profitability of commercial banks

7/31/2019 profitability of commercial banks

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Overview of Banking

Profitability of Bank


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How Do Banks Earn Profits?

The majority of revenue comes from accepting deposits from

consumers and then lending that money, with interest, out

to individuals and businesses in the form ofbank loans.

You are most likely very familiar with the fact that banks alsomake money by charging fees. Additionally, banks even

earn returns on investments


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Interest and fees on loans is traditionally the major source

of income for commercial banks.

Earnings from the Money market

Return on Equity(ROE)

Return on Assets(ROA)

Interest Margin

Bank Earnings


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Non-interest income is earned by providing a

variety of services, such as trading of securities, assisting

companies to issue new equity financing, securities

commissions and wealth management, sale of land,

building, profit and loss on revaluation of assets etc.

Ex:- Fees ,Service charges

Bank Earnings: Non Interest


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It decomposes cost management and revenue managementinto narrower categories of cost and revenue to evaluate the

source of profits. It includes:

Assets utilization

Determination of net interest income.

Efficiency ratio

Analysis of non interest expense.

Determination of net interest expense.

Profit vs. risk

Profitability Analysis


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Return on Asset = (Free income + Net interest income

operating cost)/ Average total assets

Or

Return on Asset = Net income/Average total asset

It tells that what an bank is earning on its total asset.

Return on Asset (ROA)


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Net Interest Income = Interest Received on Assets - Interest

Paid on Liabilities

Or

Net Interest income =Interest Earned on Securities & Loans-

Interest Paid on Deposits and Borrowings

High net interest income and margin indicates a well

managed bank and also indicates future profitability.

Net Interest Income


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It shows how well the bank is earning income on its assets.

Net Interest Margin = Net Interest Income / Average

total assets

Where,

Average Total Assets =(Total Assets at End of Fiscal Year- Total Assets at Start of Fiscal Year) /2

Net Interest Margin


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The Return on equity is what the bank's owners areprimarily interest in because that is the return that they

earn on their investment.

When a bank increases its liabilities to pay for assets, it isusing leverage otherwise a bank's profit would be limited

by the fees that it can charge and its interest rate spread.

Interest rate spreads are not wide and so a bank can onlyearn more net interest income by increasing the number of

loans that it makes compared with the amount of its bank

capital which it does by using leverage.

Return on Equity(ROE)


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Earning high profits in good or even normal times will be

easier if the bank is willing to take on some risk.

This risk may be more problematic in bad times.

Important to measure the risk of the banking system as

well as the profits.

Profit v/s Risk


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One way for a bank to increase expected profits is to take

on more risk.

For a bank to survive, it must balance the demands of three

constituencies: shareholders, depositors, and regulators,

each with their own interest in profitability and safety.

The bank has to be concerned with shareholder wealthmaximization.

(Cont)

Banking Dilemma:

Profitability Versus Safety


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Banks supply liquidity to customers.

Depositors store their liquidity in banks; loan customers

come to the bank to borrow liquidity.

The bank supplies liquidity from two sources: sale of

assets and borrowing.

Contd.


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A bank must successfully balance profitability on one hand

and liquidity and solvency on the other.

Bank failure can result from the depletion of capital caused

by losses on loans or securities -- from over-aggressive

profit seeking. But a bank that only invests in high-quality

assets may not be profitable.

Failure can also occur if a bank cannot meet the liquiditydemands of its depositors -- a run on the bank occurs. If

assets are profitable, but illiquid, the bank also has a

problem.

The Dilemma


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According to a Credit Rating and Information Services of India

(Crisil) study, Lower operating expenses including rationalisation of

employee costs have improved the profitability of banks, contrary

to the popular perception that only trading profits helped the

banking sector shore up their bottom lines.

The reduction in operating expenses was achieved through large-

scale voluntary retirement schemes implemented by public sector

banks. Since this reduction in operating expenses seemssustainable, it promises a brighter future for the banking sector.

The efficiency profitability models adopted at various branches of

banks which help in enhancing and profitability of banks.

Profitability of Banks in India:

Current Scenario

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profitability of commercial banks