The Mauritius Banking History

Published Date: 02 Nov 2017

The Mauritius banking history was created in the 1838 where the first ever commercial bank is being formed and during the period of 1980, the Mauritius banking industry was discernible by the process of financial liberalization. Liberation and market deregulation was the main element which developed and changed the financial service sector. Since the period of independence in 1968, Mauritius banking sector has succeeded to great high and today the sector compromises of leading international banks and strong competitive domestic banks such as MCB and SBM, serving both local and global market. Mauritius financial system is a bank based and it was quite developed compared to the developing countries particularly in African region. The rise in the Mauritius economic growth has increase many opportunities for investment in bank and increase competition in the financial market. Nowadays Mauritian banks are offering different types of services such as card based payment, internet banking and phone banking.

The international financial crisis in 2008 did not have any major impact in Mauritius financial system according to financial stability report from BOM (2009). According to Aleesha Boolaky (2010) the impact, does not affect the banking sector because they were not directly expose by vulnerable debt that affect the international financial market, however they were need to protect the rise in credit risk, , currency risk, risk management practice and the lending standard.

Risk management in Mauritius banking sector is currently in respectable position and the short term stability risk are modest. However, the main risk facing the domestic financial market is related with the structure of the fundamental economy. Credit risk concentration is important as well as the economic activities such as GDP and inflation which are related. Based on the international monetary fund (2012) Mauritius has a good risk management practice as banks are profitable, well capitalized and are generally sound. The banks in Mauritius have good and resilient regulatory framework for risk management. With the introduction of Basel II framework in 2008, Mauritius have improve the risk management practice and capital adequacy in Mauritius.

1.1 Statement of the problem

Bank in Mauritius have proven to be efficient against solvency risk. Even with the guideline from the Banking Act (2004), such as monitoring, controlling and mitigating risk was prove to be weak and the Mauritius banks implement Basel II framework with a focus on capital adequacy. The following problem was identified in Mauritius.

Bank should pay more attention to market risk and operation risk

Some small banks in Mauritius were unable to apply the Basel 2 framework as it was too expensive to implement.

Bank should continue to strengthen their banking supervision and internal risk control

Risk quantification and mitigation in banks

Bank should continue to improve their risk management techniques due to fast change in environment.

Banks should adopt better techniques on the lending approach and reduced as far as possible the counter party risk which is the main type of risk affecting Mauritius.

1.2 Objectives of the study

The subject of the research is the fundamental argument of whether banks in the Mauritius have been effective managing risk and increasing shareholders wealth. Risk management framework in Mauritius form part of Basel 2 agreement and its implementation required a good support from financial system that can operate outside the banking supervision and settle the main organization framework for a good and easy financial system function. The objectives are:

To observed whether the banks in Mauritius have an effective risk management practice to manage the different types of risks the banks are expose.

To analyses the different components and asset quality of bank in Mauritius

To see whether economic growth and inflation affect the financial performance of banks in Mauritius

To assess the banks risk profile and analyses the consequence of risk taking with bank capital base.

1.3 Importance of the study

This study provides us a review of the risk management framework in Mauritius and show the ability of the banking sector to handle the essential risks. Also provide how banks adopt the Basel framework, using the best international guidelines to improve the risk management practice in Mauritius. Since the financial stability is stable, this study will provide you an indication how the risk management background look like in Mauritius.

1.4 Organization of the chapters

The structure of the work comprises of chapter two which is the literature review and this chapter includes the types of risk and a review of risk management process with its empherical and theoretical evidence. Chapter three consists of methodology which give a description of the research process, the different variable used, analytical tools and techniques. Chapter four is the analysis of the result obtains using the descriptive statistic, random effect and coefficient of covariance. Finally chapter five include the conclusion and recommendation based on work done.

Chapter TWO- Literature Review

2.1 Introduction of Mauritian banking sector

The banking sector in Mauritius have changed since the period of 1812 to 2012 as they had a long tradition of commercial banking and nowadays the banking sector are divided into two banking regimes known as the onshore and offshore banking. The Mauritius banking sector have adopted the updated legal approach of Banking Act which state that all the banks in Mauritius are manage by a single banking act license.

The Mauritian banking sectors compromises of two main branches which dominate about more than 70% of the financial system of Mauritius and they are Mauritius Commercial Bank (MCB) and the State Bank of Mauritius (SBM). These two main banks compete against each other by offering different types of services over years to both consumers and businesses. With the growth in the Mauritius banking sector which has emerge in the African region market as a competitive country and also an important market for financial and non-financial product according to Boopen and Seeboruth (2011). There have been constant innovation and improvement of the banking products in the market such as E banking.

During the international financial crisis in 2007 in Mauritius banks started using different strategies such as giving loan to maximum number of people and innovate services. However this starts to create problems to banks as they began to accumulate different types of risks and this affect their financial performance. However, one of the main risks facing bank were customers or businesses unable to repay their dept. So banks started to improve their risk management practice so to be competitive in the market using different techniques and tools to mitigate or reduced risks.

2.1.1 Risk

Risk is derived from the Italian word Risicare means "to dare". Based on the report of the Bank in Mauritius on Banking Supervision (2000) risk is defined as "the potential that events, expected or unanticipated, may have an adverse impact on the banks capital or earnings. Banking is the business of risk taking and banks take risks when making decision, the outcome of which is uncertain".

In the finance world, risk is the basic factor that affects the financial behavior. Risk is interpreting differently from organisation to organisation depending on the context. In economic, risk is not necessarily a perception in the mind of economist and is defined as uncertainty about future. In the context of finance, risk unpredictability affects the cash flow forecast and for the Capital Asset Pricing Model (CAPM) risk is regarded as a negative outcome. This event would have a direct impact on loss on earnings or may create disturbance in achieving its business objectives, so these types of difficulties decrease the potential of bank unable to manage its ongoing business or take advantage of opportunities to enhance its business.

The word "risk" to someone means danger. According to Emmett (1997) Risk is present in every part of the world and is define as unexpected event. It refers to expected outcome becoming unfavorable

2.1.2 Risk management

Firms have centralized risk as an important part of the business to be managed and therefore use the techniques called risk management. Risk management is defined by Schmidt and Roth (1990) as "the performance of activities designed to reduce the negative impact of uncertainty regarding possible losses. Another author Redja (1998) describes risk management as an efficient approach to identify and evaluate risk affecting the organization by reducing the earning and also choosing to implement different tools to reduce risk exposure. Bessis (2010) consider risk management in involving in a set of tool and models for measuring and controlling risk. Risk management does not necessarily mean risk elimination as the four process of risk management are:

Risk identification

Risk measurement

Risk monitoring

Risk control

Nowadays, Risk management form an important aspect in every profit maximizing firms, including banks, as an well-organized Risk management practices help to significantly influence the financial performance of the firms. Risk management help a firm to identify, analyze, monitor, measure, control and mitigate risks affecting an organisation. However, it is important to include that the perception of a firm related to risk may differ from time to time and from industry to industry.

2.2.1 Categories of risk

There are different categories of risk which firms need to identify and manage, as not all risk facing banks should be borne by them and risk may be treated, control, transfer or completely eliminate. There are two ways to classified risk they are systematic and unsystematic risk. Firstly systematic risk is risk facing the whole economy or market, whereas unsystematic risk is linked to a particular asset or firm. Through the use of risk mitigation and transmission method, some systematic risk can be avoided or control. According to Oldfield and Santomeron (1997) risks facing the firm can be separated into three basic strategies they are:

Eliminate or avoid risks by simple business practices

Transfer risk to other participants

Actively manage risks at the firm level

So many financial institutions may look for a simple business approach and venture less in activities that can create risk, as a way to reduced risk. Firm has the aims of having a sound business practices by reducing services or product that yield lower return with a high risk. Firm may change strategies such as underwriting standards, hedging and diversification as a way to reduces poor return by reducing risk that are irrelevant to the bank objectives. Then there will some part of systematic and operation risk that needs to be reduced at the greatest level possible and shareholder should know all this. Some risk may be transfer to other groups as there are no financial advantages dealing or managing them. There is risk that needs to be manage efficiently, such as the internal and external risk arising in the market. An example of internal risk is a manager or employee behaving inappropriately to customers is a risk to the bank losing his current and potential customers and affecting the bank internally, so such risk needs to be eliminated. An example of external risk is changed in law or natural disaster or major changed in economic, however such external risk cannot be eliminate and management need to adopt a different approach to prevent such risk such as focusing on risk identification and risk mitigation.

2.3 Categories of bank risk

Bank is faced with different types of risk in the normal course of their business. Risk can be divided into three categories they are financial risk, operational risk and business risk. The financial risk can be subdivided into two ways of pure risk and speculative risk. Pure risk is the main risk affecting bank they are credit, liquidity and solvency risk. The speculative risk looks at the financial performance of the bank depending on financial arbitrage is good or not. The speculative risks are interest rate risk, foreign currency risk and market risk.

The operation risk is defined as those risk involved in the banking strategies. Operation risk has an indirect impact and it include internal system risk, technology risk and business strategy risk. Business risk is link with bank business risk environment, including macroeconomic and legal policy.

2.3.1 Classification of risk

2.3.1.1 Credit Risk

According to the Bank of Mauritius (2003) report credit risk occur when customers fail to conform to their financial obligation to service debt, triggering a total or partial loss. It got reflected in downgrading of the counter party. Credit risk cause cash flow problem and affect the liquidity of bank as the borrower do not paid their debt in time or unable to settle the debt at all. Credit risk is foremost the main type of risk affecting the banks in the world and need to be manage properly as it may lead to bankruptcy risk. Risk management framework in bank has the responsibility to take full advantage of bank rate return by maintaining credit risk exposure within acceptable limits.

However, poor credit management is the main cause of credit risk, as it had been seen that there is a lack of communication, narrowly defined responsibilities and over emphasis on group discussion are the common causes of such situation. In term of credit risk analysis, the attributable causes are inadequate appraisal as lack of data integrity, non-availability of data in time and inadequate credit system rating is some of the reason for poor credit administration leading rise in credit risk.

2.3.1.2 Liquidity risk

Liquidity is important for a bank to pay balance sheet fluctuation and to provide fund for investment. According to Greuning and Bratanovic (2009) Liquidity risk facing by bank is when bank is unable to efficiently increase the redemption of deposits and other liabilities to cover funding in rise in loan and investment portfolio. The liquid asset should be sufficient to meet current liabilities in form of demand deposits and other short term creditors. The authors also conclude that a bank having a good liquidity position can find funds needed by increasing its liabilities, securitizing and selling assets at a reasonable price.

The Mauritius Bankers Association (2008) defines liquidity "as the ability of a bank to fund increases in asset and meet obligation as they become due, without incurring unacceptable losses". They also state that the main role of a bank is to change the short term deposit into long term loan to adopt a preventive measure against liquidity risk and which affect the whole market. Effective management of liquidity risk help to ensure that the cash flow obligation is fulfill in bank, however it is uncertain as it is affected by the market condition. Liquidity risk management is important as fall in liquidity in a bank can have a system wide consequence.

2.3.1.2 Market Risk

Market risk indicates the adverse movement in the market value of trading portfolio during period required to liquidate the transaction. Market risk could be higher if there is a shortage in monitoring the market portfolio. Mauritius Bankers Association (2008) define market risk as "a risk of loss due to daily possible of an investors to be affected by changed in securities prices". Pyle (1997) defines market risk as change in profit because of variability in the economic factors such as interest rate, exchange rate, and commodity price and this affect banks.

2.3.1.3 Interest rate risk

Interest rate risk is when bank is exposing to financial consequences of adverse movement in the rate of interest. Fluctuation in the rate of interest may have a negative consequences on interest income depending on the portfolio mixed, rate sensitivity and gap value. Greuning and Bratanovic (2009) look as interest rate risk factor as the change in market price affecting the bank portfolio, where short and long term situation in variable instrument may be offset. Interest rate risk factors are evaluating in each currency a bank having interest rate sensitive on and off balance sheet position. According to P. Ramful (2001) the range between deposits and lending interest rate is the main factor in Mauritius financial system.

The author also explain the four main type of interest rate risk they are repricing risk, yield curve risk, basis risk and optionality. Commonly interest rate risk refer to the changing planning in the maturity of fixed asset and repricing of the floating are of liabilities, bank asset and off balance sheet position. Yield curve risk is the change of the yield which affect negatively the bank income. Basis is also known as spread risk and are changes in the basis points in the market quotes such as the pricing off of various yield curve of asset and liabilities and spread between these curve shift. Optionality refer to risk that stems from the option embedded in the asset and liabilities of bank for example in mortgage backed securities

2.3.2.4 Foreign Exchange Risk

Foreign exchange risk is the risk associated with variability in the bank income as a result of changed in the currency exchange rate. Greuning and Bratanovic (2009) define currency risk as the variation in the exchange rate of domestic currency and other currency. There is different country with different currency facing currency risk when the value of the asset and liabilities are mismatch this may cause bank to suffer as a result of unfavorable change in the exchange rate movement when bank has an open on or off balance sheet position for one person foreign currency.

2.3.2.5 Operation Risk

Operation risk arises from the dysfunctional in the banking system of internal control and corporate governance. The losses compromises of procedure covering aspect of documentation, processing, settlement accounting, legal, authorization, transaction, human error and others operation risk which bank are exposed. The Mauritius Bankers Association (2008) define operation risk as "risk of loss due to inadequate or failure in the internal process, people, system or an external event." In short it is risk which is not linked with credit and market risks. Operation risk event affect institution internally and the causes is not applicable universally. This type of risk have been consider to be very isolate occurrences which cause management sensitivity to be very difficult to deal with these losses. The Basel Committee objectives is to put more emphasis on operation risk due to its modern environment that had increase the level of bank risk, as nowadays there are increase in new technology, more retail operation, outsourcing functions and activities more used of derivatives methods that have been used to reduce credit and market risk have all been related to higher level of operation risk.

2.3.2.6 Strategic risk

These are result from a fundamental shift in the economic or political environment. According to Slywotzky and Drzik (2005), strategic risk can affect a company growth and shareholder value due to its array of external event and trends. Emblemsvag and kjostad (2002), define strategic risk as a risk which arise when firms pursues their aims either by reducing risk or taking the advantage of opportunities. This risk can be managed according to the organization characteristics that are his strength and weaknesses. This compromises communication channel, operating system, and delivery network and management capacities. The internal characteristic of a firm must evaluate against the effect of economic, technology, competition, and other environmental changes.

2.4 Importance of risk management efficiency in bank

Risk management efficiency has become an important function in the banking system. Nowadays, with more sophisticated technology and different approach in strategies, banks are facing a large number of risks. These risks may influence the survival or success of a bank as banking is a business of risk. Bank manager using risk management has the aim to diminish the variability in profits as this may lead to financial crisis. As a result stakeholders may lose confidence as there is an important loss in earning, loss of the industry strategic position and even can lead to insolvency, thus a bank risk management practice need to be efficient and increase productivity. In Mauritius Dr Kheswar Jankee analyzed the impact of efficiency and productivity as he concluded that employee cost and bank investment have a negative impact on economic efficiency of banks, however a high bank deposits and bank size contribute positively to efficiency. Risk management is practice by bank to avoid poor financial performance where they might look to external investment opportunities. The external finance may result as a low level investment and create lower value for shareholders, since it is costly to used external finance than the internal funds available because of capital market imperfection. Risk encouraged managers engaged in volatility reducing strategies which effect on reducing the inconsistency in earnings ratio.

Risk management is known in today business world as important part of good management practice. According to Ozturk (2007) view risk management as the way where managers satisfy their basic risk requirement by identifying the main factor affecting the bank performance, understand it and look which types of risk to monitor, whether to reduce or increase and by what means. So risk management is the method to assess operation risk, measure it size and diminish such exposure so not to affect the banking firm objectives.

Risk management is an important function for firm and according to Santomero and Babbel (1997) risk management is the main element for firm’s financial performance. As it help the firm to be efficient against the risk affecting his income. Bank need to manage risk, as part of their objectives and to gain competitive advantage in the market.

Oldfield and Santomero (1995) look at the main element influencing risk management. These include manager, as he will look to secure the wealth and position in the firm. It is said that their ability are restricted to have a diversify portfolio in their own firm, as they prefer not to take risk and prefer stability of the firm profit and such stability recover their own utility.

The main objectives of bank are wealth maximization, where Ali and Luft (2002) put forward that bank having risk management policies improve shareholder value. So with efficient risk management practice in bank is expected to increase the value of the firm and shareholder wealth. So management need to make good decision on three important features of finance that is financing decision, investment decision and dividend policy. All these three decision will help to maximized shareholder wealth.

2.4.1 The Basel Accord in Mauritius

The Mauritius Bankers Association (2008) define the Basel committee on Banking Supervision as a committee of supervisory in different countries whose aims is to develop a complete framework on banking supervision and improves the firm stability in particular. They have set different rules since 1988. Mauritius is not a member of the Basel Committee on Banking Supervision but the Bank of Mauritius have established the Basel Accord and agreed to implement the arguments of the World Bank, however it have no right to promptly take decision for Basel implementation in Mauritius. Mauritius bank was well prepared to implement the standardized method of Basel II over the Basel I according to Bank of Mauritius (2007).

According to Deerenjen Ramasawmy and Mootooganamen Ramen (2013) in Mauritius the Basel accord was implement to balance the objective of having a good monitoring measurement of risk and a well manage capital adequacy ratio. They also include that Basel have the concern to have a good and safe banking system and build a competitive environment in Mauritian banks market and internationally.

Basel II help bank to improve the consistency of capital regulation, to make bank more risk alert and also encourage better risk management practices among the international bank. The Basel II on risk management framework is likely to reinforce the process with the new rules in regards of holding capital by bank which will make some lending decision profitable according to M. P Odit (2011). This new concept make bank more responsive to risk against the operation risk and credit risk. So this accord will improve risk management practice in Mauritius. According to the Mauritius Bankers Association (2008) if Basel II has been implementing correctly and timely then it will help bank to achieved optimum risk level. Basel II aim to create international standard that banking regulators can used when creating regulation. It can help the international financial system from the different threat that might cause bank to close down.

Basel II aims are

To ensure capital allocation are more risk sensitive

That credit risk and operation risk are not associated together

Ensure that there is an challenge to support economic and regulatory capital more closely to reduce regulatory arbitrage

Maintaining a capital adequacy ratio to improve risk management in bank

Basel II have three pillar, the first one is deal with the minimum capital required by the bank reduce risk exposure such credit risk, market risk and operation risk. The second pillar looks at the supervisory approach which help bank to have an efficient risk management method. The third pillar arranges the disclosure requirement and recommendation for banks.

2.4.2 Capital Adequacy

Basel II was introduced in Mauritius as from March 2008 and banks in Mauritius were applying the guidance of implementing the Capital Adequacy Ratio (CAR). CAR is also known as a prudential norm, as it is a ratio to bank to known the bank asset to its risk weight ratio. Capital adequacy is the capital retained by the bank in relation to the risk arises in a bank. Ojo (2008) suggest that the new Basel framework concentrates on capital adequacy as an approach for efficient risk management, as rise in capital is consider covering the possible risk taking. Sathye (2003) look at variation of the economic to the capital base that is during economic boom the bank will be active in collecting profit to increase its capital and increase contribution in the capital market whereas during period of recession, poor loan default will result in less profit and depletion in the capital. Capital adequacy will help bank during period of insolvency. The calculation of Capital adequacy ratio will require the bank core capital (tier1) which compromises of share capital reserve, statutory reserve and general reserve and the supplementary capital (tier2).

2.4.3Risk weighted Asset

Risk weighted asset form part of the capital ratios indices. There are two ways a bank can increase his capital adequacy ratio firstly by increasing the amount of regulatory capital or by decreasing the risk weighted asset which is a denominator of the regulatory ratio. According to Merton (1995)set an example in which in place of a portfolio of mortgages, a bank can hold the economic equivalent of that portfolio at a risk weight one eight as large. The new banking product since the introduction of the first Basel framework have enable bank to control their regulatory capital.

2.5 Conclusion

Risk management have been an important element for every bank in the world and every year there are new and better concept to be able to reduce, eliminate or transfer risk. According to Mauritius Bankers Association (2008) to remain competitive in the Mauritian market, bank has to resort to the international convergence of risk management and reporting. The high growth in the financial sector in Mauritius, the banking sector is conforming to these international standards through the implementation of the Basel Framework. However according to Deerenjen Ramasawmy and Mootooganamen Ramen (2013) explain that before the implementation of Basel in Mauritius banking sector, banks were facing cost problems at international level and in method of risk measurement, however introduction of Basel have set standardized approach for bank in managing risk and a competitive bank worldwide. Also Basel II implementation has been successful in Mauritius. However, based on the authors findings Basel implementation have a big cost in term of technology and human abilities in managing risk which reduce the small bank performance because of the difficulty for the Mauritian bank to apply the Basel concept. Moreover, the Basel standard is important for Mauritian banking sector as a vital point for success in the financial sector and able to compete at international level. According to M, P Odit (2011) the bank in Mauritius used the risk management process effectively, however banks should put more emphasis on certain types of risks such as operational risk, market risk and credit risk. Thus bank must concentrate more on these types of risk as it affects the performance.

CHAPTRE THREE- METHODOLOGY

3.0 INTRODUCTION

This chapter is set down on the methodology for analysis. The main research objectives of this study are to observe the efficiency of the Mauritius banking sector in managing the different types of risks. Risk management practices in bank are usually determined by its profitability and performance indices. We will also focus also on the macroeconomic indicators such as the economic growth and inflation influencing the banking sector. Risk management is primarily used by banks as an indicator to prevent insolvency risk, so we will observe how the banks in Mauritius used risk management practice to deal with the different types of risks.

3.1 Benchmarks

In Mauritius risk management in bank is based on a comprehensive risk governance framework, a good control on risk taking activities and ensures that the bank activities are associated with the banks strategies, regulatory and legal framework, meeting shareholders expectation and customer’s requirement. These frameworks are monitor and evaluate regularly so to compete on the market within an acceptable risk return. The risk management practice is constructed by a concrete management structure and information with a good risk rating systems. The major benchmark is when banks adopted the Basel II recommendation for an even more comprehensive risk management practice and risk sensitive capital condition.

Risk management report set by the Basel committee of banking supervision set in 2008 in Mauritius to improve the bank stability and having a sound risk management practice in bank. The Basel framework for risk management is to maintain an adequate level of capital adequacy. The main procedure in achieving the objective of risk management efficiency in Mauritius banks is the used of capital adequacy indices which is the main form of prudential in a bank.

3.2 Types of research

In this study, descriptive research will be use, as it involves gathering information that describe events and then organizes, formulates, describes, and analyse the data. Descriptive study enables data collection. The two type of research for this study are:

3.2.1 Primary data

Primary data is collected specifically to address the problem in question and is conducted by the decision maker, a marketing firm, a university or Extension researcher and others. In our risk management context, data will be collected from a questionnaire submit to the bank employees for this survey.

3.2.2 Secondary data

Secondary data is information that has already been collected and is usually available in published or electronic form. Secondary data has often been collected, analysed, and organized with a specific purpose in mind. The resources used have been obtained from the internet, books and some journals and academic magazines, as well.

3.2.3 Research for this study

The type of research we used in our study is the secondary data research as we will analyze the relationship between risk management efficiency with the bank specific determinant and macroeconomic factors. In our study, data were collected from the bank’s annual report in Mauritius and other risk reports.

3.3 Analytical Variables

A stated earlier the aims of the study is to see how risk management in Mauritius is efficient in banks and compare to others countries Mauritius has a small number of banks, so in our model data were collected from the financial statement of banks for the years 2007 to 2011 which are available from the internet, taking the two largest banks affecting more than 50 percent of Mauritius bank total asset that is Mauritius Commercial Banks (MCB) and State Bank in Mauritius (SBM) and also taking two medium banks which are the MPCB and BRAMER banks. The variables are figured out as ratios and table 3.4show the variables.

3.4 Research data source and description

Table 3.4 Variables for Risk management efficiency in bank

Category

Ratios

Capital Adequacy

Regulatory capital divided by Total risk weighted asset

Credit Risk

Loan divided by Total asset

Interest Sensitivity

Interest sensitivity asset divided by interest sensitivity liabilities

SIZE

Natural logarithm of total asset

Return on total asset

Net income divided by total asset

Operating Risk

Operating expenses divided by net operating income

Liquidity Risk

Liquid asset divided by Current liabilities

GDP

Selected from Mauritius database

Inflation

Selected from Mauritius database

3.4.1 Capital adequacy ratio

Capital adequacy is taken as our dependant variable to measure efficiency of risk management in Mauritius banking sector. Capital adequacy is a measure of financial strength for bank as it helps to keep bank out of difficulties arising and ensure they have sufficient capital. Capital adequacy ratio is taken from the bank’s annual report of risk management of Basel 2. Table 3.1 show that capital adequacy are measure by taking the regulatory capital that is bank core capital divided by risk weighted assets.

3.4.2 Credit Risk

The first and most important type of risk affecting the maximum number of bank is credit risk. In short, credit risk is where a customer is unable to meet his financial obligation toward the bank for example loan. Credit risk is calculated by taking the customers loan divided by the bank total asset. Data collected for customer loan and total asset is taken from the statement of financial position of banks.

3.4.3 Interest sensitive gap

Interest sensitive gap measure the degree of change in price of an asset in response of change in the rate of interest in the market and which provides banks an overall view of their interest rate risk profile. Table 3.3 show that interest sensitive asset divided by interest sensitive liabilities will provide us the interest sensitive gap and both data are obtain from bank annual report.

3.4.4 SIZE

Another determinant in our model is Size which stands of bank total asset. To seek the management efficiency of risk in Mauritius we need to know the different in size of the banks and how they manage risk. Size is calculated using the Natural logarithm of bank total asset which are provided from the statement of financial position.

3.4.5 ROA (return on asset)

Return on asset is an indicator of bank profitability in term of its total assets. ROA give an overall view of how bank is efficient in managing its total asset to generate revenue. The formulae of ROA are net income divided by total asset. Net income can be found in the bank income statement and the total asset in the statement of financial position.

3.4.6Operating risk

Operation risk is risk that incurred internally in an organization such as failed in system, people and internal process. The operating efficiency look to the efficient quality management to ensure that asset is well priced to achieve a good cost of withholding liability. Operating efficiency of bank measure as net operating income divided by operating expenses and both data are collected from banks income statement.

3.4.7 Liquidity risk

Liquidity risk arises when bank short term obligation cannot be met and the bank is forced to liquidate part of its fixed asset below market worth. It measures the bank ability of generating cash inflow or turn repriceable asset into cash. Liquidity risk is measure by taking the liquid asset divided by current liabilities. The data are collected from the statement of financial position and liquid asset is represent as cash or cash equivalent and current liabilities as deposits customer’s deposits.

3.4.8Gross domestic product (GDP)

GDP is our macroeconomic determinant and is an indicator which gives a view of the health of the economy of the country. It is the value of all goods and services produced within a country, and are measure usually over one year. GDP data are collected from the Mauritius GDP rate of index mundi from the internet.

3.4.9 Inflation

Inflation is our macroeconomic variable and is define as an upward price movement of goods and services in an economy over a period of time. Inflation data are available from the Mauritius consumer index from the internet. Figure 3.6 shows a risk management structure in which the efficiency is determined by macro variables and other micro unit

Risk management Efficiency

Capital Adequacy

Interest sensitivity gap

Operating efficiency

Profitability

Credit exposureFigures 3.5 Risk management Framework

GDP

Inflation

3.6Analytical tools

The analysis tools used in this model was primarily based on a spread sheet of excel where data collected was input in tables. The spreadsheet was used for the calculation of ratios and these ratios will later be shift for panel data analysis. Another tool use is stata which is statistical software that provide data management, data analysis and graphics.

3.7 Panel data

In this study we will apply a panel data approach. A panel data is a set of data in which the performance of entities are analyse across different point of time. Panel data are also known as cross sectional and longitudinal series data. To analyze efficiency of risk management in bank we have applied panel data statistic using statistical software name Stata to do their work on capital adequacy in bank. The general form of panel data is

Yit=x it+ + it

Where "i" represent cross sectional and "t" stand for time. The variable "Yit" is the dependant variable, "xit" is the independent variables in the estimation model and "" is the constant term.

3.8 Econometric Specification

Risk management efficiency in Bank is determined by both the bank variables and its macroeconomics factors. The efficient form of this relationship is identified for the purpose of this study and its equation is:

CARit = f (CRit , LQRit , ISRit , ROAit , SIZEit , , OPRit , GRT, INF)

Where the dependent variable CAR stand for capital adequacy, CR is credit risk, LQR is liquidity risk, ISR is interest sensitive ratio, ROA is return on asset, SIZE is the total asset, OPR is operation efficiency, GRT is economic growth and INF is the inflation.

And it is economically express as:

CARit = a + B1*CRiskit + B2*LQRit + B3*ISRit + B4*ROAit + B5*SIZEit + B6*OPRit + 1*GRT + 2*INF + it ( = vit + ui)………………equation (1)

The "t" stands for the time period, the "i" is a notation for individual banking and the "" is the disturbance term. The "" is to capture error from undetected bank specific factors vit and ui is the robust standard error. B andare parameters for estimating bank factors and macroeconomic variables.

3.81 Descriptive panel statistic

Descriptive statistic is used in our panel data to describe the elementary features of data in our study. They provide summary about what our data shows. Descriptive statistic provides numerical measures to summarize the data collected in an understandable way. It also help us to reduce large number of data in a simpler way. The importance of descriptive statistics in our panel data variables is to show the difference exists among the time series data and its variability. Descriptive statistics calculate variables such as the coefficient of variation, standard deviation, mean, maximum and minimum for variables using the Stata software and are presented on a table for better evaluation. The coefficient of variation measure dispersion and compare difference across variables with different entities and in our study CV(coefficient of variation) is being used over standard deviation because it only measure the regular deviation of a variable from the mean.

3.8.3 Random effect model

Random effect model is used in our panel data as the variation across banks is assumed to be random and uncorrelated with the independent variable and banks specific factor unlike the fixed model. Also with random effect model we can analyse the relationship and significant figures of capital adequacy with the other independent variables. The R square in our model is used to explain and determine our dependent variables with the independent variable one. In the random effect model we can include time invariant variables compare to fixed effect model. The reason for choosing random model over fixed model without passing the Hausman test is that variables were dropped in the fixed model. The random effect model is:

Yit= X it+ +it+it

Where "" is between entity error and "" is within entity error.

The entity error in the random effect is not related with the dependant variable, so it cause time invariant variables to play a role as independent variables. Random effects we need to state the explanatory variables characteristics that may impact with the predictor variable. In our model we will analyse the relationship and importance between the predictor and the explanatory variables.

3.8.2 Covariance and coefficient for multicollinearity check

Covariance and correlation show the relationship between two variables and show whether they are positively or negatively correlated. Correlation coefficient of 1 means that the two variable are perfectly correlated and correlation coefficient of -1 means the variables are inversely correlated but a correlation coefficient of zero means there is no correlation. Covariance also indicates the way to which the variable tent to move together. Multicollinearity is when two or more variables are highly related in a regression model. In our model correlations coefficients and covariance explain variables the requirement for testing multicollinearity. Based on the assumption of classical regression model when the variable in our model are correlated, then it is said that the model is not the best one.

3.9 Limitation of Methodology

As stated earlier Mauritius is a small country with only 20 banks operating so the sample data in our study were of small sample size. Also of these 20 banks only two of them affect the market size. The problem encountered when carrying this study is that not all banks have published their annual report in Mauritius as only their financial statement are available. Based in our study the annual report gives data such as capital adequacy ratio which is our dependent variable so only four banks in Mauritius have this data available.

Chapter Four- Analysis and discussion

4.0 Introduction

This chapter will provide a summary of the results obtain from the analysis presented from the guidelines of chapter three based on the research methodology. Data was examined and the presentation of the result was introduced in a table to give a general description of our study and discuss whether the capial adequacy is a good measure of risk management in Mauritius. The analysis done for this study are descriptive statistic, random eeffect model and correlation and covariance anaysis.

4.1 Descriptive Statistic of Variables

Table 4.1 Descriptive statistic of panel variables

CR

ISR

ROA

SIZE

LQR

OPR

INF

GDP

Mean

0.550037

1.068924

0.164241

17.0407

0.657241

88.61244

6.094

4.24

Max

0.749218

1.158815

0.3168

18.86085

0.8998449

306.6908

9.73

5.4

Min

0.124233

0.847065

0.002762

15.08025

0.2266202

35.53053

2.55

3.1

Std. Dv

0.174850

0.901945

0.008232

1.417719

0.1971129

61.06853

3.0273

0.774

CV

0.137888

0.843787

0.00501

0.083196

0.299909

0.6891642

0.4967

0.182

Table 4.1 comprises the descriptive statistic of the risk variables and macroeconomic variables affecting the bank performance. The descriptive statistic of credit risk (CR) in table 4.1 show a minimum credit risk coefficient of 0.124 and a maximum of 0.749, so the wide gap of credit risk index among the banks could be because of randomness of our variables where large banks are taken together with the weak one in our study. Credit risk also has a coefficient of variation of 0.137 as it shows the dispersion in credit risk index away from the bank mean of 0.550. So the low coefficient of variation of credit risk index of 13% means the variability of the variable is lesser. The result show that credit risk management have improved in Mauritius with the introduction of Basel 2 framework using the Standardized Approach and the Internal Rating based system according to the Mauritius Bankers Association (2008) report.

The interest sensitivity ratio (ISR) from table 4.1 shows a maximum coefficient of 1.15 and minimum coefficient of 0.84, so the gap of ISR among the banks is small. The coefficient of variation of ISR is 0.84 that is 84%, so the high CV means that there is greater dispersion of the variable from the industry mean of 1.06. So a high CV in ISR is due of an unpredictable rate of interest as can rise or fall and ISR had a much wider range of outcome that has a higher probability to occur in Mauritius. The Bank of Mauritius shows the benchmark of rate of interest during finanacial crisis in the year 2007 to 2008 and the rate move from 9.35% to 6.8% as show in figure 2 below. So this shows the variability of interest rate in Mauritius.

Figure: 2 Rate of interest in Mauritius

Historical Data Chart

The Return on Asset (ROA) in table 4.1 has a minimum coefficient of 0.002 and a maximum coefficient of 0.31, this small gap mean that all the banks were profitable during these years. The coefficient of variation of ROA is very low, thus return on the banks asset was consistent and is more likely to continue. According to the Bank of Mauritius (2009) financial stability report "All the bank operating in Mauritius have so far shown considerable resilience in terms of capital adequacy, balance sheet growth and profitability" thus this report proved our analysis efficiency.

The variable SIZE have a maximum coefficient of 18.8 and minimum coefficient of 15.08, the wide gap is because in our empherical study we have taken two large banks and two medium one in Mauritius with huge differential in their total asset. The coefficient of variation of SIZE is 8.3 % thus the variation in banks total asset is small.

The Liquidity risk (LQR) and Operating efficiency (OPR) in table 4.1 shows there is a wide gap in both liquidity position and operating efficiency among the banks in Mauritius, thus as stated earlier this is due to the difference in our sample banks income in Mauritius. For example there is a big difference in the income between Mauritius Commercial Bank and Bramer bank. The coefficient of variation of liquidity risk is 30% so the low CV means that Liquidity risk is less dispersed among the banks away from the mean of 0.6572. Operating efficiency has a coefficient of variation of 68% and it means that OPR is spread out fron the industry mean. Mauritius banks should put more emphasis in managing operation risk as the result illustrate that according to M. P Odit (2011), Mauritius banks handle the risk management process positively, however the banks should concentrate more on certain types of risk preceding to risk management practice such as Market risk and Operation risk as these types of risk not only reduced the performance but combine with the financial economy crisis.

Table 4.1 also show the descriptive statistic of the macroeconomic variables of inflation (IFL) and GDP. The maximum coefficient of inflation is 9.73 and minimum of 2.55 so during these five years there is a wide gap in inflation and it has a coefficient of variation of 49%, so this is due to the financial crisis between 2007 and 2008 in Mauritius. Figure 3 show the variation in inflation rate in Mauritius. The coefficient of variation of GDP is 18%, so variability is lesser than inflation in Mauritius and the GDP change slightly from 5.4% to 3.1%

Figure 3: Inflation rate in Mauritius

Historical Data Chart

4.2 Random effect Regression Analysis

Table 4.2 Random effect result

Capital adequacy

Coef

Std. Err

Z

p>z

95% conf

Interval

CR

-1.768566

.5354168

-3.30

0.001 *

-2.817964

-0.7191685

ISR

0.443227

.3930134

0.11

0.910 ***

-0.7259693

0.8146147

ROA

10.16881

2.678089

3.80

0.000*

4.91983

15.41778

SIZE

1.553718

.025473

-2.86

0.001 *

-1.228042

-0.229484

LQR

-0.0728

.474634

3.27

0.004**

0.6234524

2.483984

OPR

0.0004279

.0003707

1.15

0.248***

-0.0002988

-0.0011546

IFL

-0.0100845

.0049213

-2.05

0.040**

-0.0197301

-0.00439

GDP

0.132654

.0184809

0.73

0.463***

-0.0221725

0.487037

_cons

1.084016

.1336688

3.46

0.001*

.4692363

1.698795

R- squared

0.6550

* . ** *** level of Significant as from 1%,5% and 10%

The econometric specification of random effect model is denotes from this equation:

CAR=1.084016-1.768566(CR)+0.443227(ISR)+10.16884+1.553718(ROA)-0.0728(SIZE)+0.0004279(OPR)-0.0100845(IFL)+0.132654(GDP)

SE = (0.5354168) (0.3930124) (2.678089) (0.25473) (0.474634) (0.0003770) (0.0049213) (0.184809)

4.2.1 Interpreting R- squared and constant term

The R squared show how the regression model fits the data well. As it measure the degree the independent variables explain the difference with the dependant variables. In our random effect regression model the R squared is 0.65 that is 65% and it represent the difference of capital ratio is explained by changed in the expalnatory and macroeconomic variables.The constant term show the minimum or maximum of the capital adequacy ratio depending on the coefficient value of the variables.

4.2.2 Relationship and significant between capital adequacy and credit risk

From the equation above it shows the relationship between the dependant variable and independent variables based from the table 4.2. The equation show that there is a negative relationship between credit risk (CR) and the capital adequacy ratio. So a rise in credit risk will reduce the the capital holding by banks. Supported by empherical evidence from the report of International monetary fund (2010) Banks in Mauritius are generally resilient to a range of adverse shock but are vulnerable to credit quality. In the period 2007 and 2008 high credit risk in sugar and textiles industry leads to deteriorations of the capital adequacy ratio from 16.2% to 12.3% and the total gross loan from 2.3% to 5.8%. Moreover the banks assets continue to improve since 2007. Overall we can conclude that credit risk affect the capital adequacy of bank and reduce bank performance hence we need to manage credit risk efficiently to be able to compete in the financial market. Table 4.2 show that P value of capital adequacy is highly significant with credit risk with 0.001. This is because bank hold a minimum capital requirement to support the risk of borrower unable to repaid their dept and also a degree of protection for depositors according to Basel report.

4.2.3 Relationship and significant between capital adequacy and interest sensitivity(ISR)

The coefficent of the variable representing interest sensitive ratio from the equation have a positive relationship with capital adequacy in Mauritius. When interest sensitivity ratio is more than one, a rise in interest rate will have a positive impact on revenue. According to the Mauritius Commercial Bank (MCB) financial risk management report " interest sensitivity affect the bank financial condition due to change in the level of rate of interest rate" So a rise in interest rate risk reduce the banks earnings as bank must paid higher rate on deposits and customers demand for loan product will decrease as borrowing become expensive. Nevertheless the P value show that capital adequacy ratio is statically insignificant with interest sensitivity of 0.910 from table 4.2 and this is because the impact on bank interest sensitive asset over interest sensitive liabilities has no effect on bank minimum capital requirement in Mauritius.

4.2.4 Relationship and significant between capital adequacy and ROA

From the equation we can deduct that Return on bank total asset (ROA) have a positive relationship with the capital adequacy ratio. So a rise in return of bank total asset will increase the bank capital base as there is an excess in return, banks will used parts of it as capital. Also in our sample banks taken, return on total asset is progressive. According to the International monetary fund (2005) report, Mauritius banking system are well capitalized and highly profitable, also the return on assets has been consistently above 2% and the average capital adequacy ratio at 13% far exceed the regulatory minimum of 10% and the Basel norm of 8%. Table 4.2 show the correlation between ROA and capital adequacy and they are highly significant, as a bank with a good return on asset and with constant management strategies can be well capitalized in the future

4.2.5 Relationship and significant between capital adequacy and Liquidity efficiency

The relationship between liquidity and capital adequacy from the equation is positive. A bank has the objectives to ensure that his current asset is superior to his current liabilities. From our result a fall in liquidity will affect the capital adequacy negatively in Mauritius and vice versa. However, in Mauritius banks face liquidity effectiveness with customer deposit exceeding customer loan in all our sample data taken in our study. According to Ravin Dajee (2011) chairman of MBA "Mauritius banking sector expect excess liquidity to remain a challenge this year due to slack demand for credit" So this show that Mauritius bank risk management practices are positively related with liquidity situation and is significant for capital adequacy.

4.2.6 Relationship and significant between capital adequacy and size

The coefficient of the variable SIZE in the equation above show that there is a negative relationship with capital adequacy. So an increse in SIZE will reduced the capital based of the bank. According to Mitchell (1984) a fall in asset quality increase the capital adequacy ratio in order to protect bank against risks. SIZE is significant with capital adequacy and according to Dr Kheswar Jankee "a high bank deposits and bank size contribute positively to efficiency".

4.2.7 Relationship and significant between capital adequacy with operating efficiency

The coefficient of the variable operating efficiency has a positive coefficient but is insignificant with the capital adequacy ratio. An increase in operating efficiency will mean that the bank are better positioned for profit and the effect on capital are likely to be positive. Empherical evidence from Boopen.S.Seeboruth(2011) that banks in Mauritus responded better to competitive business environment and the increase in performance is due mainly to technological change, as some banks responded positively to to the opportunities of new technology. However operating efficiency does not have any direct impact on the capital adequacy ratio.

4.2.8 Relationship and significant between capital adequacy with Inflation

The macroeconomic determinant inflation in equation above have a negative impact and has a significant figure with capital adequacy ratio. So a rise in inflation rate will cause a fall in customer’s deposits, thus this affect the capital base of the banks in Mauritius. Inflation rate in Mauritius are varying constantly and reach the highest peak in 2008 as shown in figure 3, So the higher the inflation rate the more bank will increase interest rate, however this cause the financing decision difficult with high interest rate as cost of funds rise and thus equity holder usually demands are higher, so this have a negative impact on the capital adequacy ratio. Empherical evidence from the Bank of Mauritius (2011) report that the central bank will increase the interest rate by a percentage point to control inflation that rise faster than expected economic growth accelerate.

4.2.9 Relationship and significant between capital adequacy with GDP

From the equation we can deduct that there is a positive relationship between GDP and capital adequacy. Economic growth has a positive impact on bank capital adequacy in Mauritius. A rise economic growth will increase capital from the financial market and in time of recession, default loan and cost of capital are high and this increase difficulty in managing risk. However capital adequacy is insignificant with GDP as it does not have a direct impact in Mauritius. Empherical evidence from Bhissum Nowbutsing (2012) who suggest "Mauritius economic growth is critical for domestic private capital formation, where high economic growth may serve as a signal to indigenous business decision" Mauritius economic growth during the recent years are constant so it does not impact on bank performance.

4.3 Correlation and Covariance Analysis

Table 4.3 correlation Covariance amoung independent variables

CR

ISR

ROA

SIZE

LQ

OP

INF

GDP

CR

1.0000

ISR

-0.0701

1.0000

ROA

-0.20462

0.2841

1.0000

SIZE

-0.1400

0.0883

0.2716

1.0000

LQ

0.4833

0.0691

-0.0766

0.00277

1.0000

OP

0.1234

-0.0870

0.2000

-0.5249

-0.0275

1.0000

INF

-0.4154

-0.07505

0.1080

0.0836

-0.4080

-0.0414

1.0000

GDP

0.4239

0.0002

0.0455

-0.0821

-0.4254

-0.0361

0.0857

1.0000

Table 4.3 represent the result of the correlation and covariance of risk management variables required for testing multicollinearity. It can be noted that credit risk (CR) have a positive correlation with Liquidity (LQ) and Operation efficiency (OP). According to Sekaran and Bougie (2010) coefficient of 0.80 or above shows the present of multicollinearity and based on the assumption of classical regression analysis when variables in a model are correlated, the model is not the best one. Table 4.3 show that the variables are not correlated and this implies there is no multicollonearity in our model.