MANAGEMENT OF COMMERCIAL BANKS

APPRAISAL OF BANKING PERFORMANCE

Introduction
Performance appraisals are use in organizations, companies, banks etc. mostly for
managerial purpose, such as making promotions and formative salaries, incentives
and bonuses. Since the 1960s, however, companies and banks have more and more
worried the use of employee assessment for motivational and organizational
planning purposes. Indeed, for many banks performance appraisal has become a
vital tool for exploit the efficiency of all aspects of the organization, from staffing
and growth to production and customer service.

Performance appraisal in any organization will be done at a precise period, like

annually or half yearly or quarterly or maybe regularly. It all depends upon the
nature or size of the organization, and sometimes necessity of the managers decide
the period of performance appraisal of their employees. Most of organizations are
insisting employee appraisal should be a continuous process and should not be
limited to a formal review once a year. The frequency of formal appraisals will
depend on the nature of the organization and on the objectives of the system.

Bank Performance
The term ‘performance’ means carrying into execution or achievement; or
accomplishment of specific activities, or the performance of an undertaking of a
duty. ‘Bank performance’ may be defined as the reflection of the way in which the
resources of a bank are used in a form which enables it to achieve its objectives.

Furthermore, the term bank performance means the adoption of a set of indicators
which are indicative of the bank’s current status and the extent of its ability to
achieve the desired objectives.

Performance Appraisal
Performance appraisal includes all formal procedures used to evaluate
personalities, contributions & potentials of group members in a working
organization. It is a continuous process to secure information necessary for making
correct and objective decisions on employees. In simple words, performance
appraisal is the systematic evaluation of the individual with respect to his
performance on the job and his potential for development.

IMPORTANCE OF MEASURING BANK PERFORMANCE APPRAISAL

Performance appraisal is a significant element of the information and control

system of the bank. It can be put to several uses concerning the entire spectrum of
"smart resource management functions.Some common applications of performance
appraisal are given below:

1. To Measure Efficiency and actual performance:- As the banking sector is

considered a vital segment of a modern economy, its efficiency is a vital
importance. In order to ensure a healthy financial system and an effective
economy, banks must be carefully evaluated and analysed.

2. To Determine contribution towards business Development:- While bank

helps business organisations by rendering a wide range of products and services,
the products and services are more or less identical from one bank to another, and
there is little scope for differntiating between them.

3. To check stability and sustainable:- It is inenviable that banks continue to

attract significant attention from the public and scrutiny by financial regulators as
there is a growing need to evaluate banks in a more efficient manner.

4. To Analyze Organisationsal Objectives:- It is very important for an institute to

work over its organizational goals and objectives. Measuring internal performance
helps in analyzing the objectives of the institution

5. Future Planning and Future Challenges:- knowing the strengths and

weaknesses helps a firm to build a better plan for future for more efficient
management. This could be usefuk infacing future challenges.

6. To Meet customer needs:- Customers are the first priority of every sound and
good commercual bank. It is important that they get to know about customer's taste
and preferences. This could be done by measuring internal performance.

7. To Gather Information:- Bank performance analysis involves gathering formal

and informal data tgat helps customers and sponsors to define and achieve their
goals. Banks are also expected to provide evidence of their credit operations and
financial flows as these influence the growth and economic development of the
country.

CONCEPTUAL FRAMEWORK OF PERFORMANCE APPRAISAL

Performance appraisal is the process of assessing the performance and progress of

an employee or of a group of employees on a given job and his/her potential for
future development. It is an objective study. Its main purpose is to secure necessary
information for making objective and correct decisions on employees. Being the
process of determining the performance of the employees on the job it helps in
communicating to them the scope for improvement if any with a proper plan of
action which leads to enhancement of performance along with building good
relations amongst superior and subordinates. It also plays an important role in the
managers to take the administrative decisions effectively relating to promotions,
fringes, payoffs and merit pay. So, performance appraisal is a must for all
organizations.
PERFORMANCE APPRAISAL SYSTEMS IN INDIAN BANKS
Banking services is one sector where a great degree of attention is being paid to
Performance Appraisal Systems. Several of the public sector banks (PSBs) have
changed their PAS or are in the process of changing them. State Bank of India has
recently adopted an open system of appraisal. Its associate banks are likely to
follow the same after detailed experiences of State Bank of India are available.
Several banks also have self-appraisal as a part of performance appraisal, although
mostly such self appraisal is more of a communication of achievements.

Allahabad Bank has introduced a system that aims in helping officers to identify
their strengths and weaknesses and encourage improvement of performance on the
job.

Indian Overseas Bank has a system in which a branch manager gives a self-
appraisal on business growth, customer service, internal administration and
training requirements in great detail.

Union Bank of India has an appraisal system in which the reporting officer is
required to assess each of his appraise officers on technical skills, human skills and
conceptual skills. All these are defined for different categories of roles and the
assessment has to be made on a five-point scale. Corporation Bank, UCO Bank,
Central Bank of India, Dena Bank and Bank of Baroda has introduced similar self-
appraisal formats.

Punjab National Bank has, primarily, a development-oriented appraisal form.

There are ten different formats available for ten different categories of employees.
The bank started the system with a self-appraisal by the appraisee. Studies of the
operating system of the successful organizations, in general, reveal that a good
PAS is the corner stone to navigate an organization successfully in this globalize
environment of uncertainty and continuous change. They have, therefore,
developed and employed such system and harnessing maximum benefits. But, like
many fields of organizational development, the PSBs are lagging behind in this
area too. Most of the PSBs have an Annual Appraisal System that is historic in
nature and documents the past activities. It is a one time annual affair only. Study
of the format of annual appraisal of many of the PSBs reveal that they are basically
uniform in character with emphasis in historical events and little or no importance
for future growth. In comparison with the new generation banks and progressive
organizations, the appraisal system in PSBs, thus, is basically dysfunctional. The
PAS, as an important component of Performance Management System, is yet to be
conceived and made operational. But developing and implementing a PAS seems
overdue and vitally important.

TOOLS FOR MEASURING BANK PERFORMANCE

The performance of any bank is measured basing upon different parameters:

● Business - Business relates to total deposits and total advances as at the end
of financial year. The size of any bank is decided by the total business
position of any bank. In India State Bank of India is the largest bank in terms
of business
● Capital adequacy ratio - According to Basel II norms, banks have to
maintain the stipulated capital adequacy ratio and earlier the banks had to
maintain at least 9 percent ratio.
● Asset quality - When it comes to banks, assets mean the amount
outstanding in the loan portfolio and the quality of assets denotes that the
bank is able to generate income from the loan accounts. Generation of
income means that the banks are regularly paying the monthly instalments
on their term loans and interest on the working capital limits and there are no
non performing assets. Normally, banks will be having non performing
assets and a bank which is having nil non performing assets is considered to
be having better asset quality.
● Management - The efficiency of the management and as to how effective in
running the banks matters a lot.
● Earnings - The total profit earned by the bank as at the financial year.
● Liquidity - The liquidity position of the bank at any point of time
● Systems and procedures - How far the banks are maintaining their internal
records. In the case of banks where the documentation and other aspects are
kept properly, there will be lesser number of internal frauds and it denotes
that the banks have systems and procedures in their control
● Profit per employee - Profit earned by the bank divided by number of
employees denotes this ratio
● Productivity per employee - Total business of the bank divided by number
of employees denotes this ratio
● There are still many more ratios and calculations and there are certain
agencies which are involved in studying the performance of the bank and
they do publish the the details for the information of the public. A bank can
be considered as a better performing bank basing upon several parameters
 and the net score gained by them in all parameters. Mere total business will
not define a bank as a better performing bank.

EVALUATING BANK PERFORMANCE

-A Framework for Evaluating Bank Performance
•Internal Performance
•External Performance

•Presentation of Bank Financial Statements

-Analyzing Bank Performance with Financial Ratios
•Profit Ratios
•Risk Ratios
-Internal Performance Evaluations Based on Economic Profit
•RAROC (Risk-Adjusted Return on Capital)
•EVA (Economic Value Added)

A FRAMEWORK FOR EVALUATING BANK PERFORMANCE

Internal Performance
-Bank Planning(policy formulation)

goals, budgets, strategic planning

-Technology

computers, payments, communication

-Personal Development

challenges (personal selling & geographic expansion)

job satisfaction (training & Compensation)

External Performance
-Market share
Earnings effects
Role of technology
-Regulatory compliance
 Capital
Lending
Securities
Other
-Public confidence
Deposit insurance
Public image

Presentation Of Bank Financial Statements

-Balance sheet (Report of Condition)
Assets: cash assets, loans, and securities
Liabilities: deposit funds and nondeposit funds
Capital: equity capital, subordinated notes and debentures, loan loss reserves

-Income Statement (Report of Income)

Interest income
Non interest income
Interest expenses
Noninterest expenses (including provision for loan losses)
Net profit

ANALYZING BANK PERFORMANCE WITH FINANCIAL

RATIOS

Profit Ratios
•Rate of return on equity
ROE = NI/TE (net income after taxes/total equity)
•Rate of return on assets
ROA = NI/TA (net income after taxes/total assets)
•Other profit measures
Net interest margin
NIM = (Total interest income - Total interest expense)/Total assets
Note: municipal bond interest is not taxable, such that it must be grossed up to a
pre-tax equivalent basis by dividing munis interest earned by the factor (1 - tax rate
of bank).
•Unraveling profit ratios
ROE = ROA x TA/TE (total assets/total equity or equity multiplier).
Thus, by decreasing equity, a bank can increase ROE based on any given level of
ROA.

ROE = NI/OR x OR/TA x TA/TE (where OR is operating

revenue).

The NI/OR ratio is the profit margin, while OR/TA reflects asset utilization. By
using this breakdown, one can make inferences concerning the reason for say
increases in ROE. If asset utilization and equity multiplier did not change, the
profit margin must have increased due to cost savings pushing this ratio up.

Risk Ratios
•Capitalization
Leverage ratio
Total equity/Total assets
Total capital ratio
(Total equity + Long-term debt + Reserve for loan losses)/Total assets
Note: book values and market values likely are different and yield different
results.
•Asset quality
Provision for loan loss ratio= PLL/TL (provision for loan losses/total loans and
leases)
Loan ratie= Net loans/Total assets
Loss ratio= Net charge-offs on loans (gross charge-offs minus recoveries)/Total
loans and leases

Reserve ratio= Reserve for loan losses (reserve for loan losses last year minus
gross charge-offs plus PLL and recoveries)/Tota loans and leases
Non performing ratio = Nonperforming assets (nonaccrual loans and restructured
loans)/Total loans and leases

•Operating efficiency (cost control)

Wages and salaries/Total expenses
Fixed occupancy expenses/Total expenses
•Liquidity
Temporary investments ratio = (Fed funds sold, short-term securities, cash, trading
account securities)/Total assetsVolatile liability dependency ratio = (Total volatile
liabilities - Temporary investments)/Net loans and leases
Note: This ratio gives an indication of the extent to which “hot” money is being
used to fund the riskiest assets of the bank.

•Other Financial Ratios

Tax rate = Total taxes paid/Net income before taxes
Dollar gap ratio = Interest rate sensitive assets - Interest-rate sensitive liabilities
Total assets where rate-sensitive means short-term with maturities of less than one
year (or re-priced in less than one year).

INTERNAL PERFORMANCE EVALUATION

Based on Economic Profit

RAROC and EVA
Both methods are beneficial in assessing managerial performance and developing
incentive compensation schemes compatible with shareholder wealth goals.
RAROC has a short-run perspective (i.e., business unit profit is compared to the
unit’s capital at risk)
EVA has a long-run perspective (i.e., business unit profit is compared to the cost of
capital of the bank)

EVA is an approach to measuring performance that compares a bank’s (or line of

business) net operating profit after-tax (NOPAT) with a capital charge.

Economic Value Added (EVA) is the capital charge which represents the required
return to stockholders assuming a specific allocated risk capital amount.