Camel Rating Model and Financial Performance of Commercial Banks in Rwanda

Abstract

Financial institutions hugely contribute to Rwandan economic development. However, different studies showed that they expose to risks that limit them from attaining their objectives. The global crisis of 2007/2008 affected Rwandan financial institutions in such a way that banks’ loans and other assets deteriorated and did not work adequately. During this period, the main clients withdrew their deposits due to the high inflation rate. The banking sector’s liquidity, efficiency, and profitability in Rwanda have weakened in the past four years (2015 to 2018), and its performance indicators (return on equity and return on assets) collapsed. This study intended to examine the effect of the CAMEL rating model on the financial performance of commercial banks in Rwanda for the period ranging from 2014 to 2018. It focused on five components of the CAMEL model as its major factors affect financial performance in the banking sector. Return on assets would measure financial performance. This study was guided by four theories; cash management theory, agency theory, liability management theory, and market power theory. The target population was the 11 commercial banks operating in Rwanda. The study adopted secondary data that is published by the Central Bank of Rwanda and the official websites of various banks. The collected data processed, edited and analyzed with STATA 16.1. Descriptive research design and panel regression were employed to evaluate the correlation between the predictor and outcome variables. The findings concluded that capital adequacy and asset quality are positively correlated to determine the value of financial performance at a 5% level. Liquidity management, management efficiency, and earnings management have a negative correlation. However, only management efficiency is statistically significant to predict the ROA. The study recommends that both the banks’ management and financial regulatory body should work together to formulates policies that help improving banking sector efficiency without violating the right of their clients. When it comes to the evaluation of financial institutions, all the CAMEL model factors should be considered.