AN ANALYSIS OF INDUSTRIAL AND COMMERCIAL BANKS AND ITS PROFITABILITY: TANISHA MISHRA

 

Introduction

Banks are like any other business, which earn profit by lending money. Although, the rate of interest, charges and other terms and conditions may vary, primarily all banks earn a margin of profit by charging higher rate of interests than the cost of money they borrow. Taking deposits and lending out as loans in itself is a big business in the banking industry. The interests that the banks collect on loans is more than the interest they pay to customers with Saving accounts etc. and the difference is the profit for the banks.

Different ways in which banks earn profit

·       Major assets for banks are providing loans to individuals and businesses, whereas major liabilities would be deposits and money it borrows either from other banks or by selling commercial paper in the money market. Profits can be measured as a return on assets and return on equity. Due to leverage, banks earn a much larger return on equity than they do on assets.[1]

·       To make loans and to buy securities, a bank must have money, which comes from the bank’s owners in the form of bank capital, from depositors and from money that it borrows from other banks or by selling debt securities. However, not all assets can be used to earn income, because banks must have enough cash balance to satisfy cash withdrawal requests if customers approach. Thus money inside ATMs and cash in hand with the banks earn no interest.

·       Return on equity is what the banks’ owners are primarily interested in, because that is the return that they earn on their investments and which depends not only on the return of assets but also on the total value of the assets that earn income. However, to purchase more assets, a bank needs to pay for it either with more liabilities or with bank capital. Therefore, if the owners want to earn a greater return, they would rather use liabilities rather than their own capital because this greatly increases their return.[2]

·       Since banks compete with each other for depositors and deposits compete with each other for investments, bankers must pay minimum market rate to attract depositors.  Banks can only charge so much for loans since there is competition from other banks.

·       Banks also earn by charging fees on certain services made available to customers, which is known as maintenance fees. Those are charging for changing accounts, credit cards etc.

·       Banks charge on overdrafts and impose other penalties as well.

·       They charge INR 300-500 for issuing a new ATM Card.[3]

·       They collect commissions for making trades.

·       When a customer applies for a loan, banks charge a percentage of the loan with different heads like processing charges, application charges etc.

·       Credit card lending by some major banks is another lucrative business to make money. Rates charged for default on credit payment, interchange fee charged to merchants for accepting the card and entering into transaction, currency exchange, over the limit fees, fees for the card user and interest rates on the balances that the credit card users carry from one month to next.[4]

·       Banks can make money by lending assets to other banks in the interbank market. As money flows in and out, banks will both lend and borrow money on the interbank market as needs require.

·       Investment banks earn huge fees for advising large companies and public invitations on issuing bonds & shares and from underwriting these issues. They also charge for advising clients, wanting to bid for other companies in Merger and Acquisition or management buy outs.[5]

·       Banks buy and sell currencies of all the nations of the world, trying to take advantage of different prices of these currencies against each other, which are charging all the time.

Banks and Covid19

India’s economy recovery from Covid19 crises could be delayed if banks stop lending to borrowers with low credit scores or charge them a much higher interest on loans. In the words of Sanjeev Prasad, Kotak Institutional Equities “bad loans are going to increase and the longer the lockdown, the more prolonged the economic recovery, the more it will be the increase in bad loans”[6]

When RBI of India told banks to clean up their balance sheets around three years ago, NPAs surged among state lenders. The Central Bank had already anticipated an increase in bad debts between September 2019 and September 2020, before Covid19. With the already existing NPAs, banks have a lot in their plates right now.

The Central Bank has stepped up efforts to inject more cash into the market, lower the cost of capital and provide bigger incentives for banks to lend. That includes cheaper financing options for banks to borrow from the RBI and lend to non-bank financial institution and microfinance lenders. However, it has received a lukewarm response.

Conclusion

It cannot be denied that banks are facing the brunt of Covid19, like any other sector. Covid19 has impacted everyone and banks have a responsibility to lend more at lower interest rates. Also, profits earned by banks will be highly affected due to the rise in NPAs. There is hope for banks as in the great recession of 2007-2009, banks earned profits by using too much leverage.[7]  Following the words of Mr. Prasad from Kotak, “some portion of the incremental credit cost will have to be taken by the Government.” And together can we all move on from the disaster that is this pandemic.

 

 

 

 

 

 

 

 

 

 

 

 

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[1] William C. Spaulding, Bank Profitability, THIS MATTER ( 25 Aug, 2020, 10:20 AM), https://thismatter-com.cdn.ampproject.org/v/s/thismatter.com/money/banking/bank-profits.amp.htm?amp_js_v=a2&amp_gsa=1&usqp=mq331AQFKAGwASA%3D#aoh=15985404373118&referrer=https%3A%2F%2Fwww.google.com&amp_tf=From%20%251%24s&ampshare=https%3A%2F%2Fthismatter.com%2Fmoney%2Fbanking%2Fbank-profits.htm.

[2] Supra note 1.

[3] Sankarsh Chanda, How Banks Make Money off You, SAVART (26 Aug, 2020, 3:30 PM), https://savart.in/blog/how-banks-make-money/.

[4] Ibid.

[5] How Banks Earn their Money, RISKS AND REWARDS (27 Aug, 2020, 11:40AM), http://www.risksandrewards.org.uk/background_banks_151.html. 

[6] Saheli Roy Choudhury, Coronavirus lockdown could set back India’s economic recovery as banks worry about bad loans, CNBC ( 27 Aug, 2020, 2:30 PM), https://www-cnbc-com.cdn.ampproject.org/v/s/www.cnbc.com/amp/2020/05/05/coronavirus-locdown-india-banks-face-rising-levels-of-bad-debt loans.html?amp_js_v=a2&amp_gsa=1&usqp=mq331AQFKAGwASA%3D#aoh=15986368064212&referrer=https%3A%2F%2Fwww.google.com&amp_tf=From%20%251%24s&ampshare=https%3A%2F%2Fwww.cnbc.com%2F2020%2F05%2F05%2Fcoronavirus-locdown-india-banks-face-rising-levels-of-bad-debt-loans.html.

[7] Supra note 1.