ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

Pu b l i s h ed b y : S o u th As i a n Aca d e m i c Re s ea r ch J o u rn a l s

ACADEMICIA:
An International Multidisciplinary Research Journal STUDY OF PERFORMANCE INDICATORS OF BANKS- A REVIEW OF LITERATURE
SHARMA ELIZA*; DR. MUKTA MANI** *Research Scholar, Jaypee Institute of Information Technology, Sector-62, Noida, U.P., India. **Assistant Professor, Jaypee Institute of Information Technology, Sector-62, Noida, U.P., India. ABSTRACT The purpose of this paper is to study the literature on performance indicators of the bank and to analyze their relationship with the performance of the banks. The study is based on the review of literature and theories related to the performance indicators of the banks from research papers, articles, journals and published reports. The parameters identified during literature survey have been classified under seven categories on the basis of their characteristics and relationship with the performance of banks. The seven categories are: Bank Specific, Profitability, Intangible Assets, Legal & Institutional, Financial Structure, Macroeconomic, and Operational Indicators. This study will be useful for policymakers in formulating future policies, bank customers in taking their decisions about the selection of bank and the bankers for taking their management decisions in a better way. KEYWORDS: Commercial Banks, Performance Appraisal, Indicators, Profitability. ______________________________________________________________________________ 1. INTRODUCTION The banking sector play an important role in providing financial intermediation and economic acceleration by converting deposits into productive investments.The performance of the banking sector is a subject that has received a lot of attention from researchers. In this cut throat competitive era, an efficient management of banking operations requires up-to-date knowledge of all those factors on which the banks profit and efficiency depends. Thus it is very much relevant to identify the parameters which may affect the performance of banks directly or South Asian Academic Research Journals http://www.saarj.com

50

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

indirectly, long run or in short run to provide a true picture of the financial and non financial health of the banks. In this paper we have made an attempt to identify the key parameters which must be considered while measuring the performance of the commercial banks. This study will be useful for policymakers for comparing the performance of different banks and in formulating future policies. It will also be relevant for bank customers in taking their decisions about the selection of bank and the bankers for taking their management decisions in a better way. 2. OBJECTIVES OF THE STUDY The following are the objectives of the study: To identify the parameters for measuring the performance of commercial banks. To classify the performance indicators. To determine the relationship between the performance indicators and the performance of the banks. 3. RESEARCH METHODOLOGY The study has been done on the basis of review of literature related to performance indicators of banks. Around seventy research papers have been studied to identify the performance indicators discussed in the literature. On the basis of their characteristics and relation to performance of bank, the performance indicators have been categorized into seven categories namely; Bank Specific, Profitability, Intangible Assets, Legal & Institutional, Financial Structure, Macroeconomic and Operational Indicators. Then each indicator has been discussed in detail to analyze its relationship with the performance of banks. 4. PERFORMANCE INDICATORS The following are the performance indicators with their interpretation and their relationship with the performance of the banks. 4.1 BANK SPECIFIC INDICATORS BANK SIZE: Sufian and Habibullah23 in his research used total assets as an indicator of bank size. He found that a cost advantage is associated with the size of the bank. Profitability of a bank increases with the increase in size of the bank up to a certain limit and beyond the limit the profitability starts decreasing. Boyd and Runkle7 also supported the above view point and stated that banks in rich countries are larger in size. Large size is expected to promote economies of scale and reduce the cost of gathering and processing information. Randhawa and Lim19 used total deposits as a measure of bank size. They pointed out that the effect of total deposits on profitability of the bank is positive as deposits are cheaper source of funds. Larger deposits mean larger interest rate spread. Chu and Lim8 have connected the total deposit with the branch network and stated that a bank with large branch network will be able to attract more deposits and loan transactions through which they are able to earn larger interest rate spreads. On the South Asian Academic Research Journals http://www.saarj.com

51

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

other side the banks with smaller branch network and small depositors database have to resort for funds on the interbank market which is very costlier. TOTAL INCOME: It is the aggregate of interest income and non-interest income. Total income has a direct impact on the profitability of the bank Ketkar et al.14 have analyzed the efficiency and productivity of the banks and supported the above statement and stated that total income is one of the important indicators which show the direct and positive relationship with the performance of the banks. Total Interest Income of the bank shows the income generated by bank in the form of interest by lending the funds to the customers and doing traditional banking activities. Uppal24 have analyzed that total interest income is the main component of the total income of the bank. If the amount of interest income is high then the bank is having a good position in the market and vice versa. Total interest income has a positive relation with the profitability of the banks. Non Interest Income shows the diversification of the bank activities. The income earned by the bank by doing activities other than lending and borrowing funds to the customers. Bashir4 the non interest income has a positive relation with the profitability of the banks and also analyzed that noninterest income of the bank shows larger business networks and expertise with respect to fee based a non traditional banking activity which adds to banks performance. CONSUMER & SHORT TERM FUNDS TO TOTAL ASSETS: This is a measure of liquidity of the bank that consists of current deposit, saving deposit and investment deposits. This ratio is equated as consumer & short term funds to the total assets of the bank. Bashir4 have used this ratio as a bank specific indicator for measuring the performance of the banks and stated that this ratio has a negative relationship with the profitability of the bank because the liquidity holding represents an expense to the bank. Piesse and Bhaumik20 supporting the view stated that liquid assets are usually associated with lowers rate of return, and so generally relationship is expected to be negative with performance of the bank. CREDIT DEPOSIT RATIO: This ratio is the proportion of loans generated by the total deposits of the bank in a particular year. Uppal24 point out that credit deposit ratio is a tool to measure the liquidity of the banks. A high ratio shows that there are more amounts of liquid cash with bank to meet its clients cash withdrawals. Thus bank may not be in a position to face liquidity crunch which signifies that the performance of the bank is better. Piesse and Bhaumik 20 stated the fact that the credit deposit ratio of a bank would be expected to increase with the expected return on the non-government assets, decrease with the risk associated with such assets, and also decrease with its degree of risk averseness. TOTAL LOANS TO TOTAL ASSETS: This ratio is a measure of loans intensity which is calculated as total loans divided by total assets of the bank. Naidu and Nair18 stated that this ratio indicates what percentage of the assets of the bank is tied up in the loans in a particular year. This ratio has a positive and significant relationship with the profitability of the banks. The higher ratio indicates the growing business of the bank more customers, more interest income along with more credit risk if the credit management of the bank is poor or credit allocation policy of the bank are not sound. Thus increased but unsafe, unsound or bad quality loans can affect the profitability of the bank negatively. Sufian and Habibullah23 have also contributed the fact that the loan performance relationship depends significantly on the expected change of the South Asian Academic Research Journals http://www.saarj.com

52

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

economy. During a strong economy expansion, only a small percentage of loans will default and the profits will rise. Because in the strong economy there are less chances that people will default any loans, borrowers remain in a situation to pay their debts full and on time. CAPITAL ADEQUACY RATIO (CAR): It is calculated by dividing the capital (Tier 1 and Tier II) by risk weighted assets. Equity capital and free reserves come under the category of Tier 1 capital. Tier II capital consists of debts. Uppal24 pointed out that CAR shows the strength of the banks. A higher CAR signifies that the bank is in a comfortable position to absorb losses. So a high CAR means less risk thus a positive relation with the banks performance. CAR is recommended by the Basal Committee as minimum capital adequacy standards in banking companies. LOAN LOSS PROVISIONS TO TOTAL LOANS: The ratio is calculated as total loan loss provisions divided by the total loans. Loan loss provisions to total loans is a measure of bank asset quality that indicates how much of the total portfolio has been provided for but not written off. Loan loss provision to total loans used as a proxy variable for measuring the credit risk of the bank. Sufian and Habibullah23 stated that the greater the exposure of the financial institutions to high risk loans, the higher would be the accumulation of unpaid loans and lower profitability would be. The level of loan loss provisions is an indication of banks asset quality and signals changes in the future performance of the banks. It is a measure of credit risk of the bank. The greater the exposure of the banks to high risk loans, the higher would be the accumulation of unpaid loans which result in lower profitability of the banks. The level of loan loss provisions is an indicator of the banks asset quality and signals changes in the future performance. OWNERSHIP: Bourke6 stated that ownership variable is measure to determine the relationship between the ownership and the profitability of the banks. Molyneux 17 supported the view that state ownership and profitability has an inverse relationship because of lower labor productivity in state owned banks compared to privately owned banks, more control or interference from the management in the public sector banks and lesser degree of human resource efficiency. BOOK VALUE OF EQUITY OVER TOTAL ASSETS: This ratio measures the capitalization over the total assets. Equity to total asset is considered as one of the basic ratio for calculating the capital strength of the bank. Bourke6 gives the view that well capitalized banks enjoy access to cheaper (less risky) sources of funds with subsequent improvement in profits rates and thus have strong and significant relationship with performance of the banks. Kosmidou et al15 also supported the above facts and stated that the higher levels of equity would decrease the cost of capital, leading to a positive impact on bank profitability. It is expected that the higher ratio will lower the need for external funding and therefore the bank need to pay less cost on obtaining funds from the external sources, lesser cost will lead to higher profit margin and higher the profitability of the bank. Goddard et al.10 also stated that well capitalized banks have higher net interest margins and more profitable. This is consistent with the fact that banks with higher capital ratios tend to face a lower cost of funding to lower prospective bankruptcy costs TOTAL LIABILITIES TO TOTAL ASSETS: This ratio is obtained by dividing the total liabilities of the bank by the total assets where total liabilities includes all the short term and long term liabilities of the bank. Uppal24 stated that this ratio is a measure of risk, the risk which a South Asian Academic Research Journals http://www.saarj.com

53

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

bank takes to obtain higher returns. If the ratio of total liabilities to total assets is high then it will affect the profitability of the bank negatively, as banks have less cash or liquid assets to pay off its debts and a low ratio shows that bank is in a position to have less liabilities in comparison to its total assets thus bank can pay of its liabilities out of its assets easily which will increase the profitability of the bank. MARKET SHARE: Market share measures how much power a bank can have to control the prices and services it offers to the customers. Market share is the percentage of the total deposits or total assets of a bank to the deposits or assets of all commercial banks in the market. Heggested12 believed that bigger the market share larger the banks potential for profits. The net effect of growth in market on profitability could be negative or positive because an increase in demand would push prices higher and at the same time would affect bank costs. Banks with larger market share can easily take the position of market dominator and can achieve more profits. 4.2 PROFITABILITY INDICATORS RETURN ON ASSETS: ROA is measured as net profit divided by total assets. Abbasoglu et al.1 stated that ROA shows the management ability to utilize the banks financial and real investment resources to generate profits. Sufian & Habibullah23 suggest that ROA is the best indicator for measuring the performance of the banks as ROA is not distorted by high equity multipliers and represents the ability of bank to generate returns on its portfolio of assets. Uppal24also supports the above view point and stated that higher the ratio higher will be the profitability of the banks. This ratio is an indicator of the performance of the banks as this ratio shows how a bank uses its assets to generate its income. Uppal24 also relates the Asset Utilization ratio with the profitability of the bank, which is calculated by dividing the total income by the total assets of the bank. He stated that this ratio indicates how much a bank earns by using its total assets. It is positively related with the profitability of the banks. The higher ratio of asset utilization signifies the better performance of the bank. RETURN ON EQUITY: ROE is calculated as net profit divided by equity of the bank. The return on equity is what the bank's owners are primarily interested in because that is the return that they earn on their investment, and depends not only on the return of assets, but also on the total value of the assets that earn income. Sufian & Habibullah23 point out that ROE reflects how effectively a bank management is in utilizing its shareholders funds. Higher ROE indicates the better performance of the bank and ROE is positively related with the profitability of the banks. While considering the ROE as a measure of performance, Equity Multiplier is also measured to see the impact of equity multiplier on ROE. Equity Multiplier is a measure of capital structure equated by Total Assets to Equity. Goddard et al.10 stated that a higher financial leverage work to the firms advantage by boosting the ROE when earnings are positive, when the firm records negative earnings, the fall in ROE is greater. NET INTEREST MARGIN: Net interest margin is the difference between the interest earned and interest expended, which is also known as spread. Arora3 have considered the net interest margin as the performance indicator for measuring the performance of the banks in the study and analyzed that higher the spread higher will be the efficiency of banks which signifies the better South Asian Academic Research Journals http://www.saarj.com

54

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

performance of the bank. Net interest margin affects the profitability of the banks positively. This indicator is a performance metric that examines how successful a firm's investment decisions are compared to its debt situations. A negative value denotes that the firm did not make an optimal decision, because interest expenses were greater than the amount of returns generated by investments. Sensarma and Ghosh21 have given a contradictory opinion and stated that the increasing net interest margin indicates the lack of competition. A competition banking system is expected to foster growth efficiency which should get reflect in lower net interest margin. EMPLOYEE EFFICIENCY INDICATORS: Mainly there are two indicators which are used to measure the efficiency of the employees these are; Business per Employee, which is calculated by dividing the aggregate of total deposits raised and total advances distributed in a particular year by the number of full time employees of the bank. And another is Profit per Employee which shows the surplus earned by per employee of the bank equated as net profit divided by total number of full time employees of the bank. Arora3 suggest that these ratios show the productivity of human resources of the bank. Higher the ratios higher will be the productivity and efficiency of the employees of the bank thus better will be the performance of the bank. 4.3 INTANGIBLE ASSETS INDICATORS VALUE ADDED INTELLECTUAL COEFFICIENT (VAIC): VAIC is a valuation methodology to assess the efficiency of key resources in business organizations. An organization adds value and creates wealth through employing physical capital, human capital, and structural capital. Value-added is thus the difference between output and input; where Output represents total income from all the products and services sold on the market, and Input contains all the expenses incurred in earning the revenue except manpower costs, as they are treated as investments. VAIC is addition of HCE, SCE and CEE where; Human capital efficiency (HCE) treat the total employee expenses as investment that captures the total human effort to generate corporate value, HCE is expressed as the amount of value-added generated per monetary unit invested in manpower. Structural capital efficiency (SCE) is reflected by the proportion of total value added accounted for by structural capital. Capital employed efficiency (CEE) is the amount of value added generated per monetary unit invested in physical capital. Capital Employed is book value of firms net assets (such as physical assets and financial capital), which is a proxy for tangible resources. Kamath13 demonstrated that VAIC had a significantly positive correlation with return on assets (ROA) and market-to-book (MB) value, but a negative correlation with asset turnover (ATO). In India, using VAIC methodology, Kamath13 ranked performance of the surveyed banks by their respective VAIC scores. A high correlation between VAIC score and business survival was observed. Most of the surveyed banks with low VAIC score were subsequently merged, liquated, or even ceased operation. ECONOMIC VALUE ADDED: EVA is the invention of Stern Stewart & Co., a global consulting firm, which launched EVA in 1989. EVA is calculated as a companys net operating profit after taxes3 (NOPAT) minus a dollar cost for the equity capital employed by the company. The dollar cost of equity capital employed by a company is equal to the companys Equity capital (reported on its balance sheet) multiplied by a percentage return that the companys shareholders require on their investment. A positive EVA reflects that the company is South Asian Academic Research Journals http://www.saarj.com

55

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

increasing its value to its shareholders, whereas a negative EVA reflects that it is diminishing its value to its shareholders. A bank may be in good position even when its shareholders are losing their value. 4.4 LEGAL & INSTITUTIONAL INDICATORS- Three types of index can be used under legal and institutional indicators to measure the performance of the commercial banks these are: Contract Enforcement Index which measures the degree to which contractual agreements are honored and not subject to language and mentality differences. Law & Order Index is the degree to which the legal system works well in adjucating disputes. And Corruption Index which reflects the degree to measure the corruption in government. Demirguc and Huizinga9 stated that lower contract enforcement, law and order index would result in higher interest margins by increasing the risk premium for taking additional risk by the bank. The additional risk taking may also affect the profitability of the banks negatively. Lower corruption index indicates that government officials are more likely to take bribes. Lower value for corruption index is associated with higher interest margins and positively affects the profitability of the banks. Banks may require a higher risk premium on providing loans to the customers in countries which has an environment relatively more corruption. 4.5 FINANCIAL STRUCTURE INDICATORS BANK SIZE TO GDP: The ratio is measured as total assets of the bank divided by GDP. This ratio reflects the overall level of development of the banking sector. Demirguc and Huizinga9 found that higher Bank/GDP ratio is a sign of developed banking system which contributes higher to the GDP. Thus banks have to face intense competition because of well developed financial system and this ratio has a significantly negative impact on margins and profits. This effect is smaller in richer countries which already have relatively developed banking sectors. MARKET CAPITALIZATION TO GDP: The ratio is measured as stock market capitalization divided by GDP. Berger5 stated that Market Capitalization to GDP ratio is a measure of the extent of stock market development. A larger stock market capitalization to GDP increases bank margins, reflecting possible complementarities between debt and equity financing. As stock market develops, improved information availability increases the potential pool of borrowers, making it easier for banks to identify and monitor them. Thus by the increased information about the potential borrowers, the bank can increase its customer data base and that increase the business of the banks, which ultimately turned into higher profit for the banks, thus higher net interest margin possible. Thus there is a positive relationship between the market capitalizations to GDP ratio and the profitability of the banks. A higher ratio indicates that the banks are able to obtain higher interest margins and higher profitability. In the emerging economies the market capitalization to GDP is high. MARKET CAPITALIZATION TO BANK SIZE: The ratio is measured as the stock market capitalization divided by the total assets of the banks. Demirguc and Huizinga9, Bashir4 stated that larger stock market relative to the banking sector lowers bank margins, reflecting substitution possibilities between debt and equity. A larger stock market relative to the banks provides more substitutes to the investors in the stock market rather than investing their money in the banks, or borrowing money from the banks. Thus the business of the banks will get South Asian Academic Research Journals http://www.saarj.com

56

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

suffered by the development in the stock market in comparison to banking sector and thus affects the profitability of the bank negatively. CONCENTRATION: This indicator measures the monopoly income earned by the banks in the market. The concentration ratio can be measured as the ratio of the n largest banks assets to total banking sector assets. Sufian and Habibullah23 stated that the degree of concentration of a market exerts a direct influence on the degree of competition among its firms. Highly concentrated markets will lower the cost of collusion and thus firms will be able to earn monopoly incomes. Goddard et al.10 stated that collusion may result in higher interest rates spread (e.g. higher interest rates charged on loans and less interest rates being paid on deposits), higher fees being charged etc. Heggested12 found that concentration has no impact or a very low impact on profitability of the banks. 4.6 MACROECONOMIC INDICATORS GROSS DOMESTIC PRODUCT: GDP is most commonly used macroeconomic indicator to measure total economic activity within an economy. The growth rate of GDP reflects the state of the economic cycle and is expected to have an impact on the demand for bank loans. The economic conditions and the specific market environment would affect the banks mixture of assets and liabilities. Sufian and Habibullah23 point out that the GDP is expected to influence numerous factors related to the supply and demand for loans and deposits. Favorable economic conditions will affect the demand and supply of banking services positively. Banks growth and profitability is limited by the growth rate of the economy. If the economy is growing at a good rate, a soundly managed bank would profit from loans and securities sales. Economic growth can enhance banks profitability by increasing the demand for financial transactions, i.e., the household and business demand for loans. Strong economic conditions also characterized by the high demand for financial services, thereby increasing the banks cash flows, profits and non interest earnings. Thus there is a positive relationship between the growth rates of Gross domestic product and the profitability of the bank. INFLATION RATE: Inflation can affect in the way of Changes in interest rates and asset prices on the profitability of banks. Bashir4 stated that the anticipated Inflation affects positively while unanticipated inflation affects negatively the profitability of the banks. There is a positive association between the anticipated inflation and performance of the bank as it gives banks the opportunity to adjust interest rates accordingly, resulting in revenues that increased faster than costs, thus implying higher profits and reverse with the unanticipated inflation. Bourke6 revealed a positive relationship between inflation and bank profitability. Higher inflation rate lead to higher loan rates, and hence higher revenues will be generated by the bank. Inflation has a negative effect on bank profitability if wages and other costs (overhead) are growing faster than the rate of inflation. GROWTH OF MONEY SUPPLY: Demirguc and Huizinga9 stated that the changes in money supply may lead to changes in the nominal GDP and the price level. Although money supply is basically determined by the central banks policy, it could also be affected by the behaviour of households and banks. Money supply as a measure of market size and found that the variable significantly affects bank profitability. South Asian Academic Research Journals http://www.saarj.com

57

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

REAL INTEREST RATE: It is calculated as the nominal interest rate minus rate of inflation. Bourke6 stated that high real interest rates are associated with higher interest margins and profitability of the banks, because in the developing countries bank pays less than market interest rate on demand deposit, thus less interest expenses to be incurred by banks, which will lead to higher spread because of less interest expenses incurred by the bank. Demirguc and Huizinga9 identified that the real interest rate do not increase spreads as much in developed countries, because there deposit rates are not tied down by deposit rate ceilings. RESERVES REQUIREMENTS: The reserve is a taxation indicator computed as the ratio of aggregate reserves to deposit multiplied by ratio of customer and short term funding to total assets. Demirguc and Huizinga9 examined that reserve requirements are an implicit tax on banks. Banks have to face implicit taxation due to reserve and liquidity requirements and other restrictions on lending through directed/subsidized credit policies. Banks are subject to indirect taxation through reserve requirements because the higher reserve requirement prevents the banks from passing their higher reserve cost on to their customers. Banks need to keep more liquid in the form of reserve requirement and remains with less cash to lend to their customers thus banks earns low interest income. Reserve requirement negatively affects the performance of the banks. The reserves reduce interest margins and profits especially in developing countries, since there the opportunity cost of holding reserves tends to be higher and remuneration rates are lower. 4.7 OPERATIONAL INDICATORS INTEREST INCOME TO TOTAL ASSETS: This ratio is calculated by dividing the interest income by the total assets of the bank. Ketkar et al.14 have studied this ratio as a performance indicator of the bank and stated that this interest income to total assets shows that how much a bank earns by making maximum utilization of its total assets from its ordinary business of lending and borrowings. They found that higher ratio of interest income to total assets signifies a higher banks profitability and also the higher efficiency of the management of Banks total assets. INTEREST EXPENDED TO TOTAL ASSETS: This ratio is equated as interest expended or interest paid on borrowings and deposits divided by total assets. Naidu and Nair18 has used this ratio in their study and stated that this ratio indicates the cost of funds used by the banks and also found that there is a negative relation between the interest expended to total assets ratio and profitability of the banks. SPREAD TO TOTAL ASSETS: Spread is the difference between the interest earned and interest expended. Naidu and Nair18 stated that the ratio of the net interest income (spread) to total assets gives the net interest margin of the bank. This ratio is the actual measure of the banks performance as an intermediary, as it examines the banks ability in mobilizing lower cost funds and investing them at a reasonably higher interest. By borrowing short and lending long, banks can earn higher spreads nevertheless by doing so they will be exposed to greater risks also. NON INTEREST INCOME TO TOTAL ASSETS: It is measured as the total noninterest income of the bank divvied by the total assets. Molyneux and Thornton17 suggested that this ratio is a measure of bank diversification into non-traditional activities. Noninterest income consists of South Asian Academic Research Journals http://www.saarj.com

58

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

commission, service charges and fees, guarantee fees, net profit from sale of investment securities and foreign exchange profit.The indicator is shows a positive relationship with bank profitability. NON INTEREST EXPENDITURE TO TOTAL ASSETS: This ratio can be calculated by dividing the non interest expenditures (operating expenses) by the total assets of the bank. Ketkar et al.14 pointed out in their study that this ratio is used to provide information on the variations of bank operating costs. The noninterest expenditures represent total amount of wages and salaries, as well as the costs of running branch office facilities. Reduced expenses improve the efficiency and hence raise the profitability of banks. They also found during their study that this ratio implies a negative relationship with performance of the bank. Ali et al.2 have used this ratio in their study and concluded that operational efficiency ratio can be used as a measurement tool for the efficiency of the bank. The lower ratio shows the efficiency of the banks operations by incurring lower costs on various banking and non banking activities. BURDEN TO TOTAL ASSETS: This ratio is calculated as burden divided by total assets of the bank, where the burden is the difference between the non interest income and noninterest expenditures. Naidu and Nair18 has used this ratio as a performance indicator in their study and analyzed that burden is generally negative due to low level of fee based activities. A bank with a low burden ratio is better off. An increasing trend would show lack of burden bearing capacity of the bank. NON PERFORMING ASSETS TO NET ADVANCES RATIO: This ratio is calculated by dividing the Non Performing Assets by the Net Advances. Kosmidou et al.14 have studied this ratio as a performance indicator of the bank and stated that this ratio is a measure of safety and soundness of banks. It reflects the asset quality of the bank. The higher the level of NPAs lower will be quality of the assets of the bank and vice versa. NPAs expose the bank not only to credit risk but also to the liquidity risk. The lower ratio signifies higher profitability and low bad debts for the bank. COST TO INCOME RATIO: This ratio is calculated by dividing the operating expenses (administrative and fixed costs, such as salaries and property expenses, but not bad debts that have been written off) by the total income generated i.e.net interest income plus the other income. Cost income ratio is an indicator of the efficiency of expenses management of the banks. The cost to income ratio measures the overheads or costs of running the bank, including staff salaries and benefits, occupancy expenses and other expenses such as office supplies, as a percentage of income. Naidu and Nair18 has stated that cost income ratio gives investors a clear view of how efficiently the firm is being run. The lower ratio indicates the better performance of the bank. A lower ratio shows that bank is incurring less costs for earning more income. Changes in the cost income ratio can also highlight potential problems what a bank can face in near future thats why this ratio is a very important indicator while measuring the performance of the banks. Kosmidou et al.14 also supported the above view and stated that a declining cost income ratio over time signifies the prudent management of the financial institution through cost minimisation, ensuring efficient operations. Thus a declining cost income ratio is a sign of profitability improvement and financial distress declines too. Thus a negative relationship South Asian Academic Research Journals http://www.saarj.com

59

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

between the cost income ratio and profitability of the bank and we can also expects that there is a positive relationship between the cost income ratio and financial distress of the banks. NET PROFIT AS A PERCENTAGE TO INTEREST SPREAD: This ratio is calculated as net profits divided by interest spread, where the spread is the difference between interests earned and interest expended while net profits are considered profits after taxes. Naidu and Nair18has pointed out that this ratio reveals that how much net profit can be earned, out of net income i.e. spread. Higher percentage of net profit to interest spread is a signal of good performance of the company and positively related with the profitability of the bank. INTEREST INCOME AS A PERCENTAGE TO WORKING FUNDS: This ratio can be calculated by dividing the interest income with working funds (Average Capital Employed). Arora3 has used this ratio as a performance indicator and stated that this ratio helps to know how efficiently the funds have been used to gain on working funds by doing the business of lending funds to the public and traditional banking activities. This ratio is positively related with the profitability of the bank. A higher percentage of this ratio shows higher profits and better performance of the banks. NON INTEREST INCOME AS A PERCENTAGE TO WORKING FUNDS: This ratio can be measured as non interest income (other income) of the bank divided by working funds (Average Capital Employed) of the bank. Arora3has used this ratio as a performance indicator and stated that noninterest income as a percentage to working fund ratio defines how a bank can earn maximum of making use of its working funds while doing the other than traditional banking activities like lending and borrowing funds to the public. The higher percentage of this ratio will contribute to the profits and thus higher will be the performance of the bank. The performance of the bank depends upon various indicators; some of these variables affect the profitability positively while some affects the profitability of the banks negatively. Legal and institutional indicators affects the profitability of the bank negatively, market growth rate, increasing market share of the banks, Increasing trend of total interest and non interest income affects the profitability of the bank positively. Increasing trend in total assets, loans & advances, investments, Return on Assets, Return on Equity, Net interest margin and lower operating ratios shows the better utilization of the resources of the banks and thus significantly affects the performance of the banks with an increase in the profitability of the banks. CONCLUSION The discussion in the paper have clearly indicates the various performance indicators which may affect the profitability of the commercial banks. This research paper is an addition to the literature related to the banking sector. The relevance of the study is that one can find almost all the important indicators with their brief description which affects the performance and profitability of the banks. Besides all, the impact of each indicator and their relationship with the performance of the bank has also been provided in the study which can help the research people to take decision about which indicators they can choose for further studies. The findings in research paper with relation to the performance indicators would surely provide a basis for the model formulation in any research related to the profitability or performance of the banks. South Asian Academic Research Journals http://www.saarj.com

60

ACADEMICIA
REFERENCES

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

1. Abbasogolu, O.F., Aysan, A.F. and Gunes, A. , Concentration, competition, efficiency and profitability of the Turkish banking sector in the post-crisis period, Banks and Bank Systems, 2, 106-15 (2007) 2. Ali, Khizer, Akhtar, Farhan Muhammad and Ahmed, Zafar Hafiz, Bank-specific and macroeconomic indicators of profitability-Empirical Evidence from the commercial banks of Pakistan, International Journal of Business and Social Science, 2, 235-242 (2011) 3. Arora, Usha, Efficiency of Public Sector Banks in India, Productivity, 46 (2), 384-90 (2005) 4. Bashir, A., Determinants of profitability in Islamic banks: Some evidence from the Middle East, Islamic Economic Studies, 11, 31-57 (2003) 5. Berger, A., The relationship between capital and earnings in banking, Journal of Money, Credit and Banking, 27, 432-456 (1995) 6. Bourke, P., Concentration and other determinants of bank profitability in Europe, North America and Australia, Journal of Banking and Finance, 13, 65-79 (1989) 7. Boyd, J.H. and Runkle, D.E., Size and performance of banking firms: Testing the prediction of theory, Journal of Monetary Economics, 31, 47-67 (1993) 8. Chu, S.F. and Lim, G.H., Share performance and profit efficiency of banks in an oligopolistic market: Evidence from Singapore, Journal of Multinational Financial Management, 8, 155-68 (1998) 9. Demirguc Kunt, A. and Huizinga, H., Determinants of commercial banks interest margin and profitability: some international evidence, World Bank Economic Review, 13, 379408 (1999) 10. Goddard, J., molyneux, Ph. And Wilson, J.O.S., European banking: Efficiency, technology and growth, Wiley & Sons Ltd., England (2001) 11. Hassan, M.K. and Bashir, A.H.M., Determinants of Islamic banking profitability, Paper presented at Tenth ERF Annual Conference, 16-18 December, Morocco (2003) 12. Heggested, Arnold J., Market structure, risk and profitability in commercial banking, Journal of Finance, 32, 1207-16 (1977) 13. Kamath, G.B., The intellectual capital performance of Indian Banking Sector, Journal of Intellectual Capital, 8 (1), 96-123 (2007) 14. Ketkar Kusum, W., Noulas Athanasios, G. and Aggarwal, Man Mohan, An analysis of South Asian Academic Research Journals http://www.saarj.com

61

ACADEMICIA

Volume 1, Issue 3 (December, 2011)

ISSN 2249-7137

efficiency and productivity growth of Indian banking sector, Finance India, 17, 511-513 (2003) 15. Kosmidou, K., Pasiouras, F. and Tsaklanganos, A., Domestic and multinational determinants of foreign bank profits: the case of Greek bank operating abroad, Journal of Multinational financial Management, 17, 1-15 (2007) 16. Kosmidou, K. and Zopounidis, C., Measurement of bank performance in Greece, South Eastern Europe Journal of Economics, 1, 79-95 (2008) 17. Moulyneux, P. and Thornton J., Determinants of European bank profitability: A note, Journal of Banking and Finance, 16, 1173-1178 (1992) 18. Naidu and Nair, V. Nagarajan and Nair, Manju S., Financial sector reforms and banking sector performance in India: A study of technical efficiency of commercial banks between pre and post reform period, Asian Economic Review, 45, 230-231 (2003) 19. Randhawa, D.S. and Lim, G.H., Competition, liberalization and efficiency: Evidence from a two stage banking models on banks in Hong Kong and Singapore, Managerial Finance, 31, 52-77 (2005) 20. Bhaumik, Sumon and Piesse, Jenifer, A closer look at banks behavior in emerging credit markets? Evidence from the Indian Banking Industry, Aditya V. Birla India Centre Working Paper 2004-001, April (2004) 21. Sensarma, Rudra and Ghosh, Saurabh, Net Interest Margin: Does Ownership Matter? , Vikalpa, 29 (1), 41-47 (2004) 22. Smirlock, Michael, Evidence on the non relationship between concentration and profitability in banking, Journal of Money, Credit and Banking, 17, 69-83 (1985) 23. Sufian, Fadzlan and Habibullah, Shah Muzafaer, Assessing the impact of financial crisis on bank performance: Empricial evidence from Indonesia, ASEAN Economic Bulletin, 27, 245-62 (2010) 24. Uppal, R.K., New competition and emerging changes in Indian banks: An analysis of comparative performance of different bank groups, Indian Journal of Commerce & Management Studies, 2, 223-237 (2011)

South Asian Academic Research Journals http://www.saarj.com

62