Analysis of Financial Performance of Commercial Banks in Rwanda

A Case Study of BPR and I&M Bank (BCR). Period of study 2008 to 2013

Master's Thesis, 2015

95 Pages, Grade: Upper level division2


Table of contents




List of tables

List of figures

List of abbreviations or acronyms

1.1 Background of the study
1.2 Statement of the problem
1.3 Objectives of the stu dy
1.4 Variables of the study
1.4.1 Dependent variables:
1.4.2 Independent variables:
1.5 Research questions
1.6 Hypotheses of the research
1.7 Significance of the study
1.8 Justification (or Rationale) of the Study
1.9 Scope and limitations of the study
1.9.1 Scope of the study
1.9.2 The limitations of the study
2.0 Structure of the study

2.0 Introduction
2.1 Definitions of concepts and key terms
2.1.1 Analysis
2.1.2 Financial Performance
2.1.3 Banking
2.1.4 Commercial banks
2.2. Commercial Banks in Rwanda
2.2.1 Problems faced by commercial banks in Rwanda
2.2.2 The role of commercial banks within economy Mobilization of savings Creation of credit Finance government Productive investment Fuller utilization of resources
2.2.3 Services offered by commercial banks Loans and advances Term loans Deposits of money Non-performing loans Loan policy
2.3 Bank Performance indicators
2.3.1 Return on Equity (ROE
2.3.2 Return on Asset (ROA)
2.3.3 Net Interest Margin (NIM)
2.4 Determinants of Bank Performance
2.4.1 Bank Specific Factors/Internal Factors
2.4.2 External Factors/ Macroeconomic Factors
2.5. Liquidity
2.5.1 Concept and meaning of liquidity risk Credit risk Current risk Cash flow and fair value interest rate Legal and regulatory risk Operational risk
2.5.2 Causes of liquidity risk
2.5.3 Liquidity Position Analysis
2.6. Financial statements
2.6.1 Financial Statement Analysis
2.7 Finance
2.7.1 Types of financial performance analysis External analysis Internal analysis Horizontal Analysis Vertical Analysis Ratio Analysis Liquidity ratios: Profitability ratios Leverage ratios: Leverage
2.8 CAMEL Model
2.8.1 Camel framework Capital Adequacy Asset Quality Management efficiency Earning quality Liquidity management
2.8.2 Student T-test
2.8.3 Previous studies

3.0 Introduction
3.1 Definition of the methodology
3.1.1 CAMEL Model Parameters used Study design
3.1.2 Methods of data collection Sources of data Secondary source data
3.1.3 Sample of the study
3.1.4 Data Presentation
3.1.5 Data Analysis techniques and methods Statistical Treatment of Data Mean and Standard deviation Horizontal and Vertical analysis
3.2.1 Historical background
3.2.2 Mission & Vision Mission Vision:
3.2.3 Core values: Authentically Rwandan
3.2.4 Goals and objectives
3.2.5 Achievements
3.2.6 Shareholders of BPR
3.2.7 Chief Executive Members of BPR
3.2.8 Boards Directors of directors
3.2.9 BPR Correspondents banks
3.2.10 Branches Network of BPR
3.3.1 Historical background
3.3.2 Mission and Vision at I&M Bank Rwanda Vision Mission Objectives
3.3.3 Core values
3.3.4 Achievements
3.3.5 The Future
3.3.6 I&M Bank Shareholders& Stock ownership
3.3.7 I&M Bank Chief executive Members
3.3.8 Management team
3.3.9 Branches of I&M Bank (BCR)
3.3.10 I&M Bank correspondent Banks
3.3.11 Services offered by both I&M BANK and BPR

4.1 Introduction
4.2 Financial performance analysis
4.2.1 Capital adequacy
4.2.2 Analysis of Assets Quality
4.2.3 Management quality
4.2.4 Analysis of Earning Quality
4.2.5 Analysis of Liquidity
4.3 Hypotheses testing

5.1 Conclusions
5.2 Recommendations and suggestions for policy change
5.3 Recommendations for further research

A. text books and Articles
B. Reports
C. Electronic sources



I truly thank God for the knowledge and strength He gave me to accomplish this work successfully and for the wealth of my family and friends. My sincere appreciation goes to my supervisor Dr. Shaik Nagoor Meera for guidance and patience up to this stage of submission. I gained a tremendous amount of knowledge under his supervision.

I would like to pay special tribute to the INILAK MBA Program Coordinators for their assistance and guide facilitated with different materials like books in Libraries until the end of this program that was not easy.

Special thanks go to Mukamana Consolee and most of all Colleagues students in MBA Program for their great support and assistance; especially TUYISENGE Jeanne, Faustin ….

God bless all of them


To Almighty God,

To my beloved mother and late father

My brothers and sisters,

My dear friends

I dedicate this Thesis.


Due to the nature of banking and the important role of banks in the economy in capital formation, banks should be more closely watched than any other type of economic unit in the economy. The CAMEL supervisory system in banking sector is a substantial improvement over the earlier systems in terms of frequency, coverage and focus. In the present study an attempt is made to evaluate relative performance of banks in Rwanda using CAMEL approach. This study was based on the “A nalysis of financial performance of commercial banks in Rwanda: a case study of BPR and I&M bank (BCR), Period of study 2008 to 2013”. As the financial sector is growing from time to time in Rwanda the level of their financial performance in the sector also is growing from time to time unless poor performance highlighted from BPR during the study period. This study has tried to analyze the financial performance of two commercial banks that are operating in the country using the CAMEL approach in order to have the glimpse of image how the private commercial sector of the bank in the country is operating in the financial sector.

The objective of this study is to analyze the performance of two selected commercial banks over a period of six years (2008-2013) in the Rwandan banking sector. For this purpose, CAMEL approach has been used and it is established that I&M Bank and BPR are at the top of the list, with their performances in terms of soundness being the best, but the commercial bank like BPR has taken a backseat and display low economic soundness in comparison. The study found that overall bank performance increased considerably in the first three years of the analysis. A significant change in trend is noticed at the onset of the global financial crisis in 2007, reaching its peak during 2008-2009. This resulted in falling profitability, low liquidity and deteriorating credit quality in the Rwandan Banking sector in general and BPR and I&M Bank particularly.

The study’s hypotheses were also tested using Student T-test that resulted, the two commercial banking groups are statistically significant as the P-values are below 0.05 and therefore the null hypothesis has to be rejected leading to the conclusion that profitability and liquidity deteriorated among two commercial banks (BPR and I&M Bank) during the study period.

List of tables

Table 1. List of licensed banks in Rwanda

Table 2. Bank performance rates

Table 3. The study population and selected sample size

Table 4. Capital adequacy ratios comparison of 2 banks

Table 5. Debt equity ratios comparison of two banks

Table 6. Advances to total assets ratios comparison of two commercial banks

Table 7. Group averages ranked

Table 8. Asset qualities ratios comparison of two commercial banks

Table 9. Group averages ranked

Table 10. Management capability ratios of I&M Bank

Table 11. Total advances to total deposits ratios of I&M Bank and BPR

Table 12. Management quality ratios of I&M Bank

Table 13. Management capability ratios of BPR

Table 14. Management quality ratios of BPR

Table 15. Earnings (Profitability) ratios of I&M Bank

Table 16. Earnings (Profitability) ratios of BPR

Table 17. Liquidity ratios of I&M Bank

Table 18. Liquidity ratios of BPR

Table 19. Liquidity ratios group averages

Table 20. Student’s T-test results

List of figures

- Figure 1. Banking Risk

- Figure 2. Capital adequacy ratio of BPR and I&M Bank compared

- Figure 3. Asset quality of BPR and I&M Bank compared

- Figure 4. Management quality of BPR and I&M Bank compared

- Figure 5. Earnings of BPR and I&M Bank compared

- Figure 6. Liquidity management of BPR and I&M Bank compared

List of abbreviations or acronyms

illustration not visible in this excerpt


1.1 Background of the study

The main objective of financial institutions is to act as an intermediary between those who have funds and those who seek funds for running their business or for personal use. For performing well these activities, the financial institution needs to have a proper management that is efficient in mobilizing the banks resource in proper manner, a capital that is used as resource to render the service, proper amount of revenue that will exceed the cost of operation, a proper system that will safeguard the asset of the business and an adequate financial position to settle claims at the time of liquidity, (Kolade Sunday Adesina, 2012). Financial sector is imperative for economic growth and industrialization via channeling funds, providing proficient financial system, sociable investor’s treatment, and optimal utilization of resources (Raza, 2011). Banking sector in any economy is performing the major role in these regards. Banking sector plays a significant role in channeling funds to industries and contributing towards economic and financial growth and stability. A well-established and managed banking sector can absorb major financial crisis in the economy and can provide a plat form for strengthening the economic system of the country (Aburime, 2009). Bank financial performance is vitally important for all stakeholders, such as the owners, the investors, the debtors, the creditors, the depositors, the managers of banks, the regulators and the government (Podder, 2012).

The study of Podder (2012) also provided evidence that concentration of commercial banks in the industry has a positive impact on the performance of commercial banks. According to the study, high concentration in the banking industry allows for a high monopolistic power of the banks and this means the banks can charge higher prices for their products. This leads to higher margins and therefore better performance. It gives direction to the debtors and the investors to make decision whether they should invest money in bank or invests somewhere else; It also flashes direction to bank managers whether to improve its finance and Regulatory agencies and government are also interested in financial performance for the regulation purposes.

Financial performance is the process of measuring the results of an organization policies and operations in terms of monetary value. These results are reflected in the firm's profitability, liquidity or leverage. Evaluating the financial performance of a business allows decision-makers to judge the results of business strategies and activities in objective monetary terms. Normally the ratios are used to determine the financial performance of an organization. A well designed and implemented financial management is expected to contribute positively to the creation of a firm’s value (Padachi, 2006).

With the integration of Rwanda financial sector with the rest of the East African communities, and the rest of the world, the concept of banks and banking has undergone a paradigm shift. Before financial reforms, Rwandan Banks were enjoying, in a protected environment with a strong cushion of the government and their banks. This had made them operationally inefficient and commercially almost wreck, as they had cumulated as much as failures (loss) as Non-performing advances. However, with the National Bank of Rwanda taking strong measures based on the recommendations of the MINECOFIN, the landscape of Rwandan banking changed altogether. All the banks were directed to follow the norms of capital adequacy, asset quality, provisioning for NPAs, prudential norms, disclosure requirements, acceleration of pace and reach of latest technology, streamlining the procedures and complying with accounting standards and making financial statements transparent. Towards this end, they re-defined their objectives, strategies, policies, processes, methods and technologies which have a direct bearing on the financial health and performance of these banks. In this way, commercial banks were not only required to take the above steps but always evaluate their financial position from period to period. Because of this factor, the interest of the analysts and researchers got developed to analyze, evaluate, measure and finally manage the financial performance of the Rwandan commercial banks; BNR (Annual Financial on stability, 2008).

The aim of our research is to analyze the financial soundness or performance of the commercial banks that operate in Rwanda, the case study of I&M Bank and BPR. In order to achieve this aim our methodology is based on the CAMEL framework. This framework, firstly known under the name of CAMEL, has been created in 1979 in USA by the bank regulatory agencies, and afterwards its use has been extended, being considered a useful tool for the supervisor authorities from different countries in order to assess the soundness of the financial institutions. The acronym CAMEL derives from the five main segments of a bank operations: Capital adequacy, Asset quality, Management quality, Earnings ability and Liquidity; IMF and the World Bank (2005).

Commercial banks in Rwanda have undergone immense regulatory and technological changes since financial sector reforms in 2007/2008. The reform of legal and regulatory framework to comply with international standards has been accelerated with the publication of the new banking law no 007/2008 of 08/04/2008 regulating banks and other financial institutions as well as the instructions no 06/2002 of 09/07/2002 regulating microfinance activities and no 05/2003 of 26/06/2003 regulating savings and credit cooperatives published in the official Gazette. Rwandan banks are faced with increasing competition and rising costs as a result of regulatory requirements, financial and technological innovation, entry of large foreign banks in the retail banking environment and challenges of the recent financial crisis. These changes had a dramatic effect on the performance of the commercial banks in Rwanda. Studies on bank performance in Rwanda had focused on bank efficiency and profitability [see Mulama Richard (2005), Mukankusi Agnes (2007)].

The present study is different from earlier studies in two ways: sample coverage and methodology. The study is motivated by the fact that, the Analysis of financial performance of the commercial sector is important for several reasons. First, financial performance is a vital factor for financial institutions wishing to carry out their business successfully and smoothly, given the increasing of competition in the financial markets. Second, in a rapidly changing and more globalised financial marketplace, governments, regulators, managers and investors are concerned about how efficiently banks transform their expensive inputs into various financial products and services. Third, the financial performance measures are critical aspects of banking sector that enable us to distinguish banks that has the capability to survive and prosper from those that may have problems with competitiveness; Zawadi Ally (2013). Lwanga Thannington (1998), asserts that there are liquidity management, asset quality, capital adequacy, management capacity as well as earning capacity problems in most commercial banks which bring poor performance and impossibility to make loans to their different customers and this is the reasons why the researcher intends to investigate on the liquidity management, capital adequacy, asset quality, asset management and earning efficiency of the commercial banks and its effect on financial performance of BPR and I&M Bank.

Additionally, financial ratios enable us to identify unique bank strengths and weaknesses, which in itself inform bank capital adequacy, asset quality, profitability, asset management, earnings capability and liquidity management through CAMEL approach. I have attempted to make a contribution in the field. Among all these researchers, no one has used the latest technique of CAMEL Parameters to study the financial performance of the Rwandan commercial banks the case study of I&M Bank and BPR. It is against this backdrop that the present study has been undertaken to fill up this gap.

1.2 Statement of the problem

Financial performance problems about commercial banks started long time years ago before financial reforms, many commercial banks were witnessed undergoing insolvency due to higher level of non-performing loans (BNR, Financial stability report 2008). Initially the banking sector and particularly commercial banks in Rwanda have faced lot of problems like, lack of resources, political uncertainty, lack of skilled human resource and socioeconomic catastrophe, high nonperforming loan affects the profitability of the bank, which affected the efficient working of Commercial banking sector. Indeed, good performance and stability of a bank lies at the heart of confidence in the banking system due to the highly leveraged nature of banks. Individual bank’s financial problem can have significant implications for the whole financial system.

However some commercial banks in Rwanda, from 2008-2013 have registered a lot of financial transformations or changes, financial failures (losses) and others were distressed or liquidated. For example:

- In 2009, 2012 and 2013 BPR (Banque Populaire du Rwanda) has registered or reported net losses of Rwf 1,123,186; Rwf 762,171; Rwf 5,166,512 respectively (BPR, Annual financial report, 2009, 2012 and 2013). These losses represented the 46% of shares capital.
- In July 2012, the former BCR that so later was liquidated or sold its shareholding to a consortium of I&M Bank Group from Kenya (55.0%), PROPARCO from France (12.50%) and the German Investment Corporation (DEG) with 12.50%. The Rwanda Government (19.80%) and others private individuals (0.20%). As result, in August 2013 BCR rebranded to I&M Bank (Rwanda) to reflect its current shareholding. According to the National Bank of Rwanda Annual Report (2005), financial distress is defined as that which occurs in financial institutions which among other things: i) fail to meet capitalization requirements; ii) have weak deposit base; and iii) are afflicted by mismanagement. Therefore, there is distress in a situation, in which the commercial is having operational, managerial and financial difficulties (weaknesses).

Therefore, all the above cited events or situations have necessitated the researcher to investigate or to carry out a financial performance analysis study, on these two leading commercial banks (BPR and I&M Bank) for measuring overall health and financial status using CAMEL approach from the period of 2008 to 2013.

1.3 Objectives of the study

The main objectives of the study are as follows:-

1. To analyze and evaluate the financial position and performance of two selected commercial banks(BPR and I&M Bank) in Rwanda, using CAMEL model for the period of 2008 to 2013;
2. To evaluate and assess the financial performance of the BPR and I&M Bank in terms of solvency, profitability, liquidity position and earnings applying CAMEL ratios.
3. To undertake the factors which have led to the current financial performance of BPR and I&M Bank
4. To suggest measures, on the basis of the study results, to improve further the financial performance of I&M Bank and BPR.

1.4 Variables of the study

1.4.1 Dependent variables:

A. Profitability Performance

The most common measure of bank performance is profitability. Profitability is measured using the following criteria:

Return on Assets (ROA) = net profit/total assets shows the ability of management to acquire deposits at a reasonable cost and invest them in profitable investments (Ahmed, 2009).The higher the ROA, the more the profitable the bank.

Return on Equity (ROE) = net profit/ total equity. ROE is the most important indicator of a bank’s profitability and growth potential. It is the rate of return to shareholders or the percentage return on each Rwf of equity invested in the bank.

Net Interest Margin (NIM) 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 interest margin, the higher the bank's profit and the more stable the bank is. Thus, it is one of the key measures of bank profitability. However, a higher net interest margin could reflect riskier lending practices associated with substantial loan loss provisions (Khrawish, 2011).

B. Liquidity performance

The following ratios are used to measure liquidity.

Liquid assets to deposit-borrowing ratio (LADST) = liquid asset/customer deposit and short term borrowed funds. This ratio indicates the percentage of short term obligations that could be met with the bank’s liquid assets in the case of sudden withdrawals.

Net Loans to total asset ratio (NLTA) = Net loans/total assets NLTA measures the percentage of assets that is tied up in loans. The higher the ratio, the less liquid the bank is.

Net loans to deposit and borrowing (NLDST) = Net loans/total deposits and short term borrowings. This ratio indicates the percentage of the total deposits locked into non-liquid assets. A high figure denotes lower liquidity.

1.4.2. Independent variables:

The study is applying CAMEL Model that includes the following independent variables:

- Capital adequacy,
- Asset quality,
- Management capability,
- Earnings capacity, and
- Liquidity management

1.5 Research questions

1 . What is the financial position of BPR and I&M Bank for the period of 2008 to 2013?
2. How is the Financial Performance of the two commercial banks over a given period of time?
3. Are there the differences, in financial performance indicators ratios of the two commercial banks?
4. What are the new challenges and opportunities come with financial performance that the banks have which finally can affect their efficiency?

1.6. Hypotheses of the research

Ho1: There is no significance means difference on ROA among I&M Bank& BPR
Ho2: There is no significance means difference on ROE among I&M Bank& BPR
Ho3: There is no significance means difference on NIM among I&M Bank& BPR

1.7. Significance of the study

This study helps to contribute to the literature in Rwanda banking system in the following manner:

1.The financial performance measures gives any indication whether the commercial banks are operating at higher level of liquidity or not and the development of capital market is still in infancy stage, this gives confidence to the policy markers, bank management and stakeholders to overcome challenges arising in the two studied commercial banks for remedial actions.
2. Finally, this study provokes the curiosity and desire of other academicians to conduct a more comprehensive study in the related field.

1.8. Justification (or Rationale) of the Study

The study employed the financial performance measures and parameters of commercial banks known as CAMEL and on that basis the performance of the two selected commercial banks is established. So many studies have been carried out by different researchers on financial performance of commercial banks in Rwanda but, I did not read any study that has adopted CAMEL model ratios on the two selected commercial banks (BPR and I&M Bank) in Rwanda. It is against this backdrop that the present study has been undertaken to fill up this gap.

1.9 Scope and limitations of the study

1.9.1 Scope of the study

Keeping in mind that time and money are always scarce resources to the researcher; the research is restricted to analyze the financial performance of two commercial banks located in Kigali. The study gives an overview picture of two commercial banks (BPR and I&M Bank) financial position in Rwanda for the period of six years (2008 to 2013).

1.9.2 The limitations of the study

1. The study is based on the secondary data and the limitation of using secondary data may affect the results.
2. The secondary data was taken from the annual reports of the BPR and I&M Bank; it may be possible that the data shown in the annual reports may be window dressed which does not show the actual position of the banks.

2.0 Structure of the study

This research study is structured in five chapters; the first chapter deals with the general introduction that includes the background of the study, the statement of the problem, and the objectives of the study, research questions, and scope of the study. Chapter two reviews the related literature with reference to different sources of data especially from textbooks; Internet annual reports and covers definitions of key words. Chapter three contains the methodology used while carrying out the research and tools used in collecting data which are analyzed and interpreted and deals also with the profile of the case study. Chapter four focuses on research findings, analysis and interpretation of data collected; thus data is interpreted and edited in relation to the objectives of the study. Chapter five highlights the summary, conclusions arising from the analysis of the data collected and recommendations of the study.


2.0. Introduction

Financial institutions embody a number of financial intermediaries. Thus, this chapter portrays the views of different authors and researchers in the field of banking and finance in order to arrive at a conceptual framework of the study. It sets to find out their findings, ideas, arguments and observations that will be available to this study.

2.1. Definitions of concepts and key terms

2.1.1. Analysis

According to the MacMillan School Dictionary (2010), analysis is the process of examining something in order to understand it or to find out what it contains. According to the Oxford-advanced learners’ Dictionary (2011), analysis is a detailed study or examination of something in order to understand more about it.

2.1.2 Financial Performance

Financial performance is the level of performance of a firm over a specific period of time and expressed in terms of the overall profits or losses incurred over the specific period under evaluation (Bodie, Kane and Marcus, 2005). According to Daft (1991) defined, Performance as the organization’s ability to attain its goals by using resources in an efficient and effective manner. He emphasized that; the managers’ responsibility is to coordinate resources in most effective and efficient manner to accomplish organizational goals. Effective means producing the results that is wanted or intended; producing a successful result. And then efficiency means doing something well thoroughly well with no waste of time, money and energy.

Performance evaluation entails the analysis of the level of financial and economic performance using both the qualitative and the quantitative data .In this case there are two possible ways of analysis that is basically quantitative in nature and qualitative in nature On the case of qualitative they can’t be quantified but they basically influence the performance of the entities (Horne, 2000). Financial performance can easily be calculated by looking the components of the financial statements which are the income statements, balance sheet and the statement of equity changes (ACCA, 2007).These components help to depict the true picture of the business by relating the items of the components of the financial statements. A comparison of ratios of the same firm over time is important in evaluating changes and trends in the firm’s financial condition including profitability. This comparison may be judged with those of similar firms in the same line of business and when appropriate with an industrial average’s (Horne, 2000 @

2.1.3 Banking

Dash (2002), banking means accepting, for the purpose of lending or investment of deposits of money from public, repayable on demand or otherwise, and withdrawals by cheque, order or otherwise. Banks deal in transactions like accepting deposits, lending money, dealing in bills, collecting instruments, issuing letter of credit, travelers’ cheque/ circular notes, buying and selling foreign exchange, underwriting and dealing in shares/ securities/ investments, acting as agents, issuing guarantee and indemnity and can do any other form of business which the government may by notification in the official gazette specify. In modern society, Banks occupy an important place because of the following reasons; they make up the point of confluence between the demand and supply of money, it is a system through which payments are made and it also collects and saves liquid assets for the purpose of credits and investments.

2.1.4 Commercial banks

Rose, Peter and Donald (1993) say that, commercial banks are financial institutions that accept demand deposits and make commercial loans as well as offering the widest array of services of any financial institution. Khambata (1996) adds that, commercial bank is a type of bank that is involved in the provision of services such as deposit taking, offering basic investment products and extending both business and personal loans.

Paul A. Meyer (1992) defines commercial banks as those private financial institutions which issue check deposits (included as money). Yeager and Neil (1989: 296), had the view that “like industrial corporations, commercial banks are private businesses operated for the benefit of their owners”. According to BLACK (2006), Commercial Bank is a bank that offers banking services to the public and to businesses. Commercial banks are the most common type of banks today. They provide a very wide range of services to customers. Because of the wide range of services they provide, they are useful to business people. Peter and Rose (1993), Commercial banks are financial institutions that accept demand deposits and make commercial loans to the government and private individuals. Commercial banks are the most important financial intermediaries serving the public today. The general idea behind commercial banks is that, they are private, profit seeking depository institutions serving business and non-business customers with deposits, current account and credits. They normally perform this duty by accepting deposits from customers and allowing writing cheques and lending money to individuals, business, non-profit making organizations, government and other organizations.

HASLEM (1985) argues that, commercial banks lie at the heart of financial system. Until recently, they have unique in the issuance of deposit liabilities which are payable upon demand, usually by cheque. These checking accounts deposits have traditionally constituted the major portion of the country's money supply. The profit seeking activities of banks and central bank interact to determine the supply of loadable and investable funds in banking system. Commercial banks may create money through their lending activities. Frederic (2004), Commercial Banks are financial intermediaries raise funds primarily by issuing checkable deposits (deposits on which checks can be written), savings deposits (deposits that are payable on demand but do not allow their owner to write checks), and time deposits (deposits with fixed terms to maturity). They then use these funds to make commercial, consumer, and mortgage loans and to buy U.S. government securities and municipal bonds. There are slightly fewer than 8,000 commercial banks in the United States, and as a group, they are the largest financial intermediary and have the most diversified portfolios (collections) of assets.

2.2. Commercial Banks in Rwanda

According to the World Bank report (1991), it is foreigners who established commercial banking in Rwanda. By 1991, those commercial banks in Rwanda were dominated by two commercial banks: BCR (I&M Bank) established in 1963 and BK established in 1967, and in the recent years the BPR has become one of them it had changed to the Banque Populaire du Rwanda SA on the 5th January 2008 but actually other commercial Banks have increased. The main sources of funds of these banks are private domestic deposit and credit market borrowing. Modern Banking has been practiced for over 50 years. Commercial banks in Rwanda have grown both in number, branches, and in a variety of services by offering like loans, credits, and ‘debit card services, and the introduction of automatic teller machines (ATMs), electronic banking and other services According to the text of law No 08/99 of 18th /6/99 concerning the regulations of banks and other financial institutions, there existed six commercial banks in Rwanda but actually there are ten commercial banks in Rwanda namely; BCR, BK, ECOBANK, FINA Bank, COGEBANQUE, BPR and BANCOR, including KCB and Equity Bank all operating under the supervision of BNR, BNR Annual report (2013:13), points out that BNR supervises the Rwandan financial sector as a legal and regulatory framework based on international standards allowing it to:

- Protect customers’ deposits
- Enable commercial banks to respond to the financing needs within the economy
- Ensure that national financial system has a good reputation and credibility to keep healthy competition between the banks.

Table 1: List of Licensed Banks

illustration not visible in this excerpt

Source: National Bank of Rwanda (

2.2.1 Problems faced by commercial banks in Rwanda

Rwandan Commercial banks face many constraints due to the existence of many poor customers who are scattered; there are also problems of savings mobilization and few creditworthy customers and lending is limited by lack of collateral security by most people. Most of the customers are illiterate other do not keep books of accounts and therefore it is difficult to assess their creditworthiness. Inflation discourages lending and leads to loss of real value of money. Commercial banks are concentrated in urban areas and hence they compete for business. They are also hindered by the shortage of communication facilities, of trained manpower and funds to finance manpower development and staff training. The rate of interest used to be fixed by the government and it was sometimes high; this discourages people from borrowing money from banks. Foreign commercial banks are sometimes faced with the problem of unfavorable government policies e.g. taxation, nationalization (Mukankusi, 2007).

2.2.2 The role of commercial banks within economy

Rose et al (1993), commercial banks play the basic function of providing credit to local customers to meet legitimate credit needs. Commercial banks perform several functions while carrying out their routine financial activities. These include:

1. Creation of money through lending and investing.
2. Provision of a payment mechanism for the transfer of funds in economic activities.
3. Pooling of savings for economic and social purposes
4. Extension of credit to borrowers.
5. Facilitation of foreign trade and fund transfer.
6. Safe keeping of customers’ assets and provision of related financial services, including credit cards, travelers’ checks, funds wire transfer, and data processing and computer based services and leasing.

According to Gordon and Natarajan (2002), it is not an exaggeration to assert that without the development of sound commercial banking, under developed countries cannot hope to join the group of advanced countries. The economy of every country aims at a substantial increase in its productive power and better levels of living for its people. Banking contributes to economic development through: Mobilization of savings

Commercial banks are important agencies for generation of savings of the community. Savings made by individuals, business houses and public authorities, thus through inspiration of confidence in people, banks make them willing to keep their surplus with them. By offering a number of incentives viz, interest on deposit, free or cheap remittance of funds and safe custody of valuables, they stimulate savings by fostering the habit of savings in people. Creation of credit

Bank credit has an important bearing on the level of economic activity especially in underdeveloped countries. Credit expansion provides more funds to entrepreneurs, which lead to more investment and more production. Thus, offering more financial resources to industries to contribute for greater economic development. Finance government

Commercial banks provide long-term credit to government securities and short-term finance by purchasing treasury bills. Thus, banks lend to individuals, firms, companies and government to start industries and keep it running and produce wealth. Encourage right type of industries: Banks prefer to advance loans only to those entrepreneurs whose products are greatly needed by the public. Productive investment

Adam Smith says that, “It is not by augmenting the capital of the country but by tendering a greater part of that capital active and productive which would otherwise, so that the most judicious operation of banking can increase the industry of the country”. Fuller utilization of resources

Commercial banks are catalytic agents, which can create opportunities for the development of national resources and provide employment on a large scale. The growth of under developed economy calls for full employment of men and material.

2.2.3 Services offered by commercial banks

According to Haslem (1995), commercial banks offer services like; deposit services, loan services, trust services, international banking services, and other services such as pay command and computer output micro film services Loans and advances

Gordon and Natarajan ( (2002), banking is essentially a business dealing with money and credit, banks are profit oriented and thus, commercial banks invest their funds in many ways to earn income. Banks make loans and advances to traders, businessmen, and industrialists against the security of some assets or on the basis of personal security of the borrower. Term loans

According to Haslem (1995:296), term loans are loans having maturities in excess of one year which is generally based on a written loan agreement. Term loans include revolving credit agreements, which run two to three years.

Benefits from term loans

- Higher interest rates due to greater uncertainty of longer maturities
- Scheduled maturities provide assured liquidity from asset reduction.
- High credit quality of loans firms with demonstrated earning power.

Gitman (1991), a term loan is a loan made by a financial institution to a business and having an initial maturity of more than one year. These loans generally have maturities of five to twelve years; shorter maturities are available, but minimum of 5 years maturities are common. Term loans are often made to finance permanent working capital needs to pay for machinery and equipment, or liquidate other loans. Deposits of money

Gordon and Natarajan (2002:34): Defined deposits as the money deposited by the customer in bank. Current deposits are where money can be deposited and withdrawn at any time. Fixed deposits mean repayment after the expiry of a predetermined period fixed by the customer himself. This period varies from 45 days to 3 years. Saving deposits are intended primarily for small-scale savers. The main object of this account is promotion of thrift. Thus, there is restriction on withdrawals in a month. In the depository process, banks pay interest to depositors and gain income by lending and investing deposits at higher rates. Banks must balance the generation of revenue from deposits with the maintenance of liquidity.

Customer responsiveness: it could be argued out that services are easier than products to adapt to individual customer needs. But then competitive success may depend on the ability to respond to customer requirements. Market share: Most performance measures may require information that is external to the company, such as market share. Such information can be gathered from sources such as government or trade statistics and can be used to measure an organization’s performance against the rest of the industry. Quality of services: it can be difficult to quantify the quality of services rendered by banks; therefore, some sort of surrogate measure may be used. Such measures might include number of customer complaints or the average waiting time for a customer. Image: Company image can be very important to banking industry or businesses and monitoring it carefully will often be crucial to success. Customer surveys may be conducted to measure performance in this particular area by either external consultants or in house resources. Non-performing loans.

A major revelation showed that many owners and directors abused or misused their privileged positions or breached their fiduciary duties by engaging in self-serving activities. The abuses included granting of unsecured credit facilities to owners, directors and related companies which in some cases were in excess of their banks’ statutory lending limits, in violation of the provisions of the law (Oluyemi, 2005). A critical review of the nation’s banking system over the years has shown that one of the problems confronting the sector had been that of poor corporate governance. From the closing reports of banks liquidated between 1994 and 2012, there were evidences that clearly established that poor corporate governance led to their failures. Loan policy

Statutory law and administrative regulations do not provide answers to questions as regards safe, sound and profitable lending. Yeager (1989) says that, individual banks must answer these questions. It is desirable to have explicit lending policies to establish the direction and use funds from stakeholders; to control the composition and the size of loans, to determine the general circumstances under which it could be appropriate to make a loan. Thus, banks have developed formal, written lending policies recently. The national bank of Rwanda has such policies that provide guidance for loaning officers thereby establishing a greater degree of uniformity in lending practices.

2.3 Bank Performance indicators

Profit is the ultimate goal of commercial banks. All the strategies designed and activities performed thereof are meant to realize this grand objective. However, this does not mean that commercial banks have no other goals. Commercial banks could also have additional social and economic goals. However, the intention of this study is related to the first objective, profitability. To measure the profitability of commercial banks there are variety of ratios used of which Return on Asset, Return on Equity and Net Interest Margin are the major ones. (Vivid Virginia Tuna, 2013)

2.3.1 Return on Equity (ROE)

ROE is a financial ratio that refers to how much profit a company earned compared to the total amount of shareholder equity invested or found on the balance sheet. ROE is what the shareholders look in return for their investment. A business that has a high return on equity is more likely to be one that is capable of generating cash internally. Thus, the higher the ROE the better the company is in terms of profit generation. It is further explained by Khrawish (2011) that ROE is the ratio of Net Income after Taxes divided by Total Equity Capital. It represents the rate of return earned on the funds invested in the bank by its stockholders. ROE reflects how effectively a bank management is using shareholders ‘funds. Thus, it can be deduced from the above statement that the better the ROE the more effective the management in utilizing the shareholders capital. Return On Equity = (Net Income / Total Equity) * 100

2.3.2 Return on Asset (ROA)

ROA is also another major ratio that indicates the profitability of a bank. It is a ratio of Income to its total asset (Wen, 2010). It measures the ability of the bank management to generate income by utilizing company assets at their disposal. In other words, it shows how efficiently the resources of the company are used to generate the income. It further indicates the efficiency of the management of a company in generating net income from all the resources of the institution (Wen, 2010). Wen (2010), state that a higher ROA shows that the company is more efficient in using its resources, it is computed as under: Return on Asset = (Net Income / Total Assets) * 100

2.3.3 Net Interest Margin (NIM)

NIM is a measure of the difference between the interest income generated by banks and the amount of interest paid out to their lenders (for example, deposits), relative to the amount of their (interest earning) assets. It is usually expressed as a percentage of what the financial institution earns on loans in a specific time period and other assets minus the interest paid on borrowed funds divided by the average amount of the assets on which it earned income in that time period (the average earning assets). The NIM variable is defined as the net interest income divided by total earnings assets (Gul et al., 2011). However, a higher net interest margin could reflect riskier lending practices associated with substantial loan loss provisions (Khrawish, 2011). It is computed as under: Profit Margin = (Net Income / Net Sales) * 100

2.4 Determinants of Bank Performance

The determinants of bank performances can be classified into bank specific (internal) and macroeconomic (external) factors (Aburime, 2005). These are stochastic variables that determine the output. Internal factors are individual bank characteristics which affect the banks performance. These factors are basically influenced by internal decisions of management and the board. The external factors are sector-wide or country-wide factors which are beyond the control of the company and affect the profitability of banks. The overall financial performance of banks in Rwanda in the last two decade has been improving. However, this doesn't mean that all banks are profitable, there are banks declaring losses (Oloo, 2010).

2.4.1 Bank Specific Factors/Internal Factors

As explained above, the internal factors are bank specific variables which influence the profitability of specific bank. These factors are within the scope of the bank to manipulate them and that they differ from bank to bank. These include capital size, size of deposit liabilities, size and composition of credit portfolio, interest rate policy, labor productivity, and state of information technology, risk level, management quality, bank size, ownership and the like. CAMEL framework is often used by scholars to proxy the bank specific factors (Vivid Virginia Tuna, 2013).

2.4.2 External Factors/ Macroeconomic Factors

The macroeconomic policy stability, Gross Domestic Product, Inflation, Interest Rate and Political instability is also other macroeconomic variables that affect the performances of banks. For instance, the trend of GDP affects the demand for banks asset. During the declining GDP growth the demand for credit falls which in turn negatively affect the profitability of banks. On the contrary, in a growing economy as expressed by positive GDP growth, the demand for credit is high due to the nature of business cycle. During boom the demand for credit is high compared to recession (Athanasoglou et al., 2005). The same authors state in relation to the Greek situation that the relationship between inflation level and banks profitability is remained to be debatable. The direction of the relationship is not clear (Vong and Chan, 2009).

According to Warren E. Buffett (2005), the financial performance of banks is expressed in terms of profitability and the profitability has no meaning except in the sense of an increase of net asset. Profitability is a company’s ability to earn a reasonable profit on the owner’s investment (Warren E. Buffett, 2005). Most organizations exist is to earn profit and profitability ratios show a company’s overall efficiency and performance. In accordance with the study by Waymond (2007), Profitability ratios are often used in a high stream as the indicators of credit analysis in banks, since profitability is associated with the results of management performance. ROA and ROE are the most commonly used ratios, and the quality level of ROE is between 15% and 30%, for ROA is at least 1%. Measuring profitability is the most important measure of the success of the business (Mishkin, 2002). A business that is not profitable cannot survive. Conversely, a business that is highly profitable has the ability to reward its owners with a large return on their investment. Increasing profitability is one of the most important tasks of the business managers; these ones look for the way to improve profitability.

2.5 Liquidity

Liquidity refers to the degree with which an asset or security can be easily sold in the market without the sale affecting its price (Bodie, et al 2005). Liquidity refers also to the ability of an institution to meet demands for funds. Liquidity management means ensuring that the institution maintains sufficient cash and liquid assets to satisfy client demand for loans and savings withdrawals, and to pay the institution’s expenses. Liquidity management involves a daily analysis and detailed estimation of the size and timing of cash inflows and outflows over the coming days and weeks to minimize the risk that savers will be unable to access their deposits in the moments they demand them; Adolphus (2006) . Liquidity indicates the ability of the bank to meet its financial obligations in a timely and effective manner. (Samad, 2004) states that ‘‘liquidity is the life and blood of a commercial bank ’’ There should be adequacy of liquidity sources compared to present and future needs, and availability of assets readily convertible to cash without undue loss. Rudolf (2009) emphasizes that “the liquidity expresses the degree to which a bank is capable of fulfilling its respective obligations”. For this study liquidity ratio will be calculated as total customer deposits to total assets.

2.5.1 Concept and meaning of liquidity risk

Why is liquidity risk management so important? During the recent financial crisis, although many banks had posted adequate levels of capital, they still experienced difficulties because they failed to manage their liquidity properly. Post-crisis, the higher cost of liquidity, larger funding spreads, higher volatility and reduced market confidence are driving financial institutions to allocate more resources to improving their liquidity risk management capabilities (BNR, 2011). One should begin analyzing risks with the conception of risk in its broadest sense. Even though a lot of authors provide slightly varying definitions of risk, generally risk can be assumed to be an expression of a probable event as a value. Risk is the perceived loss that is often measured by the possibility of unfavorable choice, which is expressed as probability. An economist may see this probability as a ratio that indicates a possible loss of profit and the occurrence of losses (BIS 2009). There are three main types of risks that can be identified: market risk, credit risk and operational risk (Crouhy, Galai, Mark 2007). These classifications of bank risks sum up the risks that banks incur, yet it does not embrace one of the key types of risks that a bank faces, which is liquidity risk. A. Gaulia and I. Mačerinskienė (2006) further expand the classification of risk as established in the Basel rules of capital adequacy by adding liquidity risk.

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Fig. 1. Banking risk (Source: Bessis J., 2008)

Bessis J.(2008) identified six principal types of risk such as credit risk, interest rate risk, market risk, liquidity risk, operational risk and foreign exchange risk. Authors of the current banks risk is reflected in Fig. 1. The scientist has added other types of risks to the ones mentioned above. Other risks may concern country risk, regulation risk and so on. Timothy W. Koch and S. Scott MacDonald (2010) cited by Brunnermeier Lasse (2009), identified six types of risks. These are credit risk, liquidity risk, market risk, operational risk, reputation risk and legality risk. These risks go hand in hand with capital risk, which is perceived as a risk that the investor will lose all or part of their funds. So, a commercial bank is affected by a plenitude of different risks. Many authors identify various risks that commercial banks face, yet the differences among them are not essential. Liquidity risk is one of the most critical risks that banks run. Adequate management of liquidity may minimize the probability that serious problems will arise in future. In fact, the issue of liquidity is not limited to just one bank. A low liquidity ratio in one financial institution could affect the entire system. It is liquidity risk that may play the definitive role in the case of a bankruptcy of a bank. At a time of economic recession, the liquidity of a bank is a guarantee for the bank’s financial stability (Brunnermeier, Lasse 2009). Credit risk

Credit risk is the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. Generally the credit risk is associated with traditional lending activities of banks and it is simply described as risk a loan not being repaid in part or in full. However credit risk also can derive from holding bonds or other securities. All banks have their own credit philosophy established in a formal written loan policy that must be supported and communicated with an appropriate credit culture. A credit culture is successful when all employees in the bank are aligned with the management’s lending priorities (Hempel and Simonson, 1999). Credit risk is the most important area in risk management. It arises from non performance by a borrower either inability or unwillingness to perform in the pre-committed contractor manner. According to Greuning, 2003 more than 80% of all bank balance sheet relate to credit. This affects the lender holding the loan contract as well as other lenders to the creditor All over the world exposure the credit risk has led to many banks failure. Credit risk exposure particularly to real estate led to widespread banking problems in Switzerland, Spain, the United Kingdom Sweden, Japan and others .The Basel (2002) states that, credit risk is one of the major financial risks that commercial banks face. It is described as the risk to have losses because counterparty is not capable to carry out its obligations according to the term of agreement. Sometimes losses occur even when the counterparty does not breach the contract, but there are certain signs showing increasing probability of borrower’s insolvency (e.g. downgrade in credit ratings of the borrower). Credit risk is one of the key for the bank’s failure to not properly manage it may lead to insolvency and bankruptcy of a Financial Institution (Basel, 2002).

According to Kenneth and Thygerson (1995), argued that when credit risk is well managed therefore, it can finally lead the organization to the effective performance which is the goal of FIs and this must be achieved by applying credit management tools and techniques that are able to help in monitoring credits and evaluating returns from the risk bearded, as follows: Current risk

Banks take on exposure to effects of fluctuations in the prevailing foreign currency exchange rates on their financial position and cash flows. Cash flow and fair value interest rate

Cash flow interest rate is the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates. Banks take on exposure to the effects of fluctuations in the prevailing levels of market interests on both their fair value and cash flow risks. Interest margins may increase as a result of such changes but may reduce or create losses in the event that unexpected movements arise. Legal and regulatory risk

Banks’ legal departments and external legal advisors are involved when banks are considering entering into new types of business and generally in all aspects of the business where there is a contractual relationship between the banks and their counter parties which could lead to disputes and claims. In addition, banks practice and demonstrate a high degree of compliance with the rules and regulations of the central bank. Operational risk

Operational risk may crystallize if there is failure to control properly every aspect of the documentation, processing, settlement and accounting for the transaction. Banks are exposed to operational risk mainly because of the high volume of transaction and the complexity of aspects of the business. The complexity arises from both the intrinsic nature of certain banking products and from the intricacy of the documentary, legal and regulatory requirements that surround banking transactions. Generally banks look to the insurance market for protection against the financial consequences of potentially large losses arising from fire, theft, fraud, professional negligence, environmental catastrophe and so on. At the same time where the potential loss is deemed to be low, banks bear it out of their annual profits.

2.5.2 Causes of liquidity risk

Darrel Duffie and Nicolae Gârleanu (2005), Liquidity risk is financial risk due to uncertain liquidity. An institution might lose liquidity if its credit rating falls, it experiences sudden unexpected cash outflows, or some other event causes counterparties to avoid trading with or lending to the institution. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. Market and funding liquidity risks compound each other as it is difficult to sell when other investors face funding problems and it is difficult to get funding when the collateral is hard to sell. Viral Acharya and Lasse Heje Pedersen (2005) argue that, liquidity risk also tends to compound other risks. If a trading organization has a position in an illiquid asset, its limited ability to liquidate that position at short notice will compound its market risk. Suppose a firm has offsetting cash flows with two different counterparties on a given day. If the counterparty that owes it a payment defaults, the firm will have to raise cash from other sources to make its payment. Should it be unable to do so, it too will default.

2.5.3 Liquidity Position Analysis

This refers to the ability of commercial banks to pay its obligations as it falls due and the level of funding. It includes core deposits to total deposits; this ratio is calculated by summing of all core deposits divided by total deposit, it measures the volatility of deposits. Liquid assets to demand liabilities this is calculated by taking the sum of all assets maturing within one year divided by all liabilities with the same maturity period. This intends to capture the liquidity mismatch of assets and liabilities and provides an indication of the extent to which banks could meet short term withdrawal of funds without facing liquidity problems. Gross loans to total deposits this is calculated by taking gross loans divided by total deposits, measure the extent to which deposits have financed loan portfolio which are considered illiquid assets (BNR, 2008).

2.6 Financial statements

‘Financial statement’ refers to formal and original statements prepared by a business concern to disclose its financial information. According to John M. Meyer (1981), “The financial statement provides summary of accounts of a business enterprise, the balance sheet reflecting assets, liabilities and capital as on a certain date and the income statement showing the result of operation during a certain period. The financial statements are prepared with a view to depict the financial position of the concern. They are based on the recorded facts and are usually expressed in monetary terms. The financial statement are prepared periodically that is generally for the accounting period. The term financial statement has been widely used to represent two statements prepared by accountants at the end of specific period. They are : - Profit and loss a/c or income statement. -Balance sheet or statement of financial position

2.6.1 Financial Statement Analysis

This seeks on establishing the relationships with the set of financial statements at a point in time with trends in these relationships over time (Baisi 2005). Financial statements analysis involves the analysis and interpretations of financial statements in order to identify the strength and weakness of the company. The financial statements analysis is the process of establishing the relationship between various items of balance sheet and income statements. Financial statement analysis is a part of a larger information processing system on which informed decisions can be based upon (Varn Horne, 2000). The evaluation of financial statements takes the historical information for the number of years. The evaluation can be of trend analysis or cross sectional analysis. Normally the historical financial statements provide the reliable source of information for predicting the future performance of the business. In making financial statements analysis various parties need to be satisfied existing and potential stakeholders, employees, suppliers, competitors, governments, and the public at large. The needs of the above group are different and each group has its own set of need e.g. management need financial statement for profit maximization but the shareholders need financial statements for wealth maximizations and overall prospect of the company (Baisi, 2005).

2.7 Finance

Finance may be defined as the art and science of managing money. It includes financial service and financial instruments. Finance also is referred as the provision of money at the time when it is needed. Finance function is the procurement of funds and their effective utilization in business concerns. The concept of finance includes capital, funds, money, and amount. But each word is having unique meaning. Studying and understanding the concept of finance become an important part of the business concern. (C.Paramasivan&T.Subramanian, retrieved 10.12.2014

In General sense, "Finance is the management of money and other valuables, which can be easily converted into cash." According to Experts, "Finance is a simple task of providing the necessary funds (money) required by the business of entities like companies, firms, individuals and others on the terms that are most favorable to achieve their economic objectives."Entrepreneurs argued that, “Finance is concerned with cash. It is so, since, every business transaction involves cash directly or indirectly." And Academicians said that, "Finance is the procurement (to get, obtain) of funds and effective (properly planned) utilization of funds. It also deals with profits that adequately compensate for the cost and risks borne by the business."

2.7.1 Types of financial performance analysis

Willian J. Bruns, Jr (1994), the process of financial statement analysis is of different types. The process of analysis is classified on the basis of information used and ‘modus operandi’ of analysis. Financial performance analysis can be classified into different categories on the basis of material used and modes operandi as under:

A. Material used: On the basis of material used financial performance can be analyzed in following two ways: External analysis

This analysis is undertaken by the outsiders of the business namely investors, credit agencies, government agencies, and other creditors who have no access to the internal records of the company. They mainly use published financial statements for the analysis and as it serves limited purposes. Internal analysis

This analysis is undertaken by the persons namely executives and employees of the organization or by the officers appointed by government or court who have access to the books of account and other information related to the business.

B. Modus operandi: On the basis of modus operandi financial performance can be analyzed in the following two ways: Horizontal Analysis

In this type of analysis financial statements for a number of years are reviewed and analyzed. The current year’s figures are compared with the standard or base year and changes are shown usually in the form of percentage. This analysis helps the management to have an insight into levels and areas of strength and weaknesses. This analysis is also called Dynamic Analysis as it based on data from various years. Vertical Analysis

In this type of Analysis study is made of quantitative relationship of the various items of financial statements on a particular date. This analysis is useful in comparing the performance of several companies in the same group, or divisions or departments in the same company. This analysis is not much helpful in proper analysis of firm’s financial position because it depends on the data for one period. This analysis is also called Static Analysis as it based on data from one date or for one accounting period. Ratio Analysis

Stanley B. Block (1987) argued that, the use of ratio analysis is rather like solving a mystery in which each clue leads to a new area of inquiry. Helfert (1994) put it that, a ratio serves as signal rather than an absolute measure among the financial analysis technique. Therefore, Ratio analysis is an important and age-old technique. It is a powerful tool of financial Analysis. It is defined as “The indicated quotient of two mathematical expressions” and as “the relationship between two or more things” .Systematic use of ratio is to interpret the financial statement so that the strength and weakness of a firm as well as its historical performance and current financial condition can be determined. A ratio is only comparison of the numerator with the denominator .The term ratio refers to the numerical or quantitative relationship between two figures. Thus, ratio is the relationship between two figures and obtained by dividing a former by the latter. Ratios are designed show how one number is related to another.

In order to evaluate financial condition and performance of a firm, the financial analyst needs certain tools to be applied on various financial aspects. One of the widely used and powerful tools is ratio or index. Ratios express the numerical relationship between two or more things. This relationship can be expressed as percentages (25% of revenue), fraction (one-fourth of revenue), or proportion of numbers (1:4). Accounting ratios are used to describe significant relationships, which exist between figures shown on a balance sheet, in a profit and loss account, in a budgetary control system or in any other part of the accounting organization. Ratio analysis plays an important role in determining the financial strengths and weaknesses of a company relative to that of other companies in the same industry. The analysis also reveals whether the company's financial position has been improving or deteriorating over time. Ratios can be classified into four broad groups on the basis of items used: (1) Liquidity Ratio, (ii) Capital Structure/Leverage Ratios, (iii) Profitability Ratios, and (iv) Activity Ratios. A business that is not profitable cannot survive. Conversely, a business that is highly profitable has the ability to reward its owners with a large return on their investment. Increasing profitability is one of the most important tasks of the business managers; these ones look for the way to improve profitability. Gitman (1991) has stated the types of ratio as follows: Liquidity ratios:

Gitman (1991), liquidity ratios measure the ability of the firm to meet it’s a current obligation. In fact, analysis of liquidity needs the preparation of cash budgets and cash and fund flow statements; but liquidity ratios, by establishing a relationship between cash and other current asset to current obligations provide a quick measure of liquidity. A firm should ensure that it does not suffer from lack of liquidity, and it does not have excess liquidity .the failure of the company to meet its obligations due to its lack of liquidity, will result in a poor creditworthiness, loss of creditor’s confidence, or even in legal tangles resulting in the closure of the company a very high degree of liquidity is also bad idle assets earn nothing. The firms fund will be unnecessarily tied up in current assets. Therefore it is necessary to strike a proper balance between high liquidity and lack of liquidity. Profitability ratios

Profitability reflects the final result of the business operations. Profit earning is considered essential for the survival of the business. There are two types of profitability ratios profit margin ratio and the rate of return ratios. Profit margin ratio shows the relationship between profit and sales. Popular profit margin ratios are gross profit margin and net profit margin ratio. Rate of return ratio reflects between profit and investment. The important rates of return measures are rate of return on total assets and rate in equity. Leverage ratios: Leverage

Calvin Engler (1988) says that leverage ratio is also called trading on equity, normally employed to increase the returns on common stockholders ‘equity and when successful, it is said to be positive. Financial leverage is positive when the cost of borrowed funds (and / or the dividend cost of preferred stock) is less than the return on total assets and the return on common stockholders’ equity exceeds the return on total assets and negative when the reserve is true. These include; debt ratio, debt/equity ratio, times interest earned ratio, fixed payment coverage ratio, and proprietary ratio.

2.8 CAMEL Model

CAMEL is an acronym for five measures (capital adequacy, assets quality, management soundness, earnings, liquidity). In this analysis the five indicators which reflect the soundness of the institution framework are considered, Hilbers Paul, Russell Krueger, and Marina Moretti (2000). The camel framework was originally intended to determine when to schedule on-site examination of a bank. A popular framework used by regulators is the camel framework, which uses some financial ratios to help evaluate a bank’s performance Yue (1992). The five camel factors, viz. Capital adequacy, asset quality, management soundness, earnings and profitability, and liquidity, indicate the increased likelihood of bank failure when any of these five factors prove inadequate. The choice of the five camel factors is based on the idea that each represents a major element in a bank’s financial statements.

2.8.1 Camel framework

The CAMEL model incorporates analysis of both quantitative and qualitative values, with quantitative meaning financial ratios while qualitative refers to the subjective elements driving the financial institutions operations. Being inter-related, the elements in the CAMEL model cannot be applied singularly. In CAMEL ratio it consists of five categories of ratios which are used to evaluate the financial performance of financial institutions. The model is explained as under: Capital Adequacy

Capital adequacy has come forth as one of the prominent indicators of the financial health of a banking system. Capital Adequacy indicates whether the bank has enough capital to absorb unexpected losses. It is very useful for a bank to conserve & protect stakeholders‟ confidence and preventing the bank from being bankrupt. The requirement for additional capital is indicated by capital adequacy. It also reflects whether the bank has enough capital to bear unexpected losses arising in the future and bank leverage. Capital adequacy ratio shows the internal strength of the bank to withstand losses during crisis. Capital adequacy ratio is directly proportional to the resilience of the bank to crisis situations. It has also a direct effect on the profitability of banks by determining its expansion to risky but profitable ventures or areas (Sangmi and Nazir, 2010).


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Tier 1 Capital = Common Equity Tier 1 + Additional Tier 1

Total Capital = Tier 1 Capital + Tier 2 Capital

Risk-weighted exposures include weighted sum of the bank’s credit exposures (including those appearing on the bank's balance sheet and those not appearing). The weights are determined in accordance with the Basel Committee guidance for assets of each credit rating slab. Asset Quality

Asset quality signifies the degree of financial strength of and risks in a bank’s assets, mainly loans and investments. The maintenance of asset quality is a fundamental feature of banking. A broad evaluation of asset quality is one of the most important components in assessing the current situation and future viability of a bank. More often than not the loan of a bank is the major asset that generates the major share of the banks income. Loan is the major asset of commercial banks from which they generate income. The quality of loan portfolio determines the profitability of banks. The loan portfolio quality has A direct bearing on bank profitability. The highest risk facing a bank is the losses derived from delinquent loans (Dang, 2011). Management efficiency

Management efficiency is another essential component of the CAMEL model that guarantee the growth and survival of a bank. Management efficiency means adherence with set norms, ability to plan and respond to changing environment, leadership and administrative capability of the bank. The capability of the management to deploy its resources efficiently, income maximization, reducing operating costs can be measured by financial ratios. One of this ratios used to measure management quality is operating profit to income ratio (Rahman et al. in Ilhomovich, 2009; Sangmi and Nazir, 2010). The higher the operating profits to total income (revenue) the more the efficient management is in terms of operational efficiency and income generation. Earning quality

The quality of earnings is a very important criterion which represents the quality of a bank’s profitability and its capability to maintain quality and earn consistently. It primarily determines the profitability of bank and explains its sustainability and growth of future earnings. The ‘Earnings/Profit’ is a Conventional Parameter of measuring financial performance. Higher income generally reflects a lack of financial difficulties and so would be expected to reduce the likelihood of failure of a bank (Prasuna, DG 2004). Liquidity management

Risk of liquidity can have an effect on the image of bank. Liquidity is a crucial aspect which reflects bank’s ability to meet its financial obligations. An adequate liquidity position means a situation, where organization can obtain sufficient liquid funds, either by increasing liabilities or by converting its assets quickly into cash. According to Dang (2011) adequate level of liquidity is positively related with bank profitability. The most common financial ratios that reflect the liquidity position of a bank according to the above author are customer deposit to total asset and total loan to customer deposits.

2.8.2 Student T-test

Student’s t-test, in statistics, a method of testing hypotheses about the mean of a small sample drawn from a normally distributed population when the population standard deviation is unknown. A statistical examination of two population means. A two-sample t-test examines whether two samples are different and is commonly used when the variances of two normal distributions are unknown and when an experiment uses a small sample size. The test statistic in the t-test is known as the t-statistic. The t-test looks at the t-statistic, t-distribution and degrees of freedom to determine a p value (probability) that can be used to determine whether the population means differ. The t-test is one of a number of hypothesis tests. To compare three or more variables, statisticians use an analysis of variance (ANOVA). If the sample size is large, they use a z-test. Other hypothesis tests include the chi-square test and f-test. The formula that is used in computation is given as under:

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In 1908 William Sealy Gosset, an Englishman publishing under the pseudonym Student developed the t -test and t distribution. The t distribution is a family of curves in which the number of degrees of freedom (the number of independent observations in the sample minus one) specifies a particular curve. As the sample size (and thus the degrees of freedom) increases, the t distribution approaches the bell shape of the standard normal distribution. In practice, for tests involving the mean of a sample of size greater than 30, the normal distribution is usually applied.

2.8.3 Previous studies

The Analysis of financial performance of banks, both public and private, has been analyzed by academicians, scholars and administrators using CAMEL model in the last decade. A summary of some of the studies is given below:

A case study of commercial banks efficiency in Tanzania by Aikaeli (2008) was made to investigate their efficiency using non parametric data envelopment analysis for the period 1998-2004. The result showed that commercial banks in Tanzania is not disappointing to financial sector reforms as the data envelopment analysis DEA efficiency scores was high, 96%. Najjar (2008) analyzed of the bank of Palestine and Jordanahli bank. The main objectives of this study were to investigate into the performance of Jordanahli bank and Palestine, and used the CAMEL analysis to ensure equitable distribution to shareholders depends on fundamental analysis. Kwan and Eisenbeis (1997) observed that Asset Quality is commonly used as a risk indicator for financial institutions, which also determines the reliability of capital ratios. Their study indicated that capitalization affects the operation of financial capitalization affects the operation of financial institution. More the capital, higher is the efficiency. Said and Saucier (2003) evaluated the liquidity, solvency and efficiency of Japanese Banks using CAMEL rating methodology. The study assessed the capital adequacy, assets and management quality, earnings ability and liquidity position. For the year 2003-04, Prasuna (2003) analyzed the performance of 65 Indian banks according to the CAMEL Model. The author concluded that better service quality, innovative products and better bargains were beneficial because of the prevailing tough competition. In Rwanda MULAMA Richard (2005) in his Dissertation “Analysis of financial performance of commercial banks: A comparative study of BCDI and I&M Bank (BCR)”, the findings revealed that, commercial banks maintain adequate liquidity to meet unexpected deposit withdrawals of their customers. This is ensured by investments in government securities which are short term and risk free and extending loans and advances to customers where the bank earns a fixed rate of interest.

Therefore, it is reviewed that the researches done previously covered the issue of liquidity position, liquidity management during financial crisis and liquidity management practice. Though a study has already been conducted regarding financial performance of BCR and BCDI, but the study made comparison between only two banks (one BCDI and one I&M bank) and the selected time period was from 2002 to 2004. We want to investigate whether the financial performance scenario of these two types of banks (BPR and I&M Bank) has been changed during recent time period and what is the update of their liquidity management practice and also to make a comparison among these two types of bank’s liquidity scenario.


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Analysis of Financial Performance of Commercial Banks in Rwanda
A Case Study of BPR and I&M Bank (BCR). Period of study 2008 to 2013
Upper level division2
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analysis, financial, performance, commercial, banks, rwanda, case, study, bank, period
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Sylvain R. Ntuite (Author), 2015, Analysis of Financial Performance of Commercial Banks in Rwanda, Munich, GRIN Verlag,


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