Impact of Supervision on Risk Management: A Study of Commercial Banks in Nepal using Camels

Abstract

Safe and sound financial system is one of the key indicators of prosperity and growth of the economy. Financial crisis 2007-2008 followed by Lehman brother collapse has highlighted the importance of adequate bank regulation and supervision. The supervisory role of central bank has always been very crucial to foster the overall banking system, nurture the governance, ethics and manage the riskiness of banks to protect the interest of depositors and investors. Designing of best guidelines and practices of appropriate tools do not just help them manage risks but also help them to perform better, grow to the desired level and maintain stability This paper uses the secondary halanced panel data from all 28 commercial banks in Nepal to provide empirical evidence on the role of supervision on risk management. The study of the relationship between banking supervision and risk management continues to be a fundamental issue in the literature of corporate governance, profitability and risk management. Findings of such literature are often inconclusive. The main contribution of this study is the analysis of banking supervision effects on risk management in banking industry. This study establishes the relationship by using the generalized method of moments (GMM) using Arellano-Bover/Blundell-Bond Estimation. Worldwide applied supervision parameters CAMELS variables are used as a regressor for all commercial banks in Nepal over the period 2004-2015. Using the secondary balanced panel data, this study has been able to establish the causal relationship between CAMELS supervision (i.e., Capital Adequacy, Assets Quality, Management Efficiency, Earning Performance, Liquidity and Sensitivity) on risk management of commercial banks in Nepal as measured by downside deviation and standard deviation of ROA and ROE. Amongst the CAMELS variables, assets quality has been identified as the most important contributor for risk management followed by management efficiency, liquidity and earning efficiency. However, the contribution of capital adequacy and sensitivity to market risk are found to be negligible. Further, the ownership and Basel II dummies are found to be insignificant along with macroeconomic variables (ie, GDP growth rate and CPI).