Determinants of Profitability of Listed Commercial Banks in India

Table of Contents

INTRODUCTION

1.1 Introduction
1.2 Statement of the Problem
1.3 Research Questions
1.4 Objectives of the Study
1.5 Research Methodology
1.6 Scope of the Study
1.7 Significance of the Study
1.8 Limitations of the Study
1.9 Chapter Scheme

References

BANKING SECTOR IN INDIA - A REVIEW

2.1 Origin of Banking
2.2 Banking in India
2.2.1 The Pre-Independence Phase
2.2.2 The Post-Independence Phase
2.3 Classification of Banks
2.3.1 The Reserve Bank of India
2.3.2 Scheduled Banks
2.3.3 Unscheduled Banks
2.3.4 Commercial Banks
2.3.5 Co-operative Banks
2.4 Function of Banks
2.4.1 Primary Functions
2.4.2 Secondary Functions:
2.5 Key Bank Performance Measures
2.5.1 The Credit Deposit Ratio
2.5.2 The Investment Deposit Ratio
2.5.3 Other Income to Total Income Ratio
2.5.4 Operating Expenses to Total Income Ratio
2.5.5 Interest Income to Total Funds Ratio
2.5.6 Interest Expended to Total Funds Ratio
2.5.7 Net Profit to Total Funds Ratio
2.6 Rating Frame Work for Banks
2.6.1 CAMEL Rating
2.7 Risks Faced by Banks
2.7.1 Credit Risk
2.7.2 Market Risk
2.7.3 Operational Risk
2.7.4 Liquidity Risk
2.7.5 Business Risk
2.7.6 Systemic Risk
2.8 Banking Regulations and Regulatory Requirements
2.8.1 Cash Reserve Ratio (CRR) and Statutory Liquid Ratio (SLR)
2.8.2 Basel III Norms
2.9 Recent Trends in Indian Banking
2.10 Measures of Bank Profitability
2.10.1 Return on Assets (ROA)
2.10.2 Return on Equity (ROE)
2.10.3 Net Interest Margin (NIM)
2.11 Determinants of Bank Profitability
2.12 Current Scenario in Indian Banking
2.12.1 Asset Quality
2.12.2 Percentage Share in Total Credit
2.12.3 Growth in Advances
2.12.4 Percentage Share in Total Assets and Profits
2.13 Operational Definitions

REVIEW OF LITERATURE

3.1 Studies in the Global Context
3.2 Studies in the Indian Context
3.3 Summary of Key Determinants of Profitability and Profitability Measures used in Select Research Studies
3.4 Conclusion

RESEARCH METHODOLOGY

4.1 Conceptual Frame Work of the Study
4.2 Research Design
4.2.1 Variables Selected
4.2.2 Development of Working Hypothesis
4.2.3 Sample Design
4.2.4 Collection of Data
4.2.5 Data Analysis
4.3 Findings Suggestions and Conclusion
4.4 Bibliography

ANALYSIS OF DATA

5.1 Test for Normality
5.2 Analysis of Key Indicators of Bank Performance
5.3 Impact of Bank Size, Lending Measures and Income Measures on Bank Profitability
5.4 Impact of Employee Productivity on Bank Profitability
5.5 Impact of Capital Adequacy and Asset Quality on Bank Profitability
5.6 Summary of Analysis
5.7 Forecasting
5.7.1 Model Fitting

FINDINGS AND CONCLUSION

6.1 Summary
6.2 Findings
6.3 Implications of the Study
6.3.1 Implications for Bankers
6.3.2 Implications for Investors
6.3.3 Implications for Regulators
6.4 Scope for Future Research
6.5 Conclusion

Bibliography

Annexures

Summary of Publications and Citations

Research Paper Publication

ACKNOWLEDGEMENT

I would like to express my sincere gratitude to my guide Dr. R. SHANMUGHAM for his invaluable guidance and continuous support during my Ph.D study. His guidance helped me in all aspects of research and writing of this thesis. I would like to thank my parents for their continuous prayers and guidance and my wife and daughter for their encouragement and support throughout this endeavor. I would like to thank my institute the Ramaiah Institute of Management for encouraging me and providing significant time off work to help me complete this task. In this regard I would like to thank our dean, our Academic head and all teaching and non-teaching staff of my institute for their help and support. Above all I would like to thank the Lord Almighty for his grace and mercy in helping me complete this study.

List of Tables

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List of Figures

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List of Abbreviations

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CHAPTER 1

INTRODUCTION

CHAPTER I

INTRODUCTION

1.1 Introduction

The reforms in the Indian banking sector have redefined the entire Indian banking landscape. The Narasimham Committee reforms in 1991 facilitated the flow of credit across all segments of the economy, deregulation of interest rates and reduction of cash reserve ratio (CRR) and statutory liquid ratio (SLR) requirements that enabled banks to be well capitalized. These reforms came along with the introduction of effective risk management practices that have made the Indian banking sector financially sound and globally competitive. These reforms were instrumental in making the Indian banking sector resilient even in the face of unprecedented global turmoil such as the global financial crisis of 2008 when a number of global financial institutions were on the verge of insolvency.

A shift in the focus of banks is visible with banks paying greater attention to customer needs and service. However, banks are now facing a number of challenges such as technological change, stringent prudential norms, increasing competition, worrying level of nonperforming assets (NPAs), rising customer expectations, increasing pressure on profitability, rising operating expenditure and increased risk in their lending operations. The spate of NPAs in the public sector banks has forced the government of India to recapitalize these banks early and often. The reforms in banking sector have also brought margins under pressure. The Reserve Bank of India’s (RBI) efforts to adopt international banking norms such as Basel III norms is forcing banks to adopt measures to control and maintain margins.

In a recent Report on the Trend and Progress of Banking in India (2017) the RBI has observed that asset quality of the Indian banking sector is extremely poor. It is found that banks have faced a significant erosion in margins, with public sector banks suffering more than their private sector counterparts. Among the key challenges in going forward the RBI lists resolution of impaired assets and strengthening bank balance sheets, moving towards activity based rather than entity based regulation with the gradual implementation of Basel III norms, promoting technology based financial services and managing cyber security risks. Thus, banks will potentially be faced with reworking their business models to satisfy customer needs, clean up their balance sheets, improve corporate governance and leverage technology to meet security threats.

In the recent years the Reserve Bank of India (RBI) has embarked on a cycle of monetary easing following the sluggish growth trends in the Indian economy. This has caused banking stocks in India to rally sharply. However, all is not well as it seems in the banking sector. Recent quarterly reports of most banks suggest rising levels of nonperforming assets (NPAs) and deteriorating asset quality. Efforts to adopt international banking norms such as Basel III have further forced banks to take notice of capital adequacy requirements. Given that the banking sector is the lifeblood of the Indian economy, it is of paramount interest to understand what drives bank profitability. Under these circumstances it would be useful to examine the factors determining profitability of commercial banks in India.

1.2 Statement of the Problem

The banking industry in India is diverse in nature. There are more than sixty listed commercial banks in India. These include banks in the public and private sector and the banks are of varying size and profitability levels. As noted early, the Indian banking system is faced with severe asset quality issues. The banking system has been flooded with non-performing assets which have significantly eroded the bank margins. Recent adverse developments in the banking sector such as lending scams and questionable advances to troubled segments of the economy have dominated the financial press. While this being so, this research is aimed at examining the contributing factors of profitability in banks.

Key measures of bank profitability include the return of assets, return on equity and net interest margin. There are several possible drivers of bank profitability. These include asset quality, capital adequacy, liquidity, productivity and income. While several studies till date (Chirwa, (2003); Sufian and Habibullah, (2010); Dietrich and Wanzenried, (2011); Zarrouk et al., (2016)) have looked at key determinants of bank profitability, very few studies have compared the effect of key determinants for a larger cross section of banks that represent the banking sector in India as a whole.

Hence an attempt has been made in this study to know the key drivers of profitability of the banking sector. The study also looks at the similarities or the differences of the influence of selected determinants on profitability measures across the sample of banks selected for research. This study also compares the key drivers of bank profitability for public and private sector banks and an attempt is made to develop models to forecast bank profitability from key determinants.

1.3 Research Questions

This study seeks to understand the impact of a series of key internal determinants of the profitability of listed commercial banks in India. Following are the research questions raised in this regard:

1) Are there differences in key performance measures of private and public sector banks?
2) Does the size of the bank affect bank profitability?
3) Does the bank’s lending activity and income generation capability affect its profitability?
4) Does the productivity of the bank impact its profitability?
5) Does the bank’s asset quality and capital adequacy affect its profitability?
6) Can bank profitability be forecasted from determinants?

Taking into consideration the research questions raised, this research study has set the following objectives for examination:

1) To examine the differences in the profitability of private and public sector commercial banks in India.
2) To determine if bank size, lending and income measures impact bank profitability.
3) To determine the impact of productivity measures on the profitability of banks.
4) To find out the effect of capital adequacy and asset quality on the profitability of commercial banks.
5) To develop forecasting models based on key determinants identified by the study, to predict bank profitability.

1.5 Research Methodology

This study used historical data of select commercial banks to study the relationship between key determinants of profitability and important profitability measures. The sample consists of 24 Public sector banks and 16 private sector banks that have been listed for at least a 5 year period between the financial years ending March 2006 and March 2015. The following variables have been considered for the study:

Independent Variables:

Key bank metric - Bank size (S) as measured by market capitalization.

Key lending measure - The deposit to credit ratio (DCR).

Income Measures - Interest income to average working funds (IIAWF) and Noninterest income/average working funds (NIIAWF) which is a measure of fee based income.

Productivity measure - Business per employee (BPE).

Measure of Capital Adequacy - The capital adequacy ratio (CAR).

Measure of Asset Quality - The percentage net non-performing assets (NNPA).

Dependent Variables:

Bank Profitability as measured by the Return on Assets (ROA) and the Return on Equity (ROE).

The study was conducted with annual data for the ten year period spanning from the financial years 2006 to 2015. Data from 2016 and 2017 was used for forecasting purposes from models developed in the study. Historical data on all of the above were obtained from the Capitaline financial database and the Reserve Bank of India data base on the Indian economy. The relationship between the variables was analyzed with the SPSS 18.0 package. Q-Q plots were used to ascertain normality of the data. Descriptive statistics that includes mean, standard deviation and the co-efficient of variation were used to compare key performance measures of public and private banks.

Scatter plots and correlation analysis were used to study the relationship between the respective variables. F-values from ANOVA analysis were used to assess the statistical significance of the correlations observed at 95% confidence intervals. Then Uni-variate and multiple regression analysis were used to study the impact of all the independent variables taken individually and together on the profitability as measured by ROA and ROE of the respective banks.

The influencing determinants were used to construct multi-variate models which were then used to forecast ROA and ROE for the years ending March 2016 and March 2017. Variance Inflation Factor (VIF) was used to detect multi-collinearity. Durbin Watson coefficient was used to detect auto correlation in the data. The adjusted R2 was used to determine the influencing variables.

The Breusch Pagan test was used to detect heteroskedasticity in the data. Given the presence of heteroskedasticity a robust estimation was performed using the quantile regression technique to estimate model parameters. The Akaike Criterion (AIC) was used to select the best model. The root mean squared error and mean absolute error were used to validate forecast accuracy. Further details on the research methodology are discussed in detail in Chapter 4.

1.6 Scope of the Study

This study had used historical data of select commercial banks to compare the relationship between key determinants of profitability and important profitability measures. The sample consists of 24 Public sector banks and 16 private sector banks that have been listed for at least a 5 year period between the financial years ending March 2006 and March 2015. Models developed were used to forecast profitability for the financial years ending March 2016 and March 2017.

1.7 Significance of the Study

The study could provide several key stake holders of banks valuable information on what drives profitability of commercial banks. It seeks to add to the existing body of literature on the impact of key determinants of profitability on bank profitability. A sound methodical approach is presented to examine the role of key determinants of profitability on two key profitability measures.

1.8 Limitations of the Study

The study only considered the impact of a select group of internal determinants on profitability of listed commercial banks in India. Only listed public sector and private sector banks that have been listed for a period of at least 5 years are considered for the study. Foreign banks listed in India are not considered in the study.

External determinants like macroeconomic factors and exchange rates are not considered. Additionally qualitative factors such as customer preferences and customer service are not considered. The impact of technology as a determinant is also not considered. In addition, the study also assumed variables vary linearly with each other which may not be the case, always.

1.9 Chapter Scheme

The first chapter introduces the study, its key objectives and the research problem. The second chapter provides an overview of the banking sector in India. The third chapter undertakes a review of literature in the field of research relevant to the study. The fourth chapter summarizes the research methodology adopted in the study. The fifth chapter presents the analysis of data and the results using relevant statistical tests. In the final chapter the findings and conclusion of the study are presented.

References

1) Chirwa, E. W. (2003). Determinants of commercial banks’ profitability in Malawi: a cointegration approach. Applied Financial Economics, 13(8), 565-571.

2) Dietrich, A., & Wanzenried, G. (2011). Determinants of bank profitability before and during the crisis: Evidence from Switzerland. Journal of International Financial Markets, Institutions and Money, 21(3), 307-327.

3) Sufian, F., & Habibullah, M. S. (2010). Bank-specific, Industry-specific and Macroeconomic Determinants of Bank Efficiency: Empirical Evidence from the Thai Banking Sector. Margin: The Journal of Applied Economic Research (Vol. 4, pp. 427-461).

4) Zarrouk, H., Jedidia, K. Ben, & Moualhi, M. (2016). Is Islamic bank profitability driven by same forces as conventional banks? International Journal of Islamic and Middle Eastern Finance and Management, 9(1), 46-66.

5) Trend and Progress of Banking in India. (2017). Retrieved from https://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Trend%20and%20 Progress%20of%20Banking%20in%20India, Accessed, 14 Feb. 2018.

CHAPTER 2

BANKING SECTOR IN INDIA - A REVIEW

CHAPTER II

BANKING SECTOR IN INDIA - A REVIEW

Taking cues from RBI reports and other publications the overall banking landscape in India is summed up in this chapter. An elaborate discussion of the nature and functions of the Indian banking system is presented. The chapter is organized into 13 sub sections. The first two sub sections look at the emergence of banking across the globe and in India. The third and fourth sub sections look at the types of banks and their functions.

The next two sub sections look at key bank performance measures and a rating system for banks. Subsections seven and eight look at key risks encountered by banks and regulatory requirements. The emerging trends in Indian banking are discussed in sub section nine. Profitability measures and determinants of profitability are presented in the next two sub sections. The current banking scenario in India is reviewed in sub section twelve and the last subsection contains the operational definitions.

2.1 Origin of Banking

The word bank has French, Italian and German roots. The French word “Banqui” and the Italian word “Banca” refer to a bank as a bench. This reference to banks originated from money changers who engaged in transactions across benches. These money changers mainly dealt with different currencies and helped exchange one currency for another. Secondly the word bank could have also emerged from the German word “banck”. The word banck was used to represent a joint stock company.

Banking traditions are deep rooted in history. The Bible has documented evidence of the activities of money changers during the times of Jesus Christ. In ancient Greece as early as 2000 B.C. the famous temples of Ephesus, Delphi and Olympia engaged in borrowing and lending serving as depositories and also facilitating lending as the need arose. The priests of these temples acted as custodians and helped facilitate depositing and lending of peoples funds. Credit transactions via transfer orders were also thought to have taken place initially in ancient Assyria, Phoenicia and Egypt and later on in Greece and Rome. In India, money lending and borrowing activities were found to have occurred in the ancient Vedic period (Hoggson, (1926)).

Public banking started in earnest around the middle of the twelfth century in Italy. The Bank of Venice, founded in 1157, was thought to be the first public banking institution. Almost three centuries following the establishment of the Bank of Venice, the Bank of Barcelona and the Bank of Genoa were founded in 1401 and 1407 respectively. The prestigious Bank of Amsterdam was established in Holland in 1609.

Modern banking commenced with the establishment of the Bank of Amsterdam. In the year 1694 the Bank of England was established. The Bank of England’s establishment kick started a revolution in banking. Joint stock companies entered the banking space in the eighteenth century following the implementation of The Banking Act of 1833. This led to the development of commercial banking system across several countries and continents across the globe (Hoggson, (1926)).

2.2 Banking in India

Banking in India can be classified into two distinct phases, the pre and post­independence phases. The pre-independence phase lasted from 1786 to 1947 and the post­independence phase lasted from 1947 to the present time.

2.2.1 The Pre-Independence Phase

The establishment of the General Bank of India in the year 1786 marked the introduction of a structured banking system in India. It was setup as a joint stock company. Later the Bank of Hindustan and Bengal Bank came into existence. The East India Company established three banks. These were the Bank of Bengal in the year 1809, the Bank of Bombay in 1840 and Bank of Madras in 1843. These three Banks were amalgamated in year 1920 to form the new Imperial Bank of India.

Between 1865 and 1906 three more banks came into existence. These were Allahabad Bank, Punjab National Bank and the Bank of India. The Bank of Baroda, Canara Bank, The Central Bank of India, Indian Bank and Bank of Mysore came into existence between 1906 and 1913. The Reserve Bank of India (RBI) was constituted as the shareholder’s bank in 1935 and was now the Central Bank of the Country ("The Advent of Modern Banking in India").

2.2.2 The Post-Independence Phase

Since banking services were inaccessible to most of the Indian public the government of India began nationalization of the banking sector. After independence, the Reserve Bank of India Bill was introduced in the parliament to make it a public bank. Since 1st January 1949, the RBI has been operating as a state owned and operated Central Bank. It regulates the Indian banking industry. The Imperial Bank was nationalized and was renamed as the State Bank of India with the passing of the State Bank of India Act of 1955.

In 1969 the government of India nationalized fourteen banks whose deposit base exceeded rupees fifty crores. These were Allahabad Bank, Punjab National Bank, the Bank of India, the Bank of Baroda, Canara Bank, the Central Bank of India, Indian Bank, the Bank of Maharashtra, Dena Bank, Indian Overseas Bank, Syndicate Bank, United Bank and UCO Bank.

Even after the nationalization of these banks people in rural areas still did not have access to proper banking services. To address these issues the Narasimham Committee was set up and as per its recommendations in 1974, Regional Rural Banks (RRB’s) were set up in October 1975 to increase the flow of credit to rural areas. In 1980 six more banks were nationalized. These were Andhra Bank, Vijaya Bank, Corporation Bank, The New Bank of India, Oriental Bank of Commerce and Punjab and Sindh Bank.

In 1990 as India embarked on economic reforms and opened up its economy the Narasimham Committee recommended a series of banking reforms intended to make the financial system stable and banks more competitive. These included stopping further bank nationalizations, enabling foreign banks to open subsidiaries in India, having a uniform regulatory process for both private and public banks, encouraging banks to take more risk and venture into higher growth areas such as underwriting, merchant banking and retail banking, encouraging joint ventures between foreign and Indian banks to offer value based financial services and allowing entry of more private players into the Indian banking space.

Based on the above recommendations several foreign banks like Citibank, Standard Charter Bank, Deutsche Bank etc. have entered the Indian banking space. These banks have partnered with several Indian banks to offer an array of financial services. Several private players like ICICI bank, HDFC bank, Axis Bank, Kotak Bank, Yes bank and more recently Bandhan bank and IDFC bank have emerged after having been granted licenses to enter the banking space in India. The detailed summary of events in the post­independence phase from 1967 to 1985 is shown below ("Reserve Bank of India - Chronology of Events"):

Table 2.1 Chronology of Events in the Banking Sector in India in the Post­Independence Phase

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2.3 Classification of Banks

The banking structure in India is described below and shows the different types of banks that are part of India’s banking system:

Figure 2.1: Classification of Banks

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Source: Jagranjosh.com

2.3.1 The Reserve Bank of India

The RBI is India’s apex bank and the absolute banking regulatory authority in India. The RBI was established on April 1935 as the central bank of India. It was nationalized in January 1949. The RBI performs some key functions such as being the government’s banker, the note issuing authority of India, the banker’s bank, the regulator of money and credit and exercising supervisory authority over the entire banking system. Under this authority the RBI regulates affairs of all players in the Indian financial system under the RBI Act of 1934 and the Banking Regulation Act of 1949.

2.3.2 Scheduled Banks

Scheduled banks are those that are included and regulated under the second schedule of the RBI act of 1934. These banks are required to have a minimum paid up capital and reserve of Rupees twenty-five lakhs. Most commercial banks that include public sector, private sector, co-operative and foreign banks operating in India would fall under this category. These banks can borrow money from the RBI for their regular banking activities and have to maintain their Cash Reserve Ratio (CRR) requirements with the RBI.

2.3.3 Unscheduled Banks

Unscheduled or non-scheduled banks are those that are not included and regulated under the second schedule of the RBI act of 1934. These banks cannot borrow money from the RBI for their regular banking activities. They have to maintain their Cash Reserve Ratio (CRR) requirements but not with the RBI.

2.3.4 Commercial Banks

These are banks which provide services to businesses, organizations and individuals. The main function of commercial banks is to accept deposits and advance loans. Deposits can be demand deposits, fixed deposits and savings deposits. Loans may be either cash credit, demand loans or short term loans. The commercial banks in India are further classified as public sector, private sector, region rural and foreign banks.

2.3.4.1 Public Sector Banks

Public sector banks are majority owned by the government implying that the government owns at least a 51% stake in them. This group of banks includes all nationalized banks. State Bank of India is India’s largest public sector bank. There are over twenty public sector banks in India. All listed public sector banks are shown in the table below. State Bank of India is the largest public sector bank in India having the largest market capitalization and asset base. It is also the most profitable public sector bank.

Table 2.2 Public Sector Banks in India

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Source: Moneycontrol.com as on 20/5/2019

2.3.4.2 Private Sector Banks

Private sector banks are banks where a major equity stake is held by private shareholders. The private banking sector has emerged post the liberalization phase in India in 1993. Examples of these banks are HDFC Bank, Kotak Bank, Axis Bank etc. There are over fifteen private sector banks in India. All listed private sector banks are shown in the table below. HDFC bank is the largest private sector bank in India having the largest market capitalization and asset base. It is also the most profitable private sector bank.

Table 2.3 Private Sector Banks in India

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Source: Moneycontrol.com as on 20/5/2019

2.3.4.3 Foreign Banks

These banks are headquartered overseas but operate subsidiaries in India. There are over thirty five foreign banks in India. Examples of foreign banks include HSBC, Citibank, Standard Chartered Bank etc.

2.3.4.4 Regional Rural Banks

As per the recommendation of the Narasimham Committee regional rural banks (RRB’s) were set up in 1975 to increase the flow of credit to agriculture and other rural segments. Regional rural banks are jointly owned by the government of India, the concerned state government and sponsor banks in the ratio 50:15:35 respectively. Prathama bank is an example of one such RRB in rural Uttar Pradesh.

2.3.5 Co-operative Banks

A co-operative bank is owned by its members who are at the same time its owners and customers. These banks are created my members of a local community to further common grounds of interest. They provide members with a wide range of banking and financial services such as bank accounts, loans and deposits. Co-operative banks operate on the “no-profit no-loss” principle. They are further classified into urban and state co­operative banks.

2.4 Function of Banks

There are some key functions that are performed by banks (Suresh & Paul, 2014). These are shown in figure 1.7. These include:

(I) Primary Functions that include Accepting Deposits and Granting Loans and

(II) Secondary Functions that include Agency Functions and General Utility Functions.

Figure 2.2 Function of Banks

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2.4.1 Primary Functions

The primary functions of modern banks include accepting deposits and advancing loans (Suresh & Paul, 2014):

2.4.1.1 Accepting Deposits

One of the most important functions of a commercial bank is to accept deposits from the public. Banks require large sums of money for their lending activities. Therefore, banks accept deposits from individuals or companies and pay interest on deposited funds. Individuals and companies deposit their surplus funds with banks for both safe keeping and earning interest. Banks pay the appropriate interest on the deposits collected. The bank not only guarantees the deposit but also agrees to meet the demands of the depositors arising from any withdrawals required. Banks generally provide the following deposit accounts:

2.4.1.1.1 Fixed Deposit Account

This is also referred to as a term deposit or time deposit account. Money in this account is accepted for a fixed period, usually between one and ten years. The money so deposited cannot be withdrawn before the maturity period. The rate of interest on this account is usually higher than that on other accounts and varies according to the time period of the deposit. It matures at the end of the fixed period. If a depositor withdraws this amount before the maturity period, he incurs an interest penalty. Thus, banks have these funds at their disposal for a certain fixed period.

2.4.1.1.2 Current Account

This is also known as a demand deposit or current deposit account. Here the depositor can withdraw the money from this account as and when he requires it. Usually, the bank pays no interest on this account because it has to keep the cash ready at all times to meet the requirement of the depositors. This account is generally opened by companies, institutions or even the government, who engage in cash transactions several times in a day. In the case of a current account, the bank has to pay either the depositor himself or a third party whom the depositor authorizes by issuing cheques. Overdraft facilities are usually made available on current accounts.

2.4.1.1.3 Savings Account

This type of account is generally opened by individuals. They deposit their savings in this account and earn interest on the amount deposited. Deposits in this account earn interest at nominal rates, as these can be redeemed by the depositor without notice. In practice, the bank imposes a limit on the number and amount of withdrawals that can be done during any given period. The depositors can also issue cheques against this account.

2.4.1.1.4 Other Accounts

Banks also provide other types of accounts as per the requirement of the customer. Some popular accounts offered by banks are Indefinite Period Deposit Accounts, Recurring Deposit Accounts, Daily Saving Deposit Accounts, Home Safe Accounts, Retirement Schemes, Monthly Income Schemes, Minor Saving Accounts, Farmers Deposit Account, Home Deposit Account and Accounts related to Insurance benefits.

2.4.1.2 Advancing Loans

A very important function of commercial bank is advancing loans to their customers. Given that banks receive deposits from their customers they are obligated to pay interest on the deposits received. Banks channel the available amount from deposits into loans and charge higher rates of interest on them. These loans are usually granted to traders, industrialists, farmers and self-employed individuals. Generally, banks sanction the following type of loans and advances.

2.4.1.2.1 Cash Credit

Banks advance loans against certain collateral. Collateral can be securities such as shares and debentures, goods and tangible assets. Cash credit may be granted also on the promissory notes of borrowers. Banks grant loans and deposit them in the borrowers account. The borrower can withdraw this amount at any time and interest is charged on the borrowed amount. The borrower cannot exceed the credit limit sanctioned to him. The collateral of the borrower in the form of goods (stock) is kept in a warehouse which remains in the possession of the bank till the borrowed amount is repaid.

2.4.1.2.2 Loans and Advances

The bank lends a specified sum of money to a person or a firm against some collateral. The loaned money is credited to the account of the borrower and the borrower can withdraw the amount according to his requirements. The borrower has to pay interest on the entire amount of the loan from the date of sanctioning of the loan to the date of repayment. If the borrower fails to repay the loan, the pledged collateral can be sold by the bank in the market to recover the loan sanctioned.

2.4.1.2.3 Overdraft

Commercial banks provide customers with an overdraft facility, where the customer can issue cheques up to a certain amount greater than the balance lying in his account. In the case of use of the overdraft, a customer pays interest on the amount by which his current account is overdrawn. He is not required to pay interest on the entire amount of the overdraft sanctioned to him by the bank. This facility is usually granted against some collateral for a short period.

2.4.1.2.4 Discounting of Bills of Exchange

Banks also discount bills of exchange for their customers. In case a holder of a bill needs money immediately, he can get his bills discounted by the bank. The bank charges a commission for discounting. When the bill matures, the bank can get the proceeds directly from the original issuer of the bill.

2.4.2 Secondary Functions:

The secondary functions of banks comprise of agency and general utility functions (Suresh & Paul, 2014):

2.4.2.1 Agency or Representative Functions

Banks perform several agency functions or services for their customers. For these services, the bank charges commissions from its customers. Some services are provided by the bank to its customers free of charge. The various agency services rendered by the bank are as follows:

2.4.2.1.1 Collection of Cheques, Bills of Exchange and other Credit Instruments

Banks collect payments on cheques, bills of exchange and other credit instruments on behalf of their customers from other banks and credit their accounts. Generally, this service is rendered free of charge but on some credit instruments, banks may charge a nominal fee.

2.4.2.1.2 Making Payment via Cheque, Bills of Exchange etc.

Commercial banks perform the function of making payments through cheques, bills of exchange etc. Banks pay insurance premiums, rent, subscriptions etc. on behalf of their customers. Banks also accept bills of exchange on behalf of their customers and make payments as and when due.

2.4.2.1.3 Collecting dividends, interest etc. on shares and debentures of the customers

Banks receive dividends and interest paid on shares and debentures of companies held by their customers on their behalf and credits them in their account.

2.4.2.1.4 Remittance Facilities

On request of their customers, banks help in transferring funds from one account to another through bank drafts, cheques, and electronic transfers. Banks charge fees for these services rendered.

Banks help their customers purchase and sell shares and debentures in the market by providing their customers with dematerialization (DEMAT) accounts. This helps customers to transact securities securely in electronic form. They charge appropriate commissions for their services.

2.4.2.1.6 Trustee and Executor

Banks also perform the functions of trustees, executors, administrators and attorneys. As a trustee, banks oversee the assets of the customers. They also help in the administration of trusts set up by their customers. As an executor banks execute wills of the customers as per their request. As an attorney, banks signs transfer forms and documents on behalf of the customer.

2.4.2.1.7 Underwriting Function

Banks also perform the function of underwriting shares, debentures, bonds and other securities issued by public limited companies or the Government. By becoming the underwriter banks guarantee subscription to the issued securities. The underwriting function of banks creates public confidence in the new issue market for securities. Banks charge appropriate commissions for the underwriting services provided.

2.4.2.1.8 Other Agency Functions

Banks also act as agents, representatives or correspondents of their customers. The bank may obtain passports, tickets for travel etc. to satisfy its customer’s requirements.

2.4.2.2 General Utility Functions

Banks also provide the following general utility services to its customers:

Banks make available locker facilities to their customers for keeping their valuables like share and debentures certificates, gold and silver jewelry, documents etc. Banks charge annual rent for the locker facilities provided.

2.4.2.2.2 Issue of Travelers Cheques

Banks may also issue travelers cheques or circular letters of credit for the benefit of their customers. Customers can use these while travelling abroad for their transaction requirements.

2.4.2.2.3 Providing Information to its Customers

Since banks work with several customers, they can pass on reliable information about the credit-worthiness of third parties to their customers. The banks information is often considered reliable by customers who could use it while transacting with third parties. This helps their customers manage their risk better.

2.4.2.2.4 Financial Advisor

As banks are fully acquainted with the economic developments in the nation, they are in a position to render useful advice to its customers on financial matters. This helps the customer in taking appropriate investment decisions.

2.4.2.2.5 Publication of Statistics

Large commercial banks publish statistics about money, banking, trade and commerce. This is useful to their customers and helps them in taking economic and business decisions.

2.4.2.2.6 Accepting Bills of Exchange:

Banks accept bills of exchange on behalf of their customers. This benefits the customers because they have a quick access to funds. This is possible because as and when the bank accepts the bill it becomes readily discountable in the money market.

Commercial banks act as guarantors of loans granted by National and International Financial Institutions. This helps their customers to gain access to a wide range of loans easily.

2.4.2.2.8 Providing Consumer Loans:

Commercial banks grant consumer loans to their customers based on their personal credit worthiness that can be repaid in affordable installments.

2.4.2.2.9 Sale of Government Debt:

Commercial banks facilitate the selling of securities issued by the Government as agents of the RBI. This includes Treasury Bills and Bonds issued by the government.

2.4.2.2.10 Facilitator of Foreign Exchange:

Commercial banks also make foreign exchange available to their customers as and when required.

2.4.2.3 Other Functions:

Other than the above mentioned functions banks perform a few other important functions like making arrangements for foreign trade and creation of credit:

2.4.2.3.1 Making Arrangements for Foreign Trade:

Commercial banks have played an important role in the expansion of foreign trade. They make available short term credit to traders engaged in foreign trade through the acceptance of letters of credit and discounting of bills. These transactions were popular as early as the medieval period. Thus banks help in establishing important relationships between exporters and importers and help in facilitating international trade.

Commercial banks play an important role in creating credit in the economy. They facilitate this by granting loans and advances. When the bank grants loans to its customers, it generally does not lend out cash as an individual money-lender does, but opens an account in the borrowers name and credits the amount of the loan into his account. Thus, whenever a bank grants a loan, it creates a deposit or a liability against itself, which leads to a net increase in the money supply in the economy. In this way banks create credit in the economy.

2.5 Key Bank Performance Measures

There are several key ratios which measure bank performance in several key operational areas such as liquidity, income generation, cost efficiency, lending and profitability. Some of these ratios are discussed below:

2.5.1 The Credit Deposit Ratio

This ratio is a key lending measure. It indicates how much a bank lends out as a function of the deposits it has received. In other words it shows how much of the mobilized funds are being used for the bank’s core lending activity. A higher ratio indicates the bank’s dependence on deposits as a source for lending and vice-versa.

A very low ratio indicates banks are not making full use of the resources at their disposal. A very high ratio is considered a warning sign and may have direct implications in deteriorating asset quality. The table below shows this important metric for Indian public sector and Indian private sector and foreign banks over the last nine years:

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