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Over the last few years Indian Banking, in its attempt to integrate itself with the global banking has been facing lots of hurdles in its way due to its inherent weaknesses, despite its high sounding claims and lofty achievements. In a developing country like ours, banking is seen as an important instrument of development, while with the strenuous NPAs, banks have become helpless burden on the economy. Looking to the changing scenario at the world level, the problem becomes more ironical because Indian banking, cannot afford to remain unresponsive to the global requirements. The banks are, however, aware of the grim situation and are trying their level best to reduce the NPAs ever since the regulatory authorities i.e., Reserve Bank of India and the Government of India are seriously chasing up the issue. Banks are exposed to credit risk, liquidity risk, interest risk, market risk, operational risk and management/ownership risk. It is the credit risk which stands out as the most dreaded one. Though often associated with lending, credit risk arises whenever a party enters into an obligation to make payment or deliver value to the bank. The nature and extent of credit risk, therefore, depend on the quality of loan assets and soundness of investments. Based on the income, expenditure, net interest income, NPAs and capital adequacy one can comment on the profitability and the long run sustenance of the bank. Further, a comparative study on the performance of various banks can be done using a ratio analysis of these parameters. There are a number of ratios that can be used to comment on the different aspects :
The essential ratios that can be used for assessing the banks' profitability and sustenance are
Profitability
Intermediation Costs/Total Assets
Assets
Net Interest Income/Total Assets
Other Income/Total Assets
Asset Quality
NPAs/Total Assets
NPAs/Advances
Staff Productivity
Net Profit/ Total Number of Employee
Sustenance
Capital/RWAs
For commenting on the Bank's performance, a comparison to the total assets of the bank will give a true picture.
Controlled Expenses
The intermediation costs of a bank refer to the operating cost of the bank and include all the administration and operational costs incurred while offering its services. The ratio of the intermediation costs of the bank to the total assets should be kept low to ensure greater profitability. As mentioned earlier, a technology savvy bank will always be in a better position to reduce its operating costs. Consider the operating expenses of the various banking sectors and the industry average for the year 1999-2000. The costs for the entire SCBs rose by 9.1 percent. The maximum rise of 25.1 percent has been witnessed in the new private sector banks while the foreign banks experienced a decline in the operating costs by 3.3 percent. The ratio of the intermediation costs to the total assets indicates a decline. The maximum decline was in the case of new private sector banks and the foreign banks.
Margins - Lowered by Subdued Interest Rates
The ratio of the net interest income (Spread) to the total assets gives the net interest margin of the bank. This ratio is the actual measure of the bank's performance as an intermediary, as it examines the bank's 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. Hence banks need to be cautious and should not accept risks beyond their ability to control/manage them. Product innovation using the right technology is one approach, which can be followed by the banks to mobilize cheaper funds.
Asset Quality - NPA burden lowering
The asset quality of the banks can be examined by considering the NPAs. These NPAs should be considered against not just total assets but also against the advances, cause the NPAs primarily arise. When NPAs arise, banks have to make provision for the same as per the regulatory prescriptions. When the provisions are adjusted against the Gross NPAs it gives rise to the net NPAs. Provisions reduce the risk exposure arising due to the NPAs to a reasonable extent as they ensure that the banks sustain the possible loss arising from these assets.
Capital Adequacy Ratio-Strengthening Further
The one important parameter that essentially relates to the bank's ability to sustain the losses due to risk exposures is the bank's capital. The intermediation activity exposes the bank to a variety of risks. Cases of big banks collapsing due to their bank's inability to sustain the risk exposures is readily available. Considering this, it is highly essential to examine the capital vis-à-vis the risk weighted assets. This is the Capital to Risk Weighted Assets Ratio (CRAR) as given by the Basle Committee. The statutory prescription for CRAR is 9 percent, which has been well surpassed by most banks.
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