“Applying the CAMEL model to assess performance of commercial banks: empirical evidence from Vietnam”

The paper aims to investigate the impact of CAMEL components on the financial performance of commercial banks in Vietnam. Three econometric models are built using four CAMEL’s crucial indicators as independent variables (capital adequacy, asset quality, management effectiveness, bank liquidity) and return on assets (ROA), return on equity (ROE), and net interest margin (NIM) as proxies for commercial banks’ financial performance – dependent variables. The research sample includes 31 Vietnamese commercial banks over the 6-year period, from 2013 to 2018. The results show a better fit of the fixed effects model (FEM) in terms of the research methodology compared to the ordinary least squares (OLS) and random effects model (REM). It was found that capital adequacy, asset quality, liquidity and management efficiency affect the performance of Vietnamese commercial banks.


INTRODUCTION
A banking system is a component of the financial system, which plays an important role in the economic development of countries of the world (Tumin & Said, 2011).McKinnon (1973), Misra and Aspal (2013) point out the role of the financial system for economic growth and development.Simultaneously, they also emphasize the strong correlation between economic growth and development of the financial system.According to Gupta (2014), the development of an economy largely depends on the deployment and optimal use of resources and, most importantly, on the performance of different sectors of the economy.In particular, the banking sector helps form capital, create money and innovate in addition to facilitating monetary policies.Therefore, careful evaluation and analysis of the operation of banks to ensure a healthy financial system and an effective economy is essential.Misra and Aspal (2013) argued that financial health of a bank is a guarantee not only for depositors, but also of great significance to employees, shareholders and the whole economy of a nation.To evaluate the performance of the banking industry, it is necessary to use efficiency indicators to check the soundness of the activities of an economy.Banks, in particular, face a range of risks that are becoming more and more complex every day (Dang, 2011).It is important to assess the overall effectiveness of banks using the prescribed banking supervision framework, and the CAMEL rating system is an effective monitoring measure.This method was first applied in the United States in 1979, and is currently being used by three U.S. watchdogs -the Federal Reserve System, the Office of Monetary Supervision (OCC) and the Federal Deposit Insurance Corporation (FDIC).It has proven to be a useful and effective tool to deal with the 2008 US government financial crisis (Dang, 2011).In Vietnam, commercial banks play a particularly important role in the national economy (Dang, 2011;Nguyen, 2012).Therefore, this paper evaluates performance of the Vietnamese commercial banks using the CAMEL model.The study also assesses the impact of each factor of the CAMEL model on the Vietnamese banks' performance for six years, from 2013 to 2018.

LITERATURE REVIEW AND HYPOTHESES
1.1.Bank performance

Performance of commercial banks
To measure the performance of commercial banks, managers and investors are interested in profitability indicators, since profits are the ultimate goal of commercial banks, especially joint stock commercial banks.Profit is also a matter of concern for managers and investors when making strategic decisions.All strategies designed and the activities implemented are aimed at realizing this great goal.There are various ratios used to measure the profitability of a commercial bank.Anggono (2017) and Kumar (2016) suggested that a bank performance variable is represented by two alternative measures, namely ROA and ROE.While in a study by Ongore and Kusa (2013), ROA, ROE and NIM are the main ratios measuring the profitability of a commercial bank.
Return on assets (ROA) is an important indicator of the bank's profitability.This is the average ratio of net profits before tax to total assets (Ongore & Kusa, 2013;Anggono, 2017).ROA indicates the ability of a bank to generate profit from its total assets.In other words, this indicator shows how profitably a commercial bank uses its resources.The higher the ROA, the more efficiently the resources are used by the bank.
Return on equity (ROE) is another financial indicator representing the relation of the bank profit to its total equity.Bank shareholders will pay much attention to this ratio because it shows the return for their investment.A bank with a high value of ROE is capable of creating an internal cash flow.Therefore, the higher the ROE, the more profit-able the company is in terms of making a profit.Ongore and Kusa (2013) explain that ROE can be measured by the ratio of Net Income to Average Tax / Total Equity.This ratio indicates the profit rate earned from money invested by shareholders, reflecting the bank management's effectiveness in using its capital.Therefore, it can be seen that the better the ROE, the more effective the management of shareholder capital.
Net interest rate (NIM), or net interest margin, is the difference between the bank's income and its expense related to interest such as the difference between the interest income received and the interest expense paid to a lender regarding his/her deposits.
Ongore and Kusa (2013, p. 239) defined that "Net interest margin measures the gap between the interest income the bank receives on loans and securities and interest cost of its borrowed funds.It reflects the cost of bank intermediation services and the efficiency of the bank".The higher the net profit rate is, the more profitable and the more stable the bank is.Therefore, the net profit rate is one of the important ratios for measuring the profitability of banks.However, according to Heid (2007), higher net interest rates may reflect more risky lending activities related to loan loss provisions.

Factors affecting the performance of commercial banks
Olweny and Shipho (2011) focused on specific industry parameters affecting the performance of commercial banks in Kenya.The CAMEL model is commonly used by scholars to authorize specific elements of a bank (Dang, 2011).CAMEL stands for Capital Adequacy, Asset Quality, Management Efficiency, Earnings and Liquidity.Each indicator is discussed as follows: Capital adequacy ratio: According to Dang (2011), the capital adequacy ratio is assessed based on capital adequacy ratio (CAR).Sangmi and Tabassum (2010) revealed that the CAR reflected the internal wealth of banks to be able to withstand losses in cases of economic crises.The higher value of this ratio reflects the better resilience ability of a bank to crisis situations.

Asset quality:
The quality of the loan portfolio has a direct effect on bank profitability.According to Dang (2011), the highest risk that commercial banks face is losses from overdue debts.Therefore, inappropriate lending rates are good credentials for the quality of the asset.Different studies used different types of financial ratios as proxies for bank performance.One of the major concerns of all commercial banks is keeping the number of non-compliant loans at the minimum level.Unsuitable loans will negatively affect bank profitability.Therefore, the more unsuitable loans, the higher the total amount of loans and the better the health of the bank's portfolio.It means that, the lower this ratio, the better the bank operates (Sangmi & Tabassum, 2010).
Management efficiency: Human management policies, general management policies of an organization, information systems, internal audit and control regimes, strategic and budgetary plans.Books are reviewed separately to reflect the overall quality of management, analyze human resources and the working style of a Board of Directors and Management, as well as to reveal the relationship between two sides.However, some ratios of financial statements act as a proxy for management efficiency.Financial ratio can partly show the bank manager's capability of efficiently organizing bank's resources, maximizing profit, and reducing operating costs.One of these is the ratio of bank operating profit over its total revenue (Ilhomovich, 2009;Sangmi & Tabassum, 2010).The higher the ratio value is, the more efficient the managers will be in bank operation and income generation.
Liquidity: Liquidity refers to the bank's ability to perform its obligations, primarily to the depositors.Dang (2011) demonstrated that the bank liquidity adequacy was positively related to its profits.Different scholars use different financial ratios for liquidity.The most widely-used ratios reflecting the commercial bank's liquidity position are the ratio of customer deposits to total assets and total customer loan deposits.
There are four factors that were studied by authors such as Ishaq, Karim, Ahmed, and Zaheer (2016), Zedan and Dass (2017), Mohiuddin (2014), and Ongore and Kusa (2013) at the banks of different countries in the world.This study will inherit this result for testing at 31 Vietnamese commercial banks.

Research hypotheses
Based on the literature review above, the paper will examine the following hypotheses: H1: The size of equity has a positive impact on ROA, ROE, and NIM.
H2: The minimum capital adequacy has a positive impact on ROA, ROE, and NIM.
H3: Financial leverage has an impact on ROA, ROE, and NIM.

H4:
The ratio of loans to assets positively affects ROA, ROE, and NIM.
H5: The lower the ratio of bad debts to outstanding loans, the higher the ROA, ROE, and NIM.
H6: The higher the operating cost index, the lower the ROA, ROE, and NIM.
H7: Deposit guarantee ratio has a positive impact on ROA, ROE, and NIM.
H8: Short-term liquidity has a positive impact on ROA, ROE, and NIM.

Data collection
This paper collected data from the financial statements, from 2013 to 2018, of Vietnamese commercial banks, with the sample size of 31 banks.In this study, secondary data sources collected from some sources, such as actual data on the system of financial analysis indicators of Vietnamese commercial banks in Vietnam and the information on the banks and financial websites, summarize the results on the financial statements, annual reports, and management reports of commercial banks for 2013-2018, collecting secondary information and data from financial statements of banks, reports of the State Bank, reports of the World Bank, and reports of the banking supervision system for a six-year period from 2013 to 2018.
where FC(1) -free coefficient; PC(i) (i = 211) -partial coefficients of the variables affecting the rendering independent youth C.

Model of ROA
According to the estimation results, FEM is suitable for a model of factors affecting ROA.
The estimation model is as follows: [ ] Thus, the research results show that the bank's ROA may be strongly affected by the short-term payment ratio, deposit guarantee coefficient, and equity safety ratio.Other factors also affect ROA but to a lesser extent.

Model of ROE
The results show that P-value = 0.3490 > 0.05, therefore, the REM model used with the model of factors affecting ROE is appropriate.
Given this result, the study offers the following estimation model with ROE as follows: [ ]  In particular, factors of equity size, deposit guarantee coefficient, the short-term liquidity coefficient, the financial leverage ratio, the bad debt ratio, the loan ratio, and the operating expense index have an impact on NIM, commercial banks is also affected by NIM, while the minimum capital adequacy ratio and the loan outstanding ratio do not affect NIM.The ratio of outstanding loans and deposits ---

RECOMMENDATIONS
Based on the results of the study, some key recommendations were proposed aiming to improve the financial performance of Vietnamese commercial banks.
Increased equity capital: In order to increase equity of the banks themselves, especially small and medium ones, banks must take the initiative in implementing the detailed plan to ensure the capital increase in the time period, review bad debts, and evaluate to what extent that bad debt can be converted into equity.When merging with other banks, the common interests of the whole banking system should be in the first place, and not the interests of individual banks, so sooner or later competitors will gain, and at that time will cause even greater damage.
Decreased bad debts: The analysis results, as well as the regression results, show that NPLs tend to increase and this is also a factor that inversely affects the performance of Vietnamese commer-cial banks.The suggestion aims at reducing the amount of bad debts in bank in order to make them healthy in operation, while contributing to the financial restructuring of Vietnam's commercial banking system.
Increased liquidity: As analyzed above, the liquidity of Vietnamese commercial banks gradually decreases over the years, and, according to the regression results, this factor positively affects the performance of the Vietnamese commercial banking system.This means that when the liquidity decreases, the operational efficiency of banks will decrease, and vice versa, so the goal of this solution is to increase the liquidity of Vietnamese commercial banks, thereby boosting their performance.
Increased quality of management: The goal of this solution is to increase the quality of management through the management process of administrators, thereby contributing to improving financial capacity of Vietnamese commercial banks.

CONCLUSION
The study aims to investigate the impact of CAMEL components on the financial performance of commercial banks in the context of Vietnam.The results confirm the effect of the CAMEL parameters on the performance of Vietnamese commercial banks.The CAMEL model parameters include Capital adequacy, Asset quality, Management efficiency and Liquidity that are taken as independent variables, while financial performance (ROA, ROE, and NIM) is considered as a dependent variable.The sample size for this study is 31 Vietnamese commercial banks.For them, 6-year financial data (from 2013 to 2018) are collected from their annual reports published on their official websites.
This empirical research found that the four categories of the CAMEL model, including capital adequacy, asset quality, management, and liquidity, affect the performance of Vietnamese commercial banks as follows: Capital adequacy: the size of equity is considered to have the most powerful and positive impact on the performance of Vietnamese commercial banks.This is followed by the leverage ratio and, finally, the minimum capital adequacy ratio.Asset quality: while the bad debt ratio has an opposite effect, the loan/ total asset ratio has a positive effect on the performance of commercial banks.Management quality: the operating expense index has no significant impact on the operational efficiency of banks.This is quite true for Vietnam when banks are not focused on improving management capacity of managers.
Earnings measured by ROA, ROE, and NIM are significantly affected by equity size, the deposit guarantee, the short-term liquidity coefficient, and the financial leverage ratio.Liquidity: deposit guarantee ratio and the short-term liquidity ratio have a strong impact on the performance of Vietnamese banks, while the other factors have no or little effect.

Table 1 .
Dependent variable measurement

Table 3 .
The impact of independent variables on ROA

Table 4 .
The impact of independent variables on ROE

Table 6 .
Summary of the impact of each factor on the performance of Vietnamese commercial banks