Profitability and Performance of Commercial Banks Done by: Pooja

MBA/7018/10

Safa
MBA/7026/10

PROFITABILITY OF COMMERCIAL BANKS

 The term profit is an accounting concept which shows the excess of income over expenditure viewed during a specified period of time. Profit is the main reason for the continued existence of every commercial organization. On the other hand, profitability depicts the relationship of the absolute amount of profit with various other factors. Profitability is a relative concept which is quite useful in decision-making.

 The rate of profitability and volume of profits are therefore, rightfully considered as indicators of efficiency in the deployment of resources of banks. Profitability indicates earning capacity of the banks. It highlights the managerial competency of the banks. It also portrays work culture, operating efficiency of the bank.

 Profitability of banks is affected by a number of factors. Some of these are endogenous, some are exogenous and yet structural. Changes in policies made by RBI are exogenous to the system. This includes changes in momentary policy, changes in quantitative credit control like changes in CRR, SLR, manipulation of bank rates, qualitative credit controls like selective credit control measures, changes in interest rates on deposits and advances, levy of tax on interest income etc. Various other factors like careful control of expenditure, timely recovery of loans are endogenous. Various structural factors include geographical spread of bank branches, decentralization in the management and structural changes in deposits and advances.

RELEVANCE OF PROFITABILITY AND PRODUCTIVITY OF COMMERCIAL BANKS

Economic surplus is an index of effective and efficient utilization of resources. The revenue must exceed the expenditure incurred. The bank should provide a reasonable return to the savers, supply funds to investors and then have sufficient margins to cover the cost of services. The profits protects the banks from credit risks and withstand any unforeseeable developments. It also helps to finance its growth and diversification programmes in future.

Contd .
Productivity is the major factor affecting profitability of a bank. It should channelize its resources and efforts towards social ends. It is concerned with fulfilling the social obligations and promoting development of the economy. Social actions of a bank enhance its image and credibility in the society. It helps the banks to store adequate resources comfortably by rendering satisfactory services to customers at reasonable price and ensure adequate safety and liquidity with reasonable return.

PHASES OF BANKING SECTOR

The banking sector is the outcome of a process of expansion, reorganization and consolidation. The banking sector has undergone 3 phases. Pre-nationalization period and post-nationalization period and the third phase is market development through innovation and diversification with focus on customer service. In pre-nationalization period, growth of banks was governed by economic considerations. In the post-nationalization period, greater emphasis was given on social objectives resulting into more branches and greater mobilization of savings through bank deposits and greater channelization of resources in the neglected sectors.

NEED FOR PROFITABILITY AND PRODUCTIVITY CONSIDERATIONS

Recently, managers performance is evaluated in terms of the business levels achieved by them focusing on productivity rather than profitability. The debt relief provided by the banks has affected the behavior of borrowers towards the repayment of loans and increased the level of bad and doubtful debts. This resulted in losing the creditworthy borrowers from the banks affecting the efficiency and profitability. Due to liberalization, the banks are exposed to artificially propped up profitability which resulted the banks to be in danger.

Contd
Due to these problems faced by the banks, there was a need for rebuilding the banking institutions by improving their viability and efficiency of financial resources. These factors become more necessary when the economy is set for global integration with a thrust on competition, deregulation and technology. Banks have now realized that it is necessary to improve their services, be customer friendly, enhance productivity and improve profitability to survive in the competitive environment.

PROFITABILITY OF INDIAN COMMERCIAL BANKS

Profitability ratios 1968 1974 1975 1980 1985 1991 1999

Net profit as % Gross operating Income Net profit as % Working Funds

5.3 0.25

1.7 0.16

2.7 0.26

1.7 0.14

1.3 0.11

2.6 0.60

2.4 0.40

FACTORS CONTRIBUTING TO LOW PRODUCTIVITY AND PROFITABILITY

Liquidity and credit policies of the central bank Increased lending to priority and preferred sectors Changes in deposit mix Expansion of branch network Increase in establishment cost High provisions Absence of healthy organization culture

SUGGESTIONS TO IMPROVE PRODUCTIVITY AND PROFITABILITY

Reduction in Statutory Preemptions Review of Policy of Cross Subsidization Control of costs Scientific pricing of services Diversification Focus on customer service Attitudinal change Cost and profitability consciousness

PERFORMANCE OF COMMERCIAL BANKS

MEASURES OF BANK PERFORMANCE

Although net income gives us an idea of how well a bank is doing, it suffers from one major drawback: It does not adjust for the banks size, thus making it hard to compare how well one bank is doing relative to another. A basic measure of bank profitability that corrects for the size of the bank is the return on assets (ROA), which divides the net income of the bank by the amount of its assets. ROA is a useful measure of how well a bank manager is doing on the job because it indicates how well a banks assets are being used to generate profits.

For eg. at the beginning of a year, the assets of all federally insured commercial banks amounted to $9,040 billion, and the net income is $114.2 billion. Thus the return on assets of: ROA= net income = 114.2 = 0.0126 = 1.26% assets 9040

Although ROA provides useful information about bank profitability but the banks owners (equity holders) care about how much the bank is earning on their equity investment, an amount that is measured by the return on equity (ROE), the net income per dollar of equity capital. For eg. at the beginning of a year, the equity capital for all federally insured commercial banks was $912.7 billion, so the ROE was therefore: Net income Capital = 114.2 = 0.1251 = 12.51% 912.7

Another commonly watched measure of bank performance is called the net interest margin (NIM), the difference between interest income and interest expenses as a percentage of total assets: NIM = interest income interest expense assets

CONCLUSION
Productivity and profitability of banks decide the future success and survival. The banks have to enhance their productivity, control cost, reduce wastages and improve the profitability. The banks performance can be measured by the participation of public in the banks shareholding. The bank has to earn profits as expected by the shareholders to ensure adequate returns on their capital investments.

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