An extended application of Factor Analysis in establishing peer groups among banks in Armenia

ABSTRACT

The introduction of this paper provides an historical backdrop to a modern-day analysis of banks in Armenia. Illustrated then are results from an extended application of Factor Analysis performed on a set of 17 banks and 13 financial variables, which are drawn from Armenia's Arka News Agency data. Factor Analysis procedures determine how banks can be classified based upon their disparate and common characteristics. Plots of outputs depict clusters of banks, which correspond with the statistical classification of banks based upon the 13 financial variables. Banks in any given cluster are deemed members of a 'peer' group which is a useful construct in performing comparative analyses among banks or for regulatory and policy-making purposes.

I. INTRODUCTION

This paper augments and extends a manuscript under review by Safdari, Scannell and Ohanian (2003) which performed Cluster and Factor analyses on like banking data. The present paper isolates and extends the Factor Analysis procedure to demonstrate and reinforce the efficacy of statistical procedures in the classification of entities. Specifically defined in this paper are the clusters of banks in Armenia which can be viewed are peer groups, polarized based on their financial characteristics embodied in the 13 banking variables available for study from the Arka News Agency (Arka, 2001).

II. HISTORICAL FRAMEWORK

In the beginning of the 20th century capitalism emerged in Armenia. The Russian capital, Moscow, ruled over Armenia, and the major banks of Russia had established their branches in principal towns of Transcaucasia (Armenia, Georgia and Azerbaijan). About 10 banking institutions were operating in Yerevan in 1914. In October 26, 1920, the law established the State Bank of the Republic of Armenia on the basis of the Yerevan branch of the State Bank. After establishment of the Soviet regime in Armenia, the Revolutionary Committee and the People's Commissariat of Finance (PCF) issued a decree on December 10, 1920, to nationalize the private banks and withdraw the currency then in circulation. In 1921 the State Bank of USSR was established, with the main office and branches created in Armenia in 1924. In 1925 the Yerevan office of the State Bank of the USSR was renamed into the Armenian office of the State Bank of the USSR (CBA, 2002).

In the late 80's, there were 52 branches of the Republican Office of the State Bank of the USSR in Armenia in 1987. Haik was the first cooperative bank established in Soviet Armenia October 6, 1988, which put basis and gave rise to a broad network of banks in the republic. In December 1988, Erevan Bank was the first among commercial banks established. Armeconombank was the first bank established immediately after the independence of the Republic of Armenia was obtained on September 26, 1991 (CBA, Banking System of Armenia; 1999, P. 11). In December 1991, the State Bank of the SSRA was charged with responsibility as a National Bank of the newly independent Armenian Republic. The Armenian Law on The Central Bank of the Republic of Armenia adopted in March 27, 1993, renamed the National Bank into the Central Bank of Armenia (CBA) (CBA, 2002).

Banks and financial institutions mushroomed rapidly during Armenia's early years of independence, but faced a number of serious problems in the years 1994 and 1995, when banking system crises forced 37 banks to cease their activities. At the end of 1995, only 34 banks were operating in Armenia (Synthesis, 2001, p. 74). The new minimum capital requirements had forced the closure of almost half of Armenia's banks (Lafferty, 1995).

As of 1995 the CBA's organizational structure has been based on experiences of European and international financial institutions adapted to take into consideration local characteristics (Asatrian, 1995, p. 60). The Association of Banks of Armenia was founded on July 27, 1995, and Tigran Sargsyan was elected as President. On June 31, 1996, the National Assembly adopted Armenian laws on banking designed to regulate the banking system (CBA, 2002). As of January 1, 1996, 38 banking institutions operated in the ROA, including 3 branches of non-resident banks. During the same year, 8 of these institutions terminated their activities--two of them through self-liquidation, while the banking licenses of the other six banks were revoked by the CBA (Asatrian, 1996, p. 39).

As of January 1, 1997, there were 33 banking institutions and one non-resident bank branch operating in Armenia. One year later, only 30 banks with 174 branches were registered in the country (CBA, Banking System of Armenia; 1999, P. 11). Mainly due to tightening of normative requirements by the CBA to increase the minimum total capital, during 1997 total assets of the banking system grew by 57.6% (as the number of banks decreased); the magnitude of actually-completed share capital of the banking system increased by 60.6%. (Sargsyan, 1997, pp. 54-55). The year 1998 heralded the installation of Tigran Sargsyan as chair of the CBA (CBA, 2002) and stabilization of the banking system of Armenia due to improvements of the regulatory field and introduction of international accounting standards (CBA, 1998, p. 35). As of January 1, 1999, 18 of 31 banks operating in Armenia were registered as Closed Joint-Stock companies, 5 Public Joint-Stock Companies, 7 Limited Liability Companies and 1 Cooperative Bank (CBA, Banking System of Armenia; 1999, P. 11).

The banking situation remained more or less stable until mid-2000 when another wave of asset mismanagement and minimum capital under-performance was observed. During 2000 and at the beginning of 2001 the CBA undertook various types of insolvency procedures against the 5 worst-performing commercial banks. At the beginning of 2001, the license of Econominvestbank was revoked because of minimum capital requirement violations. As of March 31, 2001, 30 banks with 218 branches were registered in Armenia, but only 26 of them were totally operating, out of which 4 were subsidiaries of foreign banks: HSBC-Armenia, Areximbank, Mellatbank, and International Commercial Bank-Armenia. Regarding ownership, 15 banks were closed joint-stock companies (one, Armsavingsbank, being state-owned), 6 were open joint-stock companies, 4 were limited liability companies and one was a cooperative (Synthesis, 2001, pp. 74-75).

III. THE DATA

All data analyzed in the present study are obtained from Arka News Agency publications (Arka, 2001). Of the 31 banks reported in operation by Arka as of its March 31, 2001, a sample of 17 banks (those with complete information across all 13 variables) was extracted and included in this study.

Table 1 lists 32 banks (31 banks plus an additional bank that was not included in the Arka report), along with their address information which was taken from the CBA website, (www.cba.am). The 32 numbers in column 1 of Table 1 correspond to the 32 bank locations on the map depicted in Figure 1. A letter 'X' in column 3 of Table 1 cells identify each of the 17 banks discussed in this paper--a subset of the Armenian bank population.

[FIGURE 1 OMITTED]

The 17 banks under study can also be identified by the circled numbers in Figure 1, the Map of Bank locations in Armenia's capital city, Yerevan. Note that all 17 banks are located in the capital city center with the exception of bank number 5 (ArtsakhBank CJSC) and bank number 12 (Converse Bank Corp), both Northwest of the capital city center.

Table 2 is an alphabetical list of the 17 banks used in the study. Included in the last two columns are the bank's component scores which were calculated based on a statistical analysis performed in the Safdari, et. al. (2003) study.

IV. FACTOR ANALYSIS

In this paper, Factor Analysis is extended beyond that performed in the Safdari, et. al. (2003) paper. Figure 2, Figure 3 and Figure 4 are the extended results of Factor Analyses performed on the study's 17 banks and 13 financial variables. Figure 2 and Figure 3 are identical except in one respect. The bank numbers are absent in Figure 3, in order to more clearly view the location of the plots, and, therefore view more clearly the formation of bank clusters.

[FIGURES 2-4 OMITTED]

Figure 2 plots the 17 banks in a two dimensional space with the two components (the two factors) plotted from the values found in Table 1 for each of the 17 banks. By looking at the Factor Analysis plotting of the banks in Figure 2, one can visually discern the formation of bank clusters. These bank clusters are nearly identical to those resulting from the Cluster Analyses performed in the Safdari, et. al. (2003) paper in the determination of bank peer groups. For example, HSCB, bank number 13, conspicuously stands out, alone comprising a singular peer group. Indeed, number 13 can be seen isolated at the very top of Figure 2. Thus, the analysis concludes that Armenia's HSCB bank has no peers. Thus, for policy, regulation or comparative analysis purposes, it might not be appropriate to hold it to the same standards, e.g., capital requirements as other banks.

NOTE: The diamond for the bank number 4 is partially over-written by the number 0.5 for Component 1. Also, The diamond for the bank number 6 is completely over-written by the number 0.5 for Component 2; the dot is actually located where the decimal point in 0.5 is.

Table 3 is excerpted from the Safdari, et. al. (2003) paper. The component values for each of the 13 variables are, in this study, plotted to produce Figure 4. Component 1 and Componen1 2 values for each of the 13 variables serve as coordinates in the 2-dimensional plot in Figure 4. Given that the study analyzes 13 financial variables, one might try (futilely) to imagine a 13-dimentional space. However, with Factor Analysis and with minor error (89% accuracy), a 13-dimentional space can be reduced to a 2-dimensional space and viewed on a single piece of paper, with the two components on the axes representing, respectively, the two most salient factors in explaining the variance among banks. For example, the variable, 'Loans to Economy' is one of the 17 banking variables used in the study. Its abbreviated name, LN.ECON can be seen in the southeastern section of Figure 4. This set of coordinates which defines that point on Figure 4 coincides with Table 3 values of Component 1 (.976) and Component 2 (-.123). Component 1 and Component 2 are associated, respectively, with the horizontal axis and vertical axis of Figure 4.

Further analyzing Figure 4, it can be seen that the most Northwesterly-situated variables are those which most strongly help explain variance among banks. Noted in particular are TTL.ASST (Total Assets) and AVG.ASST (Average Assets), corroborating the finding in the Safdari, et. al. (2003) paper.

Extraction Method: Principal Component Analysis. A 2-component outcome extracted. Rotation Method: Varimax with Kaiser Normalization. A rotation converged in 3 iterations.

V. SUMMARY

The extended Factor Analyses conducted in this paper reinforce the findings by Safdari, et. al. (2003). Specifically, Bank Assets, as depicted in Figure 4, is found to be the principal variable in explaining variation among the 17 banks sampled in the study. Furthermore, Figure 2 bank clusters, produced by this study using Factor Analysis, mirror the clusters produced by Cluster Analysis, in the Safdari, et. al. (2003) study. This is a robust outcome as the factor analysis is completely independent from the cluster analysis. Thus, the bank clusters statistically produced by the present study might be considered functional peer-groupings by financial professionals, policy makers and regulators when conducting comparative analyses among banks in Armenia.

Table 1. Bank Names and Addresses

Map #   Banks                    X = In
                                 Study

1       Akunk Bank CSJC
        (conservatorship)

2       Anelik Bank Co.LTD

3       AreximBank CJSC          X

4       ArdShinBank JST          X
        (receivership)

5       ArtsakhBank CJSC         X

6       GladzorBank CJSC

7       Development Bank OJSC    X

8       HSBC Bank Armenia CJSC   X

9       ITB International
        Trade bank

10      InecoBank CJSC           X

11      LendBank CJSC
        (conservatorship)

12      Converse Bank Corp       X

13      Credit-Yerevan Bank      X
        LTD (receivership)

14      Credit-Service Bank      X
        LTD (receivership)

15      ArmAgroBank OJSC         X

16      Agricultural
        Cooperative Bank of
        Armenia

17      ArmEconomBank OJSC       X

18      ArmInvestBank CJSC       X

19      ArmSavingsBank JSC

20      ArmCommunication Bank
        LTD (conservatorship)

21      ArmImpexBank JSC         X

22      Mellat Bank S/B CJSC     X

23      United Bank OJSC
        (receivership)

24      Commercial Bank of       X
        Greece (Armenia) CJSC

25      International            X
        Investment Bank CJSC

26      Prometey Bank LLC

27      TrustBank CJSC
        (period of
        conservatorship)

28      UniBank CJSC

29      Adana Bank               X

30      Econominvestbank

31      RIA bank

32      Shirakinvest bank

Map #   Banks                    Address                  Notes

1       Akunk Bank CSJC          Yerevan, Bagramian st
        (conservatorship)        1/21

2       Anelik Bank Co.LTD       Yerevan, Bagramyan st
                                 75

3       AreximBank CJSC          Yerevan, Tumanyan st
                                 20

4       ArdShinBank JST          Yerevan, Dekhatan st 3
        (receivership)

5       ArtsakhBank CJSC         Stepanakert,             Yerevan
                                 D.Sasounci st 30         Branch

6       GladzorBank CJSC         Yerevan, Charents st
                                 1-B

7       Development Bank OJSC    Yerevan, Paronyan st
                                 21/1

8       HSBC Bank Armenia CJSC   Yerevan, Vazgen
                                 Sarkissian st 9

9       ITB International        Yerevan, Koryun st 19a
        Trade bank

10      InecoBank CJSC           Yerevan, Toumanyan st
                                 17

11      LendBank CJSC            Yerevan, Ervand
        (conservatorship)        Kochari 8

12      Converse Bank Corp       Yerevan, Komitas st 49

13      Credit-Yerevan Bank      Yerevan, Amiryan st
        LTD (receivership)       2/8

14      Credit-Service Bank      Yerevan, Tigran Mets
        LTD (receivership)       st 15

15      ArmAgroBank OJSC         Yerevan, Movses
                                 Khorenatsi 7a

16      Agricultural             Yerevan, Byron st1
        Cooperative Bank of
        Armenia

17      ArmEconomBank OJSC       Yerevan, Amiryan st
                                 23/1

18      ArmInvestBank CJSC       Yerevan, Vardanants st
                                 13

19      ArmSavingsBank JSC       Yerevan, Nalbandyan st
                                 46

20      ArmCommunication Bank    Yerevan, Eznik
        LTD (conservatorship)    Kokhbacu 30

21      ArmImpexBank JSC         Yerevan, Vazgen
                                 Sarkissian st2

22      Mellat Bank S/B CJSC     Yerevan, Amiryan st 6

23      United Bank OJSC         Yerevan, Spendiarov st
        (receivership)           4

24      Commercial Bank of       Yerevan, Deghatan st 6
        Greece (Armenia) CJSC

25      International            Yerevan, Khorenatsi st
        Investment Bank CJSC     tup. 45

26      Prometey Bank LLC        Yerevan, Hanrapetutian
                                 st 44/2

27      TrustBank CJSC           Yerevan, Artsakh st 10
        (period of
        conservatorship)

28      UniBank CJSC             Yerevan, Amiryan st 12   Not in
                                                          Arka study

29      Adana Bank               Yerevan, Nalbandyan      Merged
                                 st 5                     with
                                                          Ardshinank

30      Econominvestbank         Yerevan, 2B Zakyan

31      RIA bank                 Yerevan, Hanrapetutyun
                                 st 39

32      Shirakinvest bank        7 Garegin Hzdeh Street   Not on map
                                 GYUMRI-377500            (In Gyumri)

Table 2. Bank Variable Names

Bank #   Bank Name                       Component1   Component2

1        Adana Bank                      -0.87841     -0.48399
2        Ardshinbank                     2.08948      -0.51142
3        Areximbank                      -0.76149     -0.28973
4        Armagrobank                     0.49496      -0.37512
5        Armeconombank                   -0.00425     0.01393
6        Armenian Development Bank       -0.08417     0.48922
7        Armimpexbank                    1.80838      -0.09761
8        Arminvestbank                   -0.43289     -0.51862
9        Artsahkbank                     -0.71143     -0.25002
10       Converse Bank                   0.56804      -0.13006
11       Credit-Service Bank             -0.59345     -0.46459
12       Credit-Yerevan Bank             1.67794      -0.17362
13       HSBC Bank-Armeni                -0.03175     3.68754
14       Inecobank                       -0.59914     -0.6224
15       Intern. Com. Bank (Armenia)     -1.01858     0.12642
16       International Investment Bank   -0.85866     -0.62116
17       Mellat Bank                     -0.66456     0.22123

Table 3. Rotated Component Matrices

       Financial Data
m=     Variable Name            Variable   Component   Component
1-13   (From Arka)              Name       1           2

1      Total Assets             TTL.ASST   .732        .672
2      Average Assets           AVG.ASST   .782        .610
3      Total Liabilities        TTL.LIAB   .751        .645
4      Loan Investments         LN.INVST   .913        .357
5      Total Capital            TTL.CAP    .484        .839
6      Time Deposits of         TD.PH      .839        .404
         Physical Entities
7      Total Time Deposits of   TD.PHLGL   .903        .284
         Physical & Legal
         Entities
8      Time Liabilities         TM.LIAB    .972        .152
9      Demand Liabilities       DMD.LIAB   .229        .945
10     Statutory Fund           STAT.FND   .284        .633
11     Securities               SECURIT    .116        .822
12     Loans to Economy         LN.ECON    .976        -.123
13     Interbank Loans          INTBK.LN   .0236       .934

ACKNOWLEDGMENTS

The authors wish to express their gratitude to Dr. Rubina Ohanian, Dean of the American University of Armenia's (AUA) College of Business and Management (CBM) and Director of the AUA Center for Business Research and Development (CBRD), AUA CBRD Research assistants, Ms. Christina Dombayan, and Ms. Lusine Poghosyan; and University of Illinois at Springfield research assistant, Mr. Priyoo G. Manakote, for their valuable efforts in support of this research.

REFERENCES

Arka Agency, Chief Editor, Galina Davidyan, Special Issue; Financial and Economic Bulletin of Arka Agency; Main Indicators of Banks of Armenia, May 3, 2001, Arka News Agency, Yerevan.

Asatrian, Bagrat, 1995 Annual Report to the Supreme Council of the Republic of Armenia, CBA, p. 60.

Asatrian, Bagrat, 1996 Annual Report to the Supreme Council of the Republic of Armenia, CBA, p. 39, 49.

CBA, 1998, Banking System Regulation and Development, www.cba.am/public/public.htm, p. 35.

CBA, 1999, Banking System of Armenia; Development, Regulation, Supervision, Yerevan, p. 11. CBA, 2003, www.cba.am.

Safdari, Cyrus; Scannell, Nancy; and Ohanian, Rubina, A Statistical Approach To Alternative Peer Groupings Of Banks In Armenia. Under review by refereed journal, 2003.

Federal Reserve Bank of Kansas City, 2002, Bank Peer Performance Summary, Supervision and Risk Management, http://www.kc.frb.org/bs&s/bankpeer/peermain.htm.

Lafferty Publications Limited, 1995, Armenia: Reserves Force Mass Bank Closure, East European Banker, November 1995, P. 2, Lexis-Nexis.

Sargsyan, Tigran, 1997, Annual Report to the National Assembly of the Republic of Armenia, CBA, pp. 54-55.

Synthesis, Economic Trends Quarterly Issue, January-March 2001, Armenia, European Commission, Director General IA, NIS/Tasis services, July 2001, p. 74.

Nancy Scannell earned her Ph.D. in Economics from the University of Illinois at Chicago. She is an Associate Professor of finance in the College of Business and Management at the University of Illinois--Springfield. Professor Scannell previously taught for Northwestern University and the University of Illinois--Chicago. She served in lecture, research and project capacities in Bangladesh, China, Croatia, Canada, Finland, Bulgaria (Fulbright Scholar), Armenia, and France. Dr. Scannell's research focuses on transition economies and the European Union.

Cyrus Safdari earned his Ph.D. in Civil/Transportation Engineering from Michigan State University. He has taught for MSU's Department of Civil and Environmental Engineering for seven years.

Judy Newton earned her Ph.D. in Advertising at the University of Texas at Austin in 1986, respectively. Dr. Newton has served as the Associate Dean in the College of Business and Management at the American University of Armenia (AUA) from Spring 1999 to 2002. Professor Newton took temporary leave in Summer 1998 from the University of the Incarnate Word, San Antonio, Texas, where she is an Associate Professor of Marketing, to teach for AUA.

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