242

CHAPTER - 6

IMPACT OF NON-PERFORMING ASSETS ON PROFITABILITY OF

SAMPLED BANKS

CHAPTER INDEX

No. Content of the Chapter Page No.

6.1 Introduction 243

6.2 Research Model 243

6.3 Hypotheses of the Study 244

6.4 Database for Calculation 244

6.5 Analysis and Interpretation 252

243

CHAPTER - 6

IMPACT OF NON-PERFORMING ASSETS ON PROFITABILITY OF

SAMPLED BANKS

6.1 Introduction:

The bank plays an important role in the economy of a country by performing

it’s the most important function known as credit creation. The bank creates credit in

various forms such as loans and advances, cash credit; bank over draft etc. in this

manner the bank creates money supply into the market. The banks give these loans

and advances, cash credit, bank over draft to the individuals, firms, companies,

government, etc. in this sense the bank plays role of a lender of money and all these

parties play the role of borrower. Unfortunately the credit provided by the bank

doesn’t come back to the bank. This creates bad debts, which is known as Non-

Performing Assets (NPA) in the terminology of bank.

For the last a few years the NPA of banks is increasing tremendously. Several

steps have been undertaken by the RBI and the government of India to curb the

increasing NPA of Indian banks, but these steps have not been proved to be

successful. Majority of banks are suffering from the problem of NPA and it has

attracted intense debate and attention across banking industries in the corporate

finance. The reports and review of literature reveals that increasing NPA worsens the

efficiency of the bank and in turn the profitability decreases. Now a day the increasing

NPA has become the burning issue in banking sector. This problem is more critical in

nationalized banks. Under this section of the research, the researcher has made efforts

to check impact of NPAs on profitability of the banks.

6.2 Research Model:

Regression analysis was carried out to test the impact of NPA on profitability.

Here NPA is the independent variable and profitability is the dependent variable. Here

profitability is measured with the help of five ratios viz. Interest Spread as % to Total

Assets, Net Profit Margin, Return on Net Worth, Net Profit to Total Fund, and Net

Profit to Total Assets. Non-Performing Assets is measured through Gross NPAs to

Advances Ratio and Net NPAs to Advances Ratio. The formulated hypotheses are to

be tested at 2-tailed @ 5% level of significance.

244

6.3 Hypotheses of the Study:

To justify this section of present research study, following null-hypotheses

were formulated by the researcher:

1. There is significant impact of Gross NPAs to Advances Ratio on Interest

Spread as % to Total Assets.

2. There is significant impact of Gross NPAs to Advances Ratio on Net Interest

Margin.

3. There is significant impact of Gross NPAs to Advances Ratio on Return on

Net Worth.

4. There is significant impact of Gross NPAs to Advances Ratio on Net Profit to

Total Fund.

5. There is significant impact of Gross NPAs to Advances Ratio on Net Profit to

Total Assets.

6. There is significant impact of Net NPAs to Advances Ratio on Interest Spread

as % to Total Assets.

7. There is significant impact of Net NPAs to Advances Ratio on Net Interest

Margin.

8. There is significant impact of Net NPAs to Advances Ratio on Return on Net

Worth.

9. There is significant impact of Net NPAs to Advances Ratio on Net Profit to

Total Fund.

10. There is significant impact of Net NPAs to Advances Ratio on Net Profit to

Total Assets.

6.4 Database for Calculation:

To measure the impact of NPAs on profitability of the banks, the researcher

has assumed NPAs as the independent variable and profitability as the dependent

variable. To support the calculation, the researcher has compiled the data from various

secondary sources, and presented in tabulated form to facilitate the present research.

The explanation of various ratios and presentation of database to support the research

are presented in table 6.1 to 6.7

245

6.4.1 Gross NPAs to Advances Ratio:

This ratio shows relation between the amounts of Gross NPAs to Advances in

terms of percentage. This ratio shows negative feature of the stability of the banks. If

this ratio is higher, it shows that the financial capacity of the bank is poor and vice-

versa. So the banks should try to control this ratio to the minimum. To measure the

impact of NPAs on profitability, the researcher considers this ratio as one of the

independent variable. Here, the researcher has made the presentation of this ratio for

the sample units for the period of 10 years i.e. 2002-03 to 2011-12. The said ratio is

presented in table 6.1, given below:

Formulae Gross NPAs x 100

Advances

Table – 6.1

A Table Showing Gross NPAs to Advances Ratios in Selected Nationalized Banks

of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 11.79 8.92 10.07 14.58 19.16 12.38

2003-04 11.18 8.14 8.14 13.56 15.77 9.89

2004-05 7.65 5.68 7.36 9.61 10.15 6.19

2005-06 3.99 3.80 5.73 7.16 6.67 4.21

2006-07 2.50 2.47 3.58 4.97 4.07 3.51

2007-08 1.86 1.70 2.65 3.22 2.49 2.78

2008-09 1.28 1.73 2.33 2.70 2.15 1.79

2009-10 1.37 2.90 3.00 2.43 1.81 1.72

2010-11 1.38 2.26 2.50 1.85 1.88 1.81

2011-12 1.55 2.37 2.31 4.93 1.69 2.97

Average 4.46 4.00 4.77 6.50 6.58 4.73

246

6.4.2 Net NPAs to Advances Ratio:

This ratio shows relation between amounts of Net NPAs to Advances in terms

of percentage (%). This is also a negative performance indicator for the financial

stability and soundness of the banks. If this ratio is higher, it shows that the financial

strength of the bank is poor and vice-versa. So the banks should try to control this

ratio to the as minimum as possible. To measure the impact of NPAs on profitability,

the researcher also considers this ratio as one of the independent variable. Here, the

researcher has made the presentation of this ratio for the sample units for the period of

10 years i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.2, given below:

Formulae Net NPAs x 100

Advances

Table- 6.2

A Table Showing Net NPAs to Advances Ratio in Selected Nationalized Banks of

India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 4.81 5.59 4.83 7.02 11.82 3.80

2003-04 4.95 4.50 2.46 5.57 9.40 0.95

2004-05 1.43 2.80 2.15 2.98 5.23 0.20

2005-06 0.86 1.49 2.03 2.59 3.04 0.28

2006-07 0.60 0.95 0.99 1.70 1.99 0.75

2007-08 0.46 0.52 0.87 1.45 0.94 0.63

2008-09 0.31 0.44 0.79 1.24 1.09 0.17

2009-10 0.34 1.31 1.64 0.69 1.21 0.53

2010-11 0.35 0.91 1.32 0.65 1.22 0.84

2011-12 0.54 1.47 0.84 3.09 1.01 1.52

Average 1.47 2.00 1.79 2.70 3.70 0.97

247

6.4.3 Spread as % to Total Assets:

This ratio is prepared to present the profitability of the banks. Spread is also

termed as interest spread or net interest margin or net interest spread. Net interest

spread is expressed as interest yield on earning assets (any assets, such as a loan, that

generates interest income) less interest rates paid on borrowed funds. It also refers to

the difference in lending rates and borrowing rates of financial institutions. It is the

first and foremost measure to evaluate the profitability of the banks and financial

institutions, as the spread is the main source of earning the profit.

This ratio shows relation of spread to the total assets of the banks, to measure

the earning capacity of the company against total assets held by them. For this section

of research, this ratio is considered as one if the dependent ratio. Here, the researcher

has made the presentation of this ratio for the sample units for the period of 10 years

i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.3, given below:

Formulae Interest Spread x 100 = Interest Earned – Interest Paid x 100

Total Assets Total Assets

Table- 6.3

A Table Showing Interest Spread as % to Total Assets in Selected Nationalized

Banks of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 2.75 2.67 2.72 3.32 2.82 3.62

2003-04 3.02 2.59 2.40 3.35 2.67 3.54

2004-05 3.15 2.36 2.68 3.46 2.86 3.17

2005-06 2.84 2.34 2.71 3.19 2.72 3.21

2006-07 2.50 2.43 2.80 2.66 2.72 3.21

2007-08 2.18 2.36 2.55 1.79 2.31 2.78

2008-09 2.26 2.44 2.13 1.51 2.20 2.85

2009-10 2.13 2.09 2.82 1.39 1.91 2.87

2010-11 2.46 2.22 2.58 2.54 2.49 3.12

2011-12 2.31 2.16 2.86 2.25 2.40 2.93

Average 2.56 2.366 2.625 2.546 2.51 3.13

248

6.4.4 Net Profit Margin:

Net profit margin is the percentage of revenue remaining after all operating

expenses; interest, taxes and preference share dividend have been deducted from a

company’s total revenue. By dividing net profit by total revenue, one can see what

percentage of revenue made it all the way to the bottom line, which is good for the

investors. It is considered as one of the profitability ratio in banking industry. The

higher the net profit margin is, the more effective the bank is at converting revenue

into actual profit. The net profit margin is one of the good ways of comparing

different units in the same industry. For this section of research, this ratio is

considered as one if the dependent ratio. Here, the researcher has made the

presentation of this ratio for the sample units for the period of 10 years i.e. 2002-03 to

2011-12. The said ratio is presented in table 6.4, given below:

Formulae Net Profit x 100

Revenue

Table- 6.4

A Table Showing Net Profit Margin in Selected Nationalized Banks of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 10.50 11.27 9.09 5.42 5.16 9.79

2003-04 12.13 13.38 11.42 10.25 9.79 11.45

2004-05 9.77 5.08 6.97 6.21 3.11 13.84

2005-06 10.76 8.63 2.18 4.92 3.85 14.50

2006-07 10.22 10.48 9.36 7.69 8.30 12.53

2007-08 10.38 13.96 8.65 6.31 11.61 12.68

2008-09 12.86 15.89 7.88 4.99 10.95 13.76

2009-10 15.37 8.59 8.16 7.70 11.17 15.64

2010-11 17.17 10.25 5.42 7.66 11.07 14.48

2011-12 15.12 8.53 5.52 2.61 11.04 12.02

Average 12.43 10.61 7.47 6.38 8.61 13.07

249

6.4.5 Return on Net Worth:

Net worth is a concept applicable to individuals and businesses as a key

measure of how much an entity is worth. A consistent increase in net worth indicates

good financial health of the entity. Here the term ‘net-worth’ indicates owners’ fund

i.e. sum of paid up capital and reserves and surplus. This ratio is useful to judge the

profitability of the entity from the shareholders’ point of view. Here, the researcher

has used this ratio as the indicator of profitability, which is one of the dependent

variable in this section of research, i.e. to measure the impact of NPAs on

profitability. Here, the researcher has made the presentation of this ratio for the

sample units for the period of 10 years i.e. 2002-03 to 2011-12. The said ratio is

presented in table 6.5, given below:

Formulae Net Profit x 100

Net Worth

Table- 6.5

A Table Showing Return on Net Worth in Selected Nationalized Banks of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 18.81 28.32 27.55 18.61 12.41 24.97

2003-04 20.32 28.04 23.45 28.73 26.55 26.42

2004-05 12.58 8.36 8.82 13.03 7.43 17.96

2005-06 10.54 15.37 4.08 8.77 9.03 17.01

2006-07 11.86 21.25 14.00 19.88 17.48 16.03

2007-08 12.99 22.76 18.60 15.46 22.96 19.00

2008-09 17.35 25.51 18.16 14.43 21.68 23.52

2009-10 20.24 13.60 18.28 23.03 21.36 24.06

2010-11 20.15 15.58 10.23 21.45 17.68 20.61

2011-12 18.22 13.57 9.97 4.52 18.71 17.55

Average 16.31 19.24 15.31 16.79 17.53 20.71

250

6.4.6 Net Profit to Total Fund Ratio:

This ratio shows relation between net profit and total fund in terms of

percentage. This ratio shows capacity of the enterprise to generate net profit against

the total fund employed. This ratio is one of the indicators of the profitability. . This

ratio shows efficiency of the business entity to utilize its total fund in more profitable

means. This ratio is useful to judge the profitability of the entity from the different

stakeholders’ point of view. A consistent increase in net profit to total fund ratio

indicates good financial health of the entity. Here, the researcher has used this ratio as

the indicator of profitability, which is one of the dependent variable in this section of

research, i.e. to measure the impact of NPAs on profitability. Here, the researcher has

made the presentation of this ratio for the sample units for the period of 10 years i.e.

2002-03 to 2011-12. The said ratio is presented in table 6.6, given below:

Formulae Net Profit x 100

Total Fund

Table- 6.6

A Table Showing Net Profit to Total Fund Ratio in Selected Nationalized Banks

of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 1.05 1.17 0.96 0.56 0.59 1.06

2003-04 1.20 1.25 0.97 1.04 1.13 1.18

2004-05 0.75 0.38 0.40 0.46 0.31 1.24

2005-06 1.01 0.68 0.20 0.36 0.37 1.06

2006-07 0.80 0.89 0.65 0.60 0.70 1.00

2007-08 0.89 1.26 0.75 0.51 1.03 1.14

2008-09 1.09 1.50 0.68 0.43 0.98 1.40

2009-10 1.21 0.70 0.68 0.65 0.97 1.45

2010-11 1.33 0.80 0.24 0.64 0.96 1.32

2011-12 1.24 0.73 0.52 0.24 1.02 1.17

Average 1.06 0.94 0.61 0.55 0.81 1.20

251

6.4.7 Return on Assets:

Return on assets (RoA) is a profitability ratio which indicates the net profit

(net income) generated on total assets. This ratio shows efficiency of the business

entity to utilize its assets in more profitable means. It is computed by dividing net

income by average total assets of the banks. Here the researcher has assumed this

ratio as one of the dependent ratio to measure the impact of NPAs on profitability.

Here, the researcher has made the presentation of this ratio for the sample units for the

period of 10 years i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.7,

given below:

Formulae Net Profit x 100

Average Total Assets

Table- 6.7

A Table Showing Net Profit to Average Total Assets (RoA) Ratio in Selected

Nationalized Banks of India

[In %]

Year BOB BOI BOM CBI DENA PNB

2002-03 1.01 1.12 0.89 0.54 0.57 0.98

2003-04 1.14 1.19 0.95 0.98 1.04 1.08

2004-05 0.71 0.36 0.54 0.52 0.25 1.12

2005-06 0.73 0.62 0.16 0.34 0.27 0.99

2006-07 0.72 0.79 0.70 0.54 0.64 0.95

2007-08 0.80 1.12 0.68 0.44 0.93 1.03

2008-09 0.98 1.33 0.64 0.39 0.87 1.25

2009-10 1.10 0.63 0.62 0.58 0.89 1.32

2010-11 1.18 0.71 0.43 0.60 0.86 1.17

2011-12 1.12 0.70 0.49 0.23 0.92 1.07

Average 0.95 0.86 0.61 0.52 0.72 1.10

252

Table – 6.8

A Table Showing Average Ratios of Selected Nationalized Banks of India

Ratios*

Bank X1 X2 X3 X4 X5 X6 X7

BOB 4.46 1.47 2.56 12.43 16.31 1.06 0.95

BOI 4.00 2.00 2.37 10.61 19.24 0.94 0.86

BOM 4.77 1.79 2.63 7.47 15.31 0.61 0.61

CBI 6.50 2.70 2.55 6.38 16.79 0.55 0.52

Dena 6.58 3.70 2.51 8.61 17.53 0.81 0.72

PNB 4.73 0.97 3.13 13.07 20.71 1.20 1.10

* Explanation of codes used for ratios

X1 = Gross NPAs to Advances Ratio

X2 = Net NPAs to Advances Ratio

X3 = Interest Spread as % to Total Assets Ratio

X4 = Net Profit Margin

X5 = Return on Net Worth

X6 = Net Profit to Total Fund Ratio

X7 = Net Profit to Total Assets Ratio

6.5 Analysis and Interpretation:

Table – 6.9

A Table Showing Descriptive Statistics of Ratios

Ratio Code N Range Minimum Maximum Mean Std.

Deviation

Gross NPAs to

Advances Ratio

X1 6 2.58 4.00 6.58 5.17 1.09

Net NPAs to

Advances Ratio

X2 6 2.73 0.97 3.70 2.11 0.97

Interested Spread as

% to Total Assets

Ratio

X3 6 0.76 2.37 3.13 2.63 0.26

Net Profit Margin X4 6 6.69 6.38 13.07 9.76 2.71

Return on Net Worth X5 6 5.40 15.31 20.71 17.65 2.00

Net Profit to Total

Fund Ratio

X6 6 0.65 0.55 1.20 0.86 0.25

Net Profit to Total

Assets Ratio

X7 6 0.58 0.52 1.10 0.79 0.22

253

The above mentioned table shows descriptive statistics of the different ratios

i.e. variables covered under the study. Here Gross NPAs to Advances Ratio and Net

NPAs to Advances Ratio identified as independent ratio, showing position of position

of Non-Performing Assets in sampled units. Whereas Interest Spread as % to Total

Assets, Net Profit Margin, Return on Net Worth, Net Profit to Total Fund Ratio and

Net Profit to Total Assets Ratio (RoA) are dependent variable of the study, showing

profitability in the sampled units.

The descriptive statistics show that over the period under the study i.e. 2002-

03 to 2011-12, the profitability ratios measured by interest spread as % to total assets,

net profit margin, return on net worth, net profit to total fund ratio and net profit to

total assets ratio averaged 2.63, 9.76, 17.65, 0.86 and 0.79 respectively, with the

standard deviation 0.26, 2.71, 2.00, 0.25 and 0.22. The gross NPA to advances ratio

is 5.17 and average net NPA to advances ratio is 2.11, with the standard deviation

1.09 and 0.97.

Regression Analysis:

Table – 6.10

Predictor of Profitability – Model Summary

Independent

Variable

(Ratio)

Dependent

Variable

(Ratio)

R R2 Adjusted

R2

Standard

Error of

Estimate

X1

(Gross NPA

to Advances

Ratio)

X3 0.099 0.0098 -0.238 0.29

X4 0.643 0.414 0.267 2.322

X5 0.241 0.058 -0.177 2.166

X6 0.552 0.305 0.131 0.237

X7 0.603 0.364 0.204 0.194

X2

(Net NPA to

Advances

Ratio)

X3 0.579 0.335 0.168 0.239

X4 0.659 0.434 0.293 2.281

X5 0.285 0.081 -0.149 2.14

X6 0.574 0.329 0.161 0.233

X7 0.641 0.411 0.264 0.187

254

Table – 6.11

A Table Showing Coefficient for Predictors of Performance

Independent

Variable

(Ratio)

Dependent

Variable

(Ratio)

Unstandardized

Coefficients

Standardized

Coefficients

t-value Sig.

X1

(Gross NPA

to

Advances

Ratio)

B Std. Error Beta

X3 -0.024 0.119 -0.099 -0.119 0.852

X4 -1.596 0.949 -0.643 -1.681 0.168

X5 -0.440 0.885 -0.241 -0.497 0.645

X6 -0.128 0.097 -0.552 -1.325 0.256

X7 -0.120 0.079 -0.603 -1.512 0.205

X2

(Net NPA

to

Advances

Ratio)

X3 -0.156 0.110 -0.579 -1.419 0.229

X4 1.844 1.052 -0.659 -1.752 0.155

X5 -0.586 0.987 -0.285 -0.594 0.584

X6 -0.150 0.107 -0.574 -1.400 0.234

X7 -0.144 0.086 -0.641 -1.671 0.170

The R2

values (table 6.10) of 0.0098, 0.414, 0.058, 0.305 and 0.364

denotes that 00.98%, 41.40%, 5.80%, 30.50% and 36.40% of the observed variability

in interest spread as % to total assets, net profit margin, return on net worth, net profit

to total fund ratio and net profit to total assets ratio is explained by the variability in

the independent variable of gross NPA to total advances ratio. These R2

values

indicate that there may be number of variables which may have impact on

profitability other than the gross NPA to total advances ratio.

The R2 values (table 6.10) of 0.335, 0.434, 0.081, 0.329 and 0.411 denotes that

33.50%, 43.40%, 8.10%, 32.90% and 41.10% of the observed variability in interest

spread as % to total assets, net profit margin, return on net worth, net profit to total

fund ratio and net profit to total assets ratio is explained by variability in the

independent variable net NPA to total advances ratio. These R2

values indicate that

there may be number of variables which may have impact on profitability other than

the net NPA to total advances ratio.

Literature existing on this area of research theoretically proves that the NPA is

the most influencing factor that affecting to profitability in negative manner. From the

statistical analysis given in table 6.11, it is clear that the negative association was

255

found between all the independent and dependent variables under the study.

Here, the researcher may conclude that, the Gross NPAs and Net NPAs are not

only the factors, which is affecting to the profitability of the banks under the sample.

So, the evidences found while measuring the impact of NPAs on profitability clearly

shows that the banks are required to control and monitor the other variables.

The statistical analysis of application of student ‘t’ test for the testing of

hypotheses @ 5% level of significance also reveals that all hypotheses formulated by

researcher is rejected, it means gross NPA and net NPA are not only variables that

affects to profitability of the nationalized banks of India. Hence, to check the impact

of other variables on profitability indicated as a scope of future research.