PERFORMANCE EVALUATION OF SELECTED BANKS USING ECONOMIC VALUE ADDED ABSTRACT
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1 PERFORMANCE EVALUATION OF SELECTED BANKS USING ECONOMIC VALUE ADDED Dr. Shivappa, Associate Professor, Kousali Institute of Management Studies, Karnatak University Dharwad. Mrs. Jyoti N Talreja, Assistant ProfessorDept. of MBA, Gogte Institute of Technology, Belgaum ABSTRACT Every business requires to win stakeholders confidence by presenting their reports in the most sophisticated manner. The measurement tools like cash flow statements analysis, fund flow statements analysis, ratio analysis, common size statements Return on Investment (ROI), Return on Net worth (RONW), Return on Capital employed (ROCE), Earning per share (EPS) are the most popular traditional used techniques to measure the performance. In the recent years many modern techniques have also gained popularity like Balanced score card, value added statements, Economic value Added (EVA) Cash value Added, Shareholders Value Added etc. Out of the modern techniques available Economic value added has gained popularity to measure performance from shareholders point of view. Through this paper an attempt is made to calculate EVA for two banks selected each one from public and private sector The main objectives of this paper are To determine the value added by the banks to shareholders wealth using Economic Value added and To calculate Beta and analyse the Risk of and ICICI Keywords: EconimicValue Added, Banking, Shareholders Wealth, Beta, Cost of capital Introduction: Banking Sector in India has seen a tremendous growth since its inception, introduction of Liberalization, globalization and Privatization LPG in 1990s has significantly changed the structure of banking sector. This sector plays a crucial role in the economic development of the country and is an important part of Indian Financial system. EVA concept was developed by Stern Stewart and Co. in the 1990 s in U.S. Since then many companies have used this technique to measure their financial performance. Economic value Added uses the residual income approach to measure performance. EVA is calculated by deducting total cost of capital (Debt + Equity) known as capital charge from the Net operating profit after tax. Traditional techniques dependent on the net profit which considers only cost of debt or borrowings. Therefore EVA is considered superior to Traditional techniques EVA enables the stakeholders to get a true picture about the organizations performance. Review of Literature: The literature relating to EVA begins with the publication of the book The Quest for Value by Stewart (1991), in this book the author highlights the significance of EVA as the basis of performance measurement of a company and its management. In his empirical research Stewart examined the informational content of EVA, by testing 613 American companies comparing two periods, namely and He found a strong correlation between EVA and MVA. His ideas were further supported by O Byrne (1996), Grant (1996), Dodd and Chen (1996), Peterson and Peterson (1996), Biddle et al. (1997) and many more R.SATISH AND Dr.S.S.RAO (2010): have studied on PERFORMANCE
2 MEASUREMENT OF BANKS: AN APPLICATION OF ECONOMIC VALUE ADDED & BALANCED SCORECARD this paper focuses on awareness of EVA as a performance measurement technique in Indian banks. In this comparison the researcher emphasizes on BSC as a better technique as CAMEL entirely ignores qualitative measures of performance, in section D the researcher concentrates on EVA as a performance measurement tool and in this section the researcher used primary data to analyze the awareness about EVA among the Indian banks, he used 39 banks listed on BSE as sample. The respondents selected were General Managers and assistant managers and almost 23% of the respondents assigned highest rank to EVA as a performance indicator in banking system. G Soral and Shurveer S Bhanawat (2009) have worked on Shareholder Value Creation in the Indian Banking Industry: An EVA Analysis sample of 14 public sector banks and 12 private sector banks was selected by the authors to measure bank performance on the basis of EVA. The analysis was done for 4 years and equity approach was been followed to calculate EVA. After finding the EVA the authors found out the correlation between EVA and other financial figures. The authors conclude that in Public sector has contributed highest EVA they also conclude that EVA has significant correlation with Operating profit Roji George(2005): has conducted research on Computation of EVA in Indian Banks the research concluded that banks add value to the shareholders wealth and do not destroy them and a positive relationship was found between EVA, NPA and employee productivity. The study reveals that public sector banks perform better than private sector banks for the selected period in spite of high cost of capital. The researcher suggests that public sector banks can use EVA as their USP while reaching the capital market. Samuel C. Weaver (2001): the author has worked on Measuring Economic Value Added: A survey of the practices of EVA proponents A survey was conducted by the author by selecting 29 respondents who were clients of Stern Stewart and Company The survey demonstrates that the calculation of EVA varies widely from company to company. The author concludes that EVA is primarily implemented to enhance financial performance metrics and EVA proponents perceive a link between EVA and shareholders returns. Research Methodology: Objectives of the study To study Economic Value Added and its applications in Indian Banks To determine the value added by the banks to shareholders wealth using Economic Value added To calculate Beta and analyse the Risk of selected banks To calculate the Return on capital employed by the selected banks To compare the value added by public sector banks and private sector banks using the selected banks Sample size: The study is conducted by selecting two leading banks in India one each from Public Sector and Private Sector namely State Bank of India and Collection of Data: Secondary data is used for the study. The data is collected from the annual reports of the banks, Publications by RBI and stock prices of the banks are collected from stock market websites like yahoo finance, money control and NSE
3 Tools for Analysis: Various financial tools are used for different analysis like Capital Asset pricing Model is used to calculate the cost of Equity, regression technique using excel is used to calculate the Beta values for the selected banks, ratios and Graphical representation is used to analyse and interpret the data Duration of Study: The study is conducted for a period of two years i.e., and Results and Discussions: Net Operating Profit is considered instead of Net profit to find the Economic value added Net Operating Profit = Income- Operating Expenses Net Operating Profit after Tax is used instead of Net Profit to get a true Picture of the value created NOPAT= Operating Profit Tax NOPAT (Net operating profit after Tax) Banks ICICI Year (Rs. In (Rs. In Total Income 135, , Operating expenses 29, , Operating Profit 106, , , , Taxes NOPAT 100, , , , Invested Capital is calculated by adding Equity Capital, Reserves and Surplus and Borrowings Invested Capital Bank/ ICICI Bank Return on Invested Capital: is calculated by dividing Net Operating Profit after Tax with the total capital Invested Return on Invested Capital Bank/Year s 35% 27% ICICI Bank 4.78% 5.46% BETA (β) Beta can be defined as the risk co-efficient higher the Beta higher is the RisK. It is used to calculate Cost of Equity. Beta is the systematic risk which is calculated using the following formula. Calculations of Beta are done using Excel the calculation is shown in the annexure nσxy - (Σx) (Σy) nσx2 - (Σx)2
4 Beta (β) Bank/ ICICI Market Return (Rm) Market return is calculated using 2 years Market Monthly return of NIFTY, calculations are done using excel, calculations are shown in the annexure Cost of Equity (Ke): Market Return (Rm) Bank/Year s 8.15% 17.72% ICICI 8.15% 17.72% Cost of Equity (Ke): It determines the expected rate of return for the investors it is calculated by using Capital Asset Pricing Model CAPM by taking inputs such as Beta risk factor, Rm Market Return, Rf Risk Free Rate (364 days treasury bill rate is taken for each year) Risk free rate of return Rf 7.79% 8.96% Risk free rate of return Rf 7.79% 8.96% Market Return Rm 8.15% 17.72% Market Return Rm 8.15% 17.72% Beta Beta Ke 8.14% 29.72% Ke 8.34% 33.31% Cost of Debt (Kd) Cost of debt is calculated by: Interest/ Borrowings*100 Cost of Debt (Kd) Interest expenses Interest expenses Borrowings Borrowings Cost of Debt (Kd) 3.86% 4.10% Cost of Debt (Kd) 7.36% 7.30% WACC (Weighted Average Cost of Capital) Weight of equity and debt in the total capital invested is calculated to find weighted average cost of capital
5 WACC (Weighted Average Cost of Capital) Total Borrowings Total Borrowings Total Equity Total Equity Reserves and Reserves and surplus surplus Total capital invested Total capital invested Debt weight Debt weight Equity weight Equity weight Weighted Average Cost of Capital is calculated using the following formula WACC= (Ke* weight of equity)+(kd* weight of debt) Bank/Year s WACC 5.49% 14.28% ICICI 7.67% 15.65% Capital Charge Bank/Yea rs ICICI Bank Economic Value Added (EVA) EVA= Net Operating Profit after Tax- Capital Charge Capital Charge : Capital Charge is calculated by multiplying total Capital Invested with WACC (Invested Capital*WACC) Economic Value Added (EVA) NOPAT NOPAT Capital Capital Charge Charge EVA EVA Economic Value Added (%age) EVA = Return on Capital Employed Weighted Average Cost of Capita
6 Economic Value Added Return on Invested Capital 35% 27% Return on Invested Capital 4.78% 5.46% WACC 5.49% % WACC 7.67% % EVA 29% 13% EVA -3% -10% Findings It was observed through the analysis that State bank of India added value to the shareholders wealth by generating a positive Economic Value Added and meeting its capital charge entirely. Whereas ICICI bank could not add value to the shareholders wealth Return on Capital Employed of is greater than its cost whereas in case of ICICI Cost is higher than the Returns Beta values are calculated to find the risk co-efficient of the banks it is observed that beta of both the banks is high in the year. This shows the banks stocks were very volatile in this period as compared to the market. Conclusion: Banking sector in India is growing in leaps and bounds and is also approaching capital market for infusion of funds to escalate further growth in the banking sector. It is now predominantly significant for bankers to increase the shareholders wealth and encourage them for more investment in banks. To do this the banks have to measure their performance from shareholders perspective, bankers will have to follow wealth maximization as an objective to indicate that they are adding value to shareholders wealth and not deteriorating it. In order to determine this, bankers need to apply the Economic value added measure. Through this paper an attempt is made to evaluate bank performance using Economic Value Added as a Performance measurement technique, it is concluded that EVA can be used to value bank performance from shareholders point of view. Shareholders can use EVA values to decide on their investment decisions in different banks. References [1] R.Satish and Dr.S.S.Rao Performance measurement of banks: an application of Economic Value Added & Balanced Scorecard Journal of Management Vol.VI.No.1.October 2010.pp [2] Roji George Computation of EVA in Indian Banks The IUP Journal of Bank Management, 32 May 2005 [3] Samuel C. Weaver Measuring EVA A survey of the practices of EVA proponents Journal of applied finance 2001 [4] G Soral and Shurveer S Bhanawat Shareholder Value Creation in the Indian Banking Industry: An EVA Analysis The IUP Journal of Accounting Research & Audit Practices, Vol. VIII, Nos. 3 & 4, 2009
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