suggest
that commercial banks should manage their assets and liabilites effectivelyin order to
achieve better results in long term with profit. It further discusses about the
management of assets and liabilites of bank from the perspective of sources and uses
of that is used to match the level of assets and liabilities.It further discuss about the
liability management of bank, which includes equity & reserves, deposits,
borrowings, and other liabilities (subjected to day to day fluctuations). On the other
hand, it also incorporates about the asset management of banks that is responisble for
efficient operations of all the commercial bank that includes efficinet operation and
profitability that converts liabilites into earning assets. The assets here includes: cash,
investments, loan and advances, fixed assets, and other assets.Proper management of
15
assets and liabilities is responsible for profitability, efficiency, and viability.. The book
further discusses about the concept of maturity structure of assets and liabilities which
shows the transformation effects on the best use of assets and effective utilization of
funds under as specified maturity structure. It further states the mismatch in assets
liabilities shall lead to problems in liquidity, credit recovery, fluctuations in interest
rates, and many other contingent financial catastrophe.
The combined research findings by Bourke (1988), Molyneux & Thornton (1992),
Williams & Thornton (1994), Williams, Molyneux, & Thornton(1994), and
Allen(1997) further elaborates the internal determinants as capital ratios, liquidity
ratios, assets and liability portfolio mix, and overhead expenses. It further states that
banks should focus on areas where they do have competitive advantages in endeavor
to maximize efficiency in credit policy, and related customer-service. This further
leads to bank’s concentration by geography, industry, demographics, and other market
characteristics that possess differential impacts upon bank riskiness and profitability
with respect to dynamics of economic condition of different regions and sectors. In
contrast, the research explains about the external determinants of bank’s profitability
subdivided into categories of environment related factors (market structure,
regulation, inflation, interest rate, and market growth), and firm specific factors (firm
size and ownership).
A study on the determinant of bank net interest rate margins in 10 SSA countries by
(Al-Hashimi (2007) found that credit risk and operation inefficiencies is responsible
for significant variation in net interest margins across the region. The study further
states that macroeconomics risk is accounted for limited effects on net interest margin.
16
margins and bank returns shall decompose income effects that shall further affect the
behavior of depositors and borrower. The paper further elaborates that the
macroeconomic and regulatory conditions possess impact upon margins and
profitability of banks.
A study on the determinants of the Tunisian Bank’s performance during the period of
1980-1995 by Naceur and Goaied(2001), explained about the best performing banks
on grounds of their improvement in labor and capital productivity, maintenance of
high level of deposit account relative to their assets, and reinforcement equity.
17
decade. The assessment categorizes them into three major categories of privately
owned domestic banks, publicly-owned domestic banks, and foreign-owned banks. A
statistics on Indian banks presented by La Porta, Lopez-De-Silanes, & Shleifer(2002)
report that the government owned banks were larger than in the other categories bank
in accounts of production and investment, despite the privatization wave of the 1980s
reduced government ownership of banks from 58.9% in 1970 to 41.6% in 1995. A
research by Ataullah & Le(2002)argued on noticeable improvement on efficiency of
privately owned banks and foreign banks in comparision to publically owned banks.
This research compared the postion of public banks with respect to other categories of
banks.
A paper by Jha & Hui(2012) on Nepalese Commercial banks suggested that Public
sector banks hold substantial shares in the total assets of industry with enormous
assets base including wide branch networks around the country. It further argues that
the public sector banks are the largest banks in Nepalese context from all the aspects
of deposits and credits to number of branches in operations.
18
other funds’ resource elements that give the bank the opportunities to have profit-
generating invested assets.
Naceur & Goaied (2001) studied the factors that affected the Tunisian Bank’s
performances during the period 1980-1995. The scope of studies includes the banks
that have maintained a high level of deposits accounts comparative to their assets.
Findings of a research illustrated that deposits have the positive and significant impact
on the profitability that deposits for funds can achieve better return on assets.
Gul, Irshad, and Zaman (2011)stated that loans has positive and significant
relationship with profitability as increase in loans possess high changes of increase in
return on assets. Ritz (2012) combined impact of both deposit and loans together and
stated that an increase in bank’s deposit base reduces the funding risk exposure of
further loan commitments. This makes loans themselves more attractive with more
concentration on asset-liability management function.
Bordeleau and Graham (2010) stated that liquid assets such as cash and government
securities generally possess a relatively low return in comparison to other money
market tools. Holding of such assets imposes opportunity cost an opportunity cost. It
further argues that banks are expected to hold liquid assets only to that optimum level
where they can maximize the firm’s profitability. Despite of these findings, an
instance during the crisis in banks in Canada and United States, banks held liquid
assets with opportunity cost, but they recognized the operational benefit of having
more liquidity that could represent robust bank to investors and funding markets
19
Morris and Shin(2010) arguedon impact on profitability of a bank’s holding of liquid
assets (i.e. cash reserves) is dependent on contingencies. The bank’s holding priorities
of liquidity depends on the funding that comes due in the short-term in general state
of economic cycle. This is to avoid the risk “sudden stop” or freeze in funding market.
Kahf (2004) stated positive relationship between growth in investment and growth in
profit of bank. Here, growth in investment indicates the bank’s ability to generate
earnings as growth in asset increases bank’s ability to invest in projects with higher
returns.
20
Miller & Noulas(1997) argued about negative relationship between credit risk and
profitability. The risk here maximized with loans, higher level of loan loss supplies
that troubles profit maximizing strength of a bank.
Accord Implementation Group, NRB(2007)states that the total risk weighted exposure
shall comprise of risk weights calculated in respect of bank’s credit, operational and
market risks reflected by the capital adequacy conditions of banks.
Some other researchers have used loan loss provisions to measure credit risk, whereas
some consider it as accounting breakdown of the revenue with negative correlation
between two variables
International Financial Management by Eun & Resnick (2011) discusses about capital
adequacy and its impact upon the risk position of bank. Capital Adequacy here, refers
to the amount of equity capital and other securities a bank holds as a reserves against
risky assets to reduce the probability of a bank failure. The basel accord defines the
minimum capital adequacy ratio for banks is 8 percent of risk-weighted assets for
internatioanlly active banks. It further breaks capital into two categories of: Tier I core
capital (shareholders equity and retained earnings), and Tier II supplemental capital
(preferred stock, and subordinated bonds). Accord Implementation Group,
NRB(2007) states that Nepalese commercial banks need to maintain at least 6% Tier-
1 capital and 10% total capital (Tier 1 and Tier 2). Tier 1 capital consists of paid-up
capital, share premium, non-redeemable preference share, general reserve fund,
accumulated profit, capital redemption reserve, capital adjustment fund, and other free
21
reserves. The Tier 2 capital comprises of general loan loss provision, assets
revaluation reserve, hybrid capital instruments, subordinated term loan, exchange
equalization reserve, excess loan loss provision, and investment adjustment reserve.
22
Sources and Uses Deposit
Investment
Investment
Investment
FIGURE 1 CONCEPTUAL FRAMEWORK ON IMPACT OF VARIABLES UPON PROFITABLITY OF PSB
At second stage, impact of bank’s profit is measured through the variables of ratio
(according to benchmark of NRB). Here, the dependent variable is ROA or ROE for
either of the model. The independent variables for both are CDR, NPL to TL, LLP to
NPL, and CAR.
23
CD Ratio
NBL
NPL to TL ROA/ROE
LLP to NPL
CAR
CAR
CD Ratio
ADBL
ROA/ROE
NPL to TL ProfiNet Profit
LLP to NPL
CAR
The logical relationship formulated between variable based upon the literature survey
are mentioned as following:
Hypothesis 1: There is positive relationship between Deposit and Bank’s profit.
Hypothesis 2: There is positive relationship between Credit and Bank’s profit.
Hypothesis 3: There is positive relationship between CDR and Bank’s profitability.
Hypothesis 3: There is positive relationship between NII and Bank’s profit.
Hypothesis 4: There is positive relationship between Cash and Bank’s profit.
Hypothesis 5: There is negative relationship between Risk factors and Bank’s profit.
Hypothesis 6: There is positive relationship between investment and Bank’s profit.
Hypothesis 7: There is positive relationship between CAR and Bank’s profitability
24
Section III: Methodology
3.3.1 Research Design
An explanatory study is undertaken in order to ascertain and be able to describe the
characteristics of the variables of interest in a situation.[ CITATION She12 \l 1033 ]
This study aims at finding the quantitative impact of different variables that determine
profitability of PSBs as a whole, thus purpose of study here is a descriptive study to
find impact of performance related variables. Such studies are also undertaken to
understand the characteristics of organizations that follow certain practices, where this
study too aims at comparative analysis between performances of PSBs in Nepal.
The project’s finding on operational efficiency shall be based on the sources and uses
of fund, liquidity condition of bank, risk position, and investment portfolio of bank.
The performances of PSB are compared on the basis of standard ratio allotted by
NRB, which shall further compare the performance and operational conditions of
banks. As mentioned in framework, the variables for impact and comparative analysis
are deposits, loans and advances, loan loss provision, cash and bank, investment. The
ratios taken for analysis as allotted by NRB are: CD Ratio, NPL to TL, LLP to NPL,
CA ratio.
Both Panel and individual data regression model were used to analyze the impact of
independent variable on dependent variable. The following are models in specific
format:
For impact of banking variables upon profitability
Profit = β0 + β1.Deposit + β2.Credit + β3.Investment + β4.Cash + β5.NII + µ
(Profit)it = β0 + β1.(Deposit)it + β2.(Credit)it + β3.(Investment)it + β4.(Cash)it + β5.
(NII)it + µit
Where, NII is calculated as net interest expenses subtracted from net interest income.
For impact of banking ratios upon profitability
(ROA) = β0 + β1.CDR + β2.NPL/TL + β3.LLP/NPL + β4.CAR + µ
(ROE) = β0 + β1.CDR + β2.NPL/TL + β3.LLP/NPL + β4.CAR + µ
(ROA)it = β0 + β1.(CDR)it + β2.(NPL/TL)it + β3.(LLP/NPL)it + β4.(CAR)it + µit
(ROA)it = β0 + β1.(CDR)it + β2.(NPL/TL)it + β3.(LLP/NPL)it + β4.(CAR)it + µit
Where, ROA is calculated as Net Income to total asset and ROE as Net Income to
Total Equity.
25
3.3.3 Data
Here, secondary data is considered for the study. For this purpose, quarterly data on
deposit, loans and advances, investment, cash, net interest income, profit/loss, ROA,
CD Ratio, NPL to TL, LLP to NPL and Capital fund to RWA from third quarter of
FY2003-04 to fourth quarter of FY 2012-13 is taken. Data were extracted from the
available quarterly financial highlights of different banks listed NRB website
(URL:http://bfr.nrb.-
org.np/bfrstatistics.php?tp=quart_fina_highlights&&vw=15), from third quarter of FY
2003-04 to first quarter of FY 2010-2011. Remaining are collected from respective
website of NBL (URL: http://nepalbank.com.np/financialresults/index.php), RBB (URL:
http://www.rbb.com.np/financial_reports.php), and ADBL (URL: http://adbl.gov.np-
/adbl_progress_report.html)
In term of data, we have taken available data from different source thus convenience
sampling is done. Here, for research we have taken data from third quarter of 2003-04
for NBL and RBB, whereas from fourth quarter of 2008-09 for ADBL.
26
Sources and Uses of Fund: Sources and uses of fund are represented by Deposits,
and loans of bank (Naceur & Goaied, 2001; Gul, Irshad, & Zaman, 2011). Return
generate through both of the variables are represented by Net Interest Income that
represents the operational efficiency of bank in terms of lag between receipt and
payments. CDR represents banks generation of credit out of its deposit which
represents the ratio between uses and sources of fund. Positive relationship is found
between sources and uses of fund and profitability of bank.
Risk: Loan Loss Provision is one of the major indicators of banks risk position as
significant risk lies is loan turning out to be non-performing one. Khizer, Farhan, &
Zafar (2011) found negative relationship between risk and profitability of bank. Risk
can further be illustrated by NPL to TL, LLP to NPL and CAR. CAR represents
banks’ ability to absorb contingent risk that has positive impact upon profitability.
Investment: Investment is another major source to generate return for Banks. Growth
in investment indicates the bank’s ability to generate earnings because of growth in
asset [ CITATION Kah04 \l 1033 ]. Thus investment possesses positive impact upon
profitability of bank.
27
Section IV: Presentation and analysis of the project
3.4.1 Descriptive analysis for Variables
The summary of descriptive analysis for both panel and individual data of variables
illustrated the following outcome: (Detail in Annex 2, 3, 4, 5) (in ‘000)
The descriptive study of data illustrated that deposit has highest fluctuation during the
period of study. It is followed by credit figures. Least fluctuation is noticed in profit
and loss figure which is followed by fluctuation in NII. The highest average figure is
of deposits whereas the least average is of profit/loss. The figures further illustrated
that the highest risk is associated with deposit with higher standard deviation whereas
least in terms of profit/loss with least values.RBB has the highest standard deviation
in all of the aspects of banking variables (deposit, credit, investment, cash, and LLP).
ADBL has high variability in LLP, whereas NBL has least variance in terms of their
banking performance.
Ratios:
The descriptive analysis for variables of ratio illustrated the following outcome:
(Detail in Annex 6, 7, 8, 9)
28
The data illustrated highest fluctuation in ROE during study period whereas least
fluctuation in ROA. Some exceptional figures were seen for CDR where credit is
greater than deposit. Data for LLP had highest standard deviation that indicates the
bank’s risk hedging position along with funds invested in loan/credit. Both indicators
for return ROA and ROE suggested lower return for overall PSB in Nepal. PSB are in
risky position with high Non-performing assets as suggested by NRB directives.
Values for CAR suggest too low values that suggest least risk absorption capacity of
PSBs over time excluding some good figures for ratio as per NRB standards.
Variables
The correlation analysis suggested the following result for variables:
. correlate
(obs=90)
Deposit 1.0000
Credit 0.5192 1.0000
LLP -0.2544 -0.1388 1.0000
Investment 0.7082 0.0978 -0.2282 1.0000
Cash 0.6893 0.2858 -0.2628 0.4521 1.0000
Spread 0.2913 -0.0940 -0.0652 0.7783 -0.2082 1.0000
ProfitLoss 0.2534 0.2657 0.0908 0.1220 0.1413 0.0343 1.0000
.
TABLE 5 CORRELATIOTABLE 6N ANALYSIS OF BANKING VARIABLES
The hypothesis of no correlation among the variable is rejected as there existed some
degree of correlation among variables. Among variables, NII has highest degree of
positive correlation with profitability (0.6927) of banks followed by credit (0.2657)
and deposit (0.2534). LLP is negatively correlated with all the variables except for
profit with lower degree of positive correlation (0.0908). The net interest income is
negatively correlated with investment (-0.1059), and least correlated with cash
position (0.0843). Cash and investment are positive high correlation with deposit
0.6893 and 0.7083 which suggest deposit being one of the major sources of fund for
bank. Negative correlation of LLP with deposit (-0.2545) and credit (-0.1388) suggest
that with more of deposits and credits, bank must maintain least in loan loss provision.
Ratios
29
There exists a degree of correlation between the variables in terms of various banking
performance as illustrated by tables below:
. correlate
(obs=81)
ROE 1.0000
CDRatio 0.0536 1.0000
NPLtoTL 0.0243 -0.2994 1.0000
LLPtoNPL 0.1047 0.3660 -0.4456 1.0000
CA 0.0589 0.7865 -0.6417 0.5697 1.0000
There exists high positive correlation between CAR and CDR (0.7865). All of the
variables are least positively correlated with ROE between ranges of 0.02 to 0.1. LLP
to NPL is positively correlated with CDR (0.3660) and CAR (0.5697).
. correlate
(obs=81)
CDRatio 1.0000
NPLtoTL -0.2994 1.0000
LLPtoNPL 0.3660 -0.4456 1.0000
CA 0.7865 -0.6417 0.5697 1.0000
ROA 0.5719 -0.1898 0.4858 0.6025 1.0000
ROA is positively correlated with CDR (0.5719), LLP to NPL (0.4858), and CAR
(0.6025)
The summarized STATA output for regression analysis for individual PSB illustrated
the following outcomes: (Details Annex 10, 11, 12)
Variables Coefficient(NBL) Coefficient (ADBL) Coefficient (RBB)
30
(0.793) (0.192) (0.615)
Investment -0.096 -0.0005 -0.003
(0.005) (0.984) (0.825)
NII 0.48 0.52 0.8
(0.000) (0.043) (0.000)
Constant 651875 223585 992774
(0.197) (0.878) (0.000)
TABLE 9 SUMMARIZED REGRESSION OUTPUT FOR BANKING VARIABLES
31
significant impact. This accepts hypothesis 4 and rejects hypothesis 2, as Rs.1000
increase in NII increases profit by Rs.800, and keeping all factors constant, profit
increases by Rs.992774. On The other hand, Rs.1000 increase in credit decreases
profit by Rs.20. High impact of NII on profit makes bank highly sensitive on interest
rate fluctuation. This model also suggests poor credit policy of bank as bank is not
generating profit from its credit investment. Negative insignificant coefficient for
deposit infers bank not being able to mobilize its deposit. Coefficient for investment
having negative but insignificant impact suggests poor investment policy of Bank.
Cash that possess positive but insignificant impact also suggest improper investment
policy.
Based on the individual regression analysis of each PSB, the interest spread is found
to be the significant factor that affects the bank’s profitability (except credit for RBB
and Investment for NBL). This makes PSBs highly sensitive of interest rate, with
inefficiencies in their operation of sources and uses, investment and risk hedging
positions.
Based on the panel data regression of all the PSBs, deposits, credit, LLP and NII have
been the significant factors which have contributed to the profit of PSBs. Out of these
four significant variables, increase in deposits by Rs.1000 will increase the profit by
Rs.13, increase in LLP by Rs.1000 will increase the profit by Rs.37 and increase in
NII by Rs.1000 will increase the profitability by Rs.500. Only in case of Credit which
if increase by Rs.1000 will decrease the profit by Rs.20. This result accepts
hypothesis 1 and hypothesis 4, where deposit and NII has positive impact on profit of
banks. IT rejects hypothesis 2 and hypothesis 6 where credit has negative impact on
profit whereas LLP has positive impact on it.
Deposit is one of the major sources of bank’s fund that has positive impact upon
profitability. At PSB level, the deposits are mobilized efficiently that has generated
32
return for banks. On the other hand, negative impact of credit upon profitability
indicates poor policy and credit standards of PSB. Investment and cash in hand was
not found to be significant contributors of banks profitability. Investment has positive
but non-significant contribution on profit. This infers banks ineffective investments or
macroeconomic condition that possesses limited of such investment opportunities to
ensure better return on such. Cash has negative but non-significant impact on profit.
Having least money market tools and platform makes banks inefficient in terms of
mobilizing their cash in short term tools, where excessive cash are invested
immediately and sold back at nominal transaction cost at time of shortage.
3.4.5 Regression analysis (ratios)
In the data analysis of RBB, we found the variables CA, LLP to NPL and NPL to TL
to are significant based on STATA output at 95% level of confidence. This accepts
33
hypothesis 8, whereas rejects hypothesis 6 for risk factors having positive impact on
profitability of bank. All of those variables have positive impact upon the ROE of the
RBB. The R-square of 54% shows that 54% of the total variation in the ROE is due to
the effects of independent variables. 1 unit increase in CA will lead to 2.09 unit
increase in ROE of the bank. Similarly the increase in 1 unit of LLP to NPL and NPL
to TL will lead to 1.64 and 1.9 unit increase in ROE respectively. This further
indicates more capitalization in form of equity capital leads for increased profit. It
also implies this bank’s success in writing back its non-performing loans and book
LLP as profit.
In the data analysis of ADBL, when ROE is taken as a dependent variable, and other
various ratios as independent variables, we found none of the variable to be
significant based on the regression of STATA output at 95% level of confidence. The
R-square is also found to be only 10% which shows that the model is not a better
predictor of dependent variable. The bank is not efficient enough in its operational and
capital parameters to generate efficient profit through it.
For panel data regression with ROE as dependent variable, Panel Ratio with ROE As
dependent, we found none of the variable to be significant based on the panel
regression of STATA output at 95% level of confidence. The overall model itself is
also insignificant as we can see the Prob.>chi2 is 0.82, where the null hypothesis of
no impact cannot be rejected. The model was insignificant in sensitivity test by
removing any of the variables so result is based upon the exact model. This implies
that PSB are unable to mobilize the fund deposit pool with non-significant CDR. NPL
seems insignificant because of poor credit policy of banks. These ratios are
insignificant in terms of defining their impact on ROE of bank.
34
CDR -0.013 0.0133 -0.0315 0.017
(0.433) (0.747) (0.027) (0.539)
NPL to TL 0.0033 -0.243 -0.036 0.076
(0.746) (0.388) (0.096) (0.015)
LLP to NPL 0.005 -0.009 0.0125 Removed
(0.108) (0.549) (0.548)
CAR 0.055 0.064 -0.042 0.105
(0.733) (0.701) (0.077) (0.000)
Constant 0.0074 0.053 0.011 0.019
(0.574) (0.618) (0.708) (0.290)
For RBB, With R square of 27%, at 95% level of confidence, and Prob > F is greater
than 5% which also shows that the overall model is insignificant. The overall
operational and capital parameters have failed to have impact upon ROA parameter.
Being some of the variables significant does not have impact of independent variables
upon dependent variable.
For ADBL, it is stated that none of the variable is significant at 95% level of
confidence. The R square is only 7% and Prob. > F is greater than 5%, which shows
that the model is not significant to determine impact on dependent variable similar to
ROE as dependent variable.
35
significant amount of NPL ratio in past that has created tendency of positive impact of
NPL over profit condition. NPL later recovered and written in form of profit made
NPL positively significant on profitability of bank. PSBs are not able to mobilize their
deposit with insignificant CDR. This finding further strengthen findings of previous
model. The poor asset quality of bank in term of poor credit policy is reflected in
ROA.
Normality Test
The graphical normality plot of different variables with Profit/Loss, Ratios with ROA
and ROE as dependent variable (Refer to Annex 23, 24, 25) has a fixed upward
moving pattern, thus they are normally distributed. The Histogram from the STATA
output (Refer to Annex 26, 27) figure shows that the residuals of banking variables
with Profit/Loss as dependent variable and ratio with ROA are normally distributed
with a symmetric bell shaped with right side skewness. That of ROE is seems not
normally distributed as it shows double top pattern. (Refer to Annex 28)
Hausman Test
Hausman test was carried out to choose between fixed and random effect model. As
the result was significant for both banking variables and ratio with ROA, so fixed
effect model was used. (Refer to Annex 29, 30, 31). In case of ROE, random effect
was chosen.
Wooldridge Test
Wooldridge test for autocorrelation in panel data of different variables with
Profit/Loss, ROA and ROE was used to check the autocorrelation. The null here is no
serial correlation. We fail to reject the null and conclude the data does not have first-
order autocorrelation for Profit/Loss (0.25>0.05), and ROE (0.0997>0.05)(Refer to
Annex 32, 33). But in case of ROA, there is first order autocorrelation (0.0054<0.05)
(Refer to Annex 34)
To remove the auto correlation, we removed independent variable LLP to NPL from
ROA regeression. The output failed to reject the null and conclude that there is no
auto correlation (0.084<0.05). (Refer to Annex 35)
36
The variables such as deposits, loans and advances, Loan Loss provision, and Net
Interest Income were statistically significant whereas, Cash & Banks, Investment
were statistically insignificant to have impact on PSB’s profit.
The ratios such as NPL to TL and CAR were statistically significant to have impact on
ROA (when LLP to NPL was removed) of PSBs, whereas CDR and LLP to NPL were
statistically insignificant. On the other hand, all these ratios were statistically
insignificant to have impact upon ROE of PSB’s.
At individual PSB’s level, NII is statistically significant for all PSB to have impact
upon their profit. Credit for RBB and Investment for NBL were also statistically
significant. Cash and LLP were insignificant for all the PSBs.
In terms of ratio, CAR, LLP to NPL, and NPL to TL were statistically significant to
have impact on ROE of RBB, whereas CDR has significant effect on it ROA. All the
ratios were statistically insignificant to have impact on ROE and ROA of other two
PSBs as NBL, and ADBL.
Deposits and have positive impact upon the profit of PSBs as a whole. It supports the
findings of Naceur & Goaied (2001) of deposit having positive and significant
relationship with profitability of banks. On the other hand, the findings at individual
PSB’s level contradicted the findings in literature survey where, deposits have non-
significant negative impact upon profit. On contradiction, credit has negative impact
upon profit of banks. This contradicts the finding of Gul, Irshad, and Zaman (2011).
The outcome of deposit and credit in terms of NII possess high positive impact upon
profitability of banks. The findings were strengthened by CDR not being significant
for both profit indicators (except only for ROA of RBB).
Measures proxy to Risk position has positive impact upon profitability of Banks. LLP
being statistically significant for profit of PSB with positive coefficient had
contradictory result with findings of Miller & Noulas(1997). NPL to TL having
significant positive impact upon ROA of PSB further strengthens the findings.
Significance of NPL to TL and LLP to NPL for RBB agrees with findings of
Brissimis, & Delis (2008) where risk management has positively affected profit,
contradicts the results of other findings on literature survey. Positive impact of CAR
on ROA of PSB, and ROE of RBB supports findings in literature survey.
37
Considerable amount provisioned as LLP written back as profit on other quarter had
positive impact.
Liquidity measure (cash and bank) has no significant impact on profitability of banks
both at PSB and individual level. Having negative but no significant impact on profit
of PSB, and RBB at individual level makes findings strongly contradicting against
findings of Bordeleau and Graham (2010) where more liquidity assured operational
benefits to the banks.
Investment has no significant impact upon profitability of PSBs (except for negative
impact on profit of NBL). This variable has positive but no significant impact upon
profit of PSB. The insignificance of data rejects the argument that investment has
positive impact upon profit of PSB both at individual and macro level with
contradiction to findings of Kahf(2004). Lack of investment opportunities and
platform at macroeconomic environment, and regulatory implications for mode of
investment has further supported this contradictory finding against different referred
literatures.
38
Section V: Conclusion and recommendation
3.5.1 Conclusion for Public sector banks
For PSB, deposit, credit, LLP and NII has impact on its profitability. Among them,
NII has largest contribution upon profit that supports existing findings from recent
quarterly report. Half amount of NII, contributing on profit infers wide interest rate
spread of banks. This keeps Public Banking System under risk imposed by monetary
policy or direct regulatory actions from CB. PSB’s earnings are highly sensitive to
interest rates.
Deposits and credit being significant for profit, but credit having negative impact
suggests poor credit policy in terms of mobilizing fund. Non-significant of CDR on
both ROE and ROA illustrates large chunk of idle fund in Public Banking System.
This finding is further supported by above average ratio of NPL to TL.
PSBs are successful in terms of writing back their NPA with positive impact of proxy
risk indicators upon profitability. Further, PSBs are under-capitalized in terms of
equity to cover risk associated with holding assets. Pumping equity capital into Public
Banking System shall have positive impact upon their profitability. Insignificance of
cash and investment for industry reflects poor macroeconomic conditions for
investment in long term as well as short term instruments.
RBB is found to be risky in comparison to other PSB in Nepal. The position seems
risky because of huge deposit variability, credit variability, less variability in risk
hedging position, investment variability, net income variability, and profit and loss
variability. ADBL has secured hedged position with high variability in LLP, whereas
NBL has least variance in terms of their banking performance. CD ratio for PSBs has
been very low according to standards of NRB. All three PSBs possess poor asset
quality in terms of NPL that imposed credit risk along with liquidity risk for business.
The average CA of bank is negative because of heavy accumulated loss in past.
NII has highest impact upon profit of all PSBs at or above the industry average and
this variable has highest impact upon profitability compared to other individual
variables. Thus, it concludes that all the PSBs are highly sensitive to interest rate
39
fluctuations.. None of PSBs are able to mobilize their deposit with negative return on
credit. All the PSB hold idle fund that is not mobilized in any of productive sector.
Apart from NII, negative impact of investment for NBL and credit for RBB concludes
that all PSB are lacking efficiency in their operation. Among three, ADBL hold strong
position followed by RBB and NBL in terms of both banking variables and ratios.
RBB is under-capitalized in terms of equity capital, which signifies further addition of
capital adds on its profitability. Lack of proper credit policy has reduced profitability
on further issue of profit. CA and NPL affect ROA, whereas CD ratio affects ROE for
RBB. None of ratios have impact upon profitability of other individual PSB.
3.5.3 Recommendations
The study illustrated those PSBs profitability is immensely dependent upon net
interest income generated through its operation. On the other hand, it is allocated that
they can be in better condition if they can properly utilize their deposits into some
better market segment to add profitability of bank. Thus, the primary focus of bank
should be on reducing risk that is through interest rate fluctuation and allocate
alternatives for the use of fund that contributes to add upon the profitability of bank.
Some of the recommendations for PSBs in Nepal:
The study illustrated that Net Interest Income is one of the major sources for
profitability of PSBs in Nepal, thus it is sensitive to changes in interest rates. Here, we
recommend PSB to formulate an immunization technique to immunize the funding
gap. A book by Shrestha & Bhandari(2008) states that funding gap is the difference
between assets and liabilites sensitive to the variation in interest rate in terms of
income and expenses. The mismatch or imbalance in their protfolio composition of
asset and liabilities. Mathematically,
GAP = Variable Rate Asset – Variable Rate Liabilities
It further adds that interest rate change over planing horizon to manage bank’s assets
and liabilities, where net interest margin can be used to immunize the net interest
income. Banks can immunize when variable rate assets equals variable rate liabilities.
Mathematically,
∆ NII =[VRA x ∆ARVA – VRL x ∆ARVL] or (RSA - RSL) ∆Ri
= (VRA – VRL) ∆r
= GAP x ∆r
40
∆ NIM
Thus, GAP=EA x
∆r
Where, NII – Net Interest Income, VRA/VRL – Variable Rate Assets/Liabilities,
ARVA/ AVRL – Average Variable Rate Asset/Liabilities, R – Interest Rate , EA-
Earning Assets
Thus, bank can immunize the funding GAP immunizing the value of bank’s equity by
setting it to zero. The relationship can further be illustrated by:
d x NII
E=
r
Where, E= Equity, d=dividend
Change in equity depends upon change in interest rate as it affects the present value of
dividends to shareholders. Thus, expanding formula to immunize equity against
interest rate fluctuation can be as:
d x ∆ NII E
E= – x ∆r
r r
This helps bank to immunize itself from the interest rate risk creating balance between
rate sensitive assets and rate sensitive liabilities. PSBs can immunize the gap between
such assets and liabilities and ensure return in case of both interest rate changes. This
too reduces the risk position of firm against the macroeconomic variables that
fluctuates the interest rate of the firm.
The accumulated non-performing loan of bank has signified poor credit policy of
PSBs. The banks must focus on developing better credit policy to ensure quality of
their assets. Amounts in NPA reduce credibility of bank and negatively affects
profitability of bank. Since, profitability of banks is highly affected by NPA position
of PSBs. The banks should invest some money to write back those NPA into
performing one, dragging it down to the recommendable level. Some of the measures
to recover NPL for government banks can be:
Restructuring loan: Under this strategy, the banks can negotiate with the parties
to change installment amount, interest rate, time horizon for ease of burrower.
This system can be integrated with the loan amount below 10 million.
Mobile branch: The banks can even mobilize employees in the area with high
accumulation of bad loans to monitor, evaluate, and take necessary action against
41
them. This team can identify the reasons behind their asset quality and suggest
measures to amend credit policy of banks.
This measure also adds strength in position of banks adding confidence on depositors,
investors and other stakeholders.
Study showed that the CD ratio of PSBs is below the acceptable level, which suggests
that funds are unused within banks at significant amount. For this, bank must allocate
different sources where bank can invest upon its fund. For this, some suggested
measures are as following:
Banks must strengthen its marketing activities that can market its products at
public level. Since, not much marketing effort is seen from PSBs, the excessive
funds can be spent for marketing activities. These banks can follow the marketing
techniques by some of the private sector and joint venture banks in electronic and
print media. The marketing activity may also include awareness program at rural
areas of country to aware people about banking and its importance. This can bring
the traditional methods of lending and borrowing into a formal banking procedure.
42
Research department in most of the PSBs are in almost inactive state. These banks
need to strengthen their research activities in order to allocate new products
(deposits and loans), as well as feasible market segment to expand its business.
The research must target on the feasibility analysis at rural level, where no formal
channel of banking exists. This too shall help banks to mobilize their funds in new
sector (both agro and manufacturing) creating better CD ratio.
The capital adequacy condition of PSB is not good as they are far below the
recommended level suggested by NRB. This helps to allocate the banks capacity to
meet the time liabilities, and other risks. Since the ratio is negative at both PSB level,
and individual banks level of public sector, banks can further add up capital that better
capitalizes them to meet the timely contingencies avoiding the risk. Capital restructure
plan of NBL on previous quarter have almost brought back the negative ratio in
positive figures, whereas RBB is in just positive figures. This signifies that banks can
further add up the equity to bring back net worth into positive figures thus adding
confidence in banking as well as investors by providing them timely return in form of
dividends. This too shall further strengthen position of PSBs in capital market with
huge confidence of investors. Here we suggest them to improve condition of CA by
adding Tier-1 capital (equity funds) promoting it to institutional investors, and
individual investors that shall help in adding positive figure in Capital condition of
banks.
e) Consortium Financing
Consortium financing is the best option for banks to mobilize deposits into mega
profitable projects. If significant portion of deposits are idle within banking system
without proper platform to invest them, they can go for Consortium Financing among
themselves for big projects. Hydroelectricity, telecommunication, aviation are some
prospects that have long term market demand. Such projects can add better return in
future.
43
f) Penetrate into new market segment
Different new market segment for banks has been arising in today’s context. In such,
PSBs have better fund position to launch themselves into feasible new market
segment. Once of such segment can be sector of mutual fund. Some private banks
such as Siddhartha Bank Ltd, NABIL Bank Ltd, and Nepal Investment Bank Ltd,
have already launched themselves into this new market segment. PSBs can better
launch themselves into sector of such investment banking where they can further
mobilize their funds, and add new investment opportunities apart from traditional
investment methods of government securities and interbank lending at nominal
interest rate. This too shall help in strengthening capital market position of country
creating liquidity in secondary capital market.
44
recommendation) in parallel to credit policy as suggested in recommendation. The
performance of amended policy should be reviewed and evaluated in
corresponding next quarter.
2. Banks should study the feasibility of marketing plan and execute the same within
two months. A marketing research can be conducted to find out the gap and
efficiency of the executed plan in the next quarter and make necessary changes if
there is any deviation from the expected outcome. After that, effectiveness of
program should be analyzed every month.
3. Banks should then analyze the feasibility of fund gap immunization technique in
parallel with other action through team of finance department. This may take
panel of experts (from finance, credit, and planning department) and approximate
two month period to formulate a feasibility report. If in case, it is feasible, they
shall implement it by next quarter, in order to minimize interest related risks. The
review of policy should be made every quarter.
4. In case the marketing plan execution will not be able to capitalize the deposits and
loans, the PSBs management committee should plan for the consortium financing
with other PSBs, within the next quarter of implementation of reform plan. The
cross organizational panel should be formed in order to study on feasibility of
such financing mode. The joint committee should study the feasibility of various
mega projects and present the report to the management by a quarter after its
commencement.
5. All the three PSBs have gone through change in their paid up capital recently,
however in case of ADBL the capital adequacy is strong whereas those of RBB
and NBL are below the benchmark level. Since, capital has positive impact upon
profitability; banks should find optimal capital condition by adding Tier-1 capital
in their structure with more funds through big institutional investors. Moreover,
they should come up with new capital plan within the end of this fiscal year.
6. If companies have adequate fund position after implementing policies, they can
further penetrate themselves in investment banking being sponsor for mutual fund.
This shall provide new investment opportunities for banks in capital market. This
creates opportunities to bank to get involved in investment activities generating
efficient returns on their investment.
7. In long term, if inefficiencies are not eradicated, they must go for merger
consolidating their asset and capital base. The outcome shall be competitive,
improvised banking to compete with international banks in domestic market.
45
46
Part four: Reflection of Internship
Three months of internship at Nepal Bank Limited has added learning and experience
in our profile. All the task and environment were considered to be new opportunities
that granted us with platform to explore our classroom theories into real time
experiences. This experience enhanced our understanding about banking and various
other processes to finance banking fund requirement.
47
Professionalism
Being a part of the organization, we got opportunity to adapt into various work ethics
like punctuality, deadlines, business etiquettes, and value of providing quality
services. Though we were not directly involved with the interaction with customers,
we showed professionalism by our formal dress-up, punctuality and quick completion
of tasks. Moreover, after completion, we are used to with the office environment and
time management, which will further be beneficial in our working career. It also gave
us an opportunity to polish our writing skills while sending out business emails, letters
and while communicating within the intra-network with other staffs in the
organization.
Market Research
A comprehensive research was conducted to study Comparative Study on Impact of
Operational Efficiency, Liquidity, and Risk upon Profitability of PSBs in Nepal. It
was an opportunity to learn the systematic process involved while conducting a
research. The process included steps like designing research through interaction with
intern supervisor, senior manager and senior staffs of the bank. Moreover, we also
learnt thoroughly the tools and techniques of research, output generation through
STATA and concrete analysis of the results. The insightful information from members
of management, and staffs shall help us further explore on similar such topics.
48
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51
Annexes
52
Annex 2: Panel (Variables) Descriptive table and chart
. summarize
250,000,000
200,000,000
150,000,000
Deposit
Credit
LLP
100,000,000 Investment
Cash
NII
Proft/ Loss
50,000,000
0
06 08 10 12
0 5- 07- 09- 11-
20 20 20 20
-50,000,000
53
Variable Obs Mean Std. Dev. Min Max
200.00%
150.00%
100.00%
ROE
50.00% ROA
CDR
NPL to TL
0.00% LLP to NPL
04 08 11 CAR
0 3- 07- 10-
20
-50.00% 20 20
-100.00%
-150.00%
55
. summarize
. summarize
56
. regress ProfitLoss Deposit Credit LLP Investment Cash NetIntInc
57
. regress ProfitLoss Deposit Credit LLP Investment Cash NetIntInc
sigma_u 0
sigma_e 311915.64
rho 0 (fraction of variance due to u_i)
58
. regress ROE CDRatio NPLtoTL LLPtoNPL CAR
59
. regress ROE CDRatio NPLtoTL LLPtoNPL CAR
sigma_u 0
sigma_e .56619569
rho 0 (fraction of variance due to u_i)
60
. regress ROA CDRatio NPLtoTL LLPtoNPL CA
61
. regress ROA CDRatio NPLtoTL LLPtoNPL CA
sigma_u 0
sigma_e .00740383
rho 0 (fraction of variance due to u_i)
62
. xtreg ROA CDRatio NPLtoTL CA, re
sigma_u 0
sigma_e .0203211
rho 0 (fraction of variance due to u_i)
63
1.00
N orm a l F [(resid s-m )/s]
0.25 0.50 0.00 0.75
64
Annex 26: Histogram with P/L as dependent
1.0e-06
Density
5.0e-07
0
65
Annex 28: Histogram with ROE as dependent
6
4
Density
2
0
-.2 -.1 0 .1 .2
Linear prediction
. hausman FE RE
Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
FE RE Difference S.E.
chi2(6) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 104.33
Prob>chi2 = 0.0000
(V_b-V_B is not positive definite)
66
Annex 30: Hausman Test Output with ROA as dependent
. hausman FE RE
Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
FE RE Difference S.E.
chi2(4) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 21.06
Prob>chi2 = 0.0003
(V_b-V_B is not positive definite)
. hausman FE RE
Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
FE RE Difference S.E.
chi2(4) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 4.51
Prob>chi2 = 0.3412
(V_b-V_B is not positive definite)
67
Annex 32: Wooldridge Test Output with P/L as dependent
. xtserial ProfitLoss Deposit Credit LLP Investment Cash Spread
.
.
68