Impact of Non-Core Income on the Profitability of Banks in India: An Econometric Analysis

Transcription

1 Volume 119 No , ISSN: (on-line version) url: ijpam.eu Impact of Non-Core Income on the Profitability of Banks in India: An Econometric Analysis 1 Dileep G. Menon and 2 Srividhya G. Pillai 1 Department of Management, Amritapuri Campus, Amrita Vishwa Vidyapeetham, Kollam, Kerala, India. dileepgmenon@gmail.com 2 Department of Management, Amritapuri Campus, Amrita Vishwa Vidyapeetham, Kollam, Kerala, India. srividhyapillai95@gmail.com Abstract Banks, in their role as intermediaries, are engaged in the core business activity of accepting deposits for the purpose of lending. In India, according to the standards by the Reserve Bank of India, there has to be a least possible capital adequacy ratio i.e., 9%. A bank s financial strength is measured using its capital and assets. Income through lending will result in higher NPA s which in turn needs higher capital adequacy ratio. Regulators demand banks to maintain high capital adequacy ratio. Since banks find difficult to maintain higher capital adequacy ratio, they are diversifying their business to new revenue-generating products. Over the time, third-party products business has become a prominent source of non-core income for banks. The global financial crisis has impacted the profitability and revenues of business across the world. The causes of this crisis were experienced in the various aspects of the functioning of the financial system. Insurance is one of the major thirdparty product which helps the banks to increase their revenue without a requirement for any additional capital. For insurance sector, Bancassurance channel is one of the most revenue making distribution channel. The collaboration of banks and insurance companies reduces the business risks and achieves better profitability and other collective benefits for banks and insurance companies. We consider this increasing importance of non-core income in the banking sector as financialization. This is in accord anc 2559

2 the definition suggested by (Epstein, 2005) who said: financialization is a pattern of revenue generation in which income accrues majorly from financial products. T o estab lish th is w fourteen banks for the period We use commission from insurance business to establish financialization in the banking industry. For this, we use variables like the Return on assets, Capital adequacy ratio and Return on equity for further analysis. Herein results reveal that commission from sale on insurance is the significant factor and that it has higher relation to the net profit. Ownership also has an impact which shows that increase in profitability due to the commission from sale of insurance varies according to public and private banks. Key Words: Bancassurance, Non-core income, Bank Profitability, Bank Efficiency, Financialization. 2560

3 1. Introduction The recession during December 2007 has impacted the profitability and revenues of businesses across the world. Indian banks were able to withstand and proved among one of the soundest financial institutes around the globe. There had also been instances in regard to the enactment of the various banking institutes owing to the extensive performance differences. Bancassurance is the term which is used to explain the relation between a bank and an insurance company wherein the insurance company uses banks as a distribution channel to sell insurance products. The banks act as a mediator to the insurance companies which help them in increasing their market share and also help in achieving targeted customers. Both banks and insurance company benefit from Bancassurance business model. Banks get benefit by earning commission on selling insurance products along with existing services using their existing staffs. Insurance companies get the benefit by attaining right of entry for novel customers by aid from this distribution channel that in turn surges their income exceptionally. Insurance has always been a big business in the developed markets. However, it has gained popularity in India after Today, in across many countries around the world, Bancassurance business has created a significant impact and has played a major role in banking operations. Banks are now creating more income as commission from sale of insurance through this business model. For an efficient distribution channel, many countries are using Bancassurance business model. Development in the financial market has prompted competition in the industry and this has stimulated aggressive banking practices. Bancassurance increases the economies of scale. When we look towards global perspective, there are countries who do not involve much into Bancassurance business. In the US, the level of Bancassurance activity is very low due to the regulatory compliances which lead to separation between banks and insurance providers. BNP Paribas, ING have the highest share in the global market. The main aim of the study is to investigate the effect of Bancassurance business model on bank s performance. The study is to test the efficiency and the profitability of the banks when they are involved in the Bancassurance business using the actual data on commission from sale of insurance. Various studies have analyzed other forms like joint ventures and alliances between banks and other firms. Previous studies have also observed the consolidation between various insurance and banks in the financial sector. Some related studies have also stated that Bancassurance business benefits to insurers. They get the advantage of lower costs through this business. The effect of Bancassurance the enactment of the banks was unknown in the 2561

4 earlier studies due to the lack of data. This paper aims to fill this gap. Study on the impact of Bancassurance on the performance of banks is done using the dataset from Results reveal that when banks involve more into the Bancassurance business they generate more revenue and also improve overall performance. It is found that performance of the banks improves when they earn commission from different sources i.e. when they opt to operate with various insurance partners. 2. Literature Review A profitable banking sector can endure adverse shudders and at the same time contribute towards the steadiness of the financial system. Subsequently, after 1991, nation beheld a change in its economy that was revealed in the banking system too. The liberalization of the banking industry was instigated by the Narasimham committee that paved the way for the new and private sector banks (Y V Reddy, 2005). Since 1990 s the scale of banking institution activities are increasing, the banking sector began to determine the condition of the global economy. In 1992, RBI introduced reforms in the banking sector that aimed at creating more profitable and efficient banking system. In India, the regulatory body RBI has demanded banks to maintain 9% capital adequacy ratio. Banks have increased profits by shifting from conventional banking functions to fee-based income generating activities like mutual fund distribution, mortgage banking, insurance brokerage and other transaction services. Insolvency risk will reduce if more products, either interest income generating or non-interest income generating are added to the portfolio. Studies state that banks with higher trading expertise often increase their investments in securities the crisis (Sanya & Wolfe, 2011). India has grown tremendously according to the banking industry. Examples like insurance and mutual funds have diversified themselves into a large area of operations. A descriptive research design is used in this study. According to the author, customers now look for multichannel sales and services from the banks which in turn force the banks for a major balanced approach their third-party products.(joy, 2015) The main reason behind the Bancassurance partnerships in India has been the fact that the banks and insurance both tend to lose nothing. In European Countries, the development of Bancassurance has added to the complete effectiveness, intensification in economies of scope and an upsurge in cooperation of banks and insurance companies(chen & Tan, 2011). Banks are not permitted to be brokers since the parameter binds them to be engaged utterly to the insurance broking and also RBI is against the bank to allow 2562

5 them to promote insurance broking outfits distinctly. MNC are henceforth not liable to endorse broking holdingsw.r.t the Foreign Direct Investment cap of 26% which hinders the bank from becoming brokers. Banks are entitled and could also perform as corporate agents provided the case for only one life insurance company and one non-life insurance company exclusively for a warrant according to the present controlling agenda set up by Insurance regulatory and development authority of India. So this rules out the possibility for the bank to gain payout and enables from commission only. Banks are answerable to both the customer and the principal insurer as mandated and prearranged in the code of conduct (Pani & Swain, 2013). If we look at the global perspective, countries like Brazil, Spain, France, Italy has the highest market share in Bancassurance business. Compare to other countries only European countries are doing better. There are countries which show strong growth in the Bancassurance business while there are also some countries which show limited growth. The growth of a bank might decline if the claim for normal banking products is inadequate. It might be economic to consume fixed capacity resources for new bank products(peng, Jeng, Wang, & Chen, 2017). Referral model, Deposit-linked Insurance Schemes, and corporate agency model are the three different Bancassurance model. The model followed in India is corporate agency model where banks involvement is maximum. In India, the regulatory body IRDA has allowed banks for sale of insurance products as corporate agents. In this model, banks are allowed to tie up with only one insurance company to sell insurance products. Banks sell both life and non-life insurance as well (Fan & Cheng, 2011; Purohit, 2016). Prior studies have concentrated only on profitability analysis. This study analyzes shift of profit from one source to another. 3. Data and Methodology Here for this study, we have taken into account the bank activities for a decade i.e., from 2007 to The data sources are secondary and have been collected from the annual reports of the respective banks. The methodology we have applied in here is by computing the magnitude of Bancassurance engrossment (Banc) with the following formula. It is noteworthy as non-interest income comprises of the service charges along with the trading revenue and also all sort of non-interest income such as fiduciary income. When the value gained is higher for the Banc or Bancnon, it is clear that the involvement of bank is more towards the bancassurance business with the insurance companies. 2563

6 Herein the profitability measure comprises of the ROE that could be termed as Return on Equity i.e., net income over total equity and the ROA could be termed as Return on Assets i.e., net income over total assets. Return on assets commonly denoted as ROE is a pointer of how gainful a firm is in comparison to its complete assets. Return on assets gives a number of insights to numerous people at various designations be it a manager, an analyst, or an investor in regard to impression about how well-organized a company's management is overriding its assets to generate earnings. Return on equity commonly denoted as ROE is the expanse of net income which is reverted as a part of the shareholder's equity. Return on equity processes a firm's viability by enlightening to a quantifiable unit of turnover that a company produces the shareholders capital. Control Variable is an experimental element that is constant and its value doesn t change also known as the dummy variable. Here in this scenario, we have opted for Ownership and the year (2007 to 2017) as the dummy variable. Ownership is used as an indicator to understand the nature of the nationalized and private bank institutions. Net interest income can be defined as the variance amid the revenue that is generated within a bank's assets and the expenditures related to clearing the liabilities. The distinctive assets of a bank contain of all schemes of loans which include securities, mortgages, personal loans and commercial loans. The net interest income could be understood as surplus revenue that is formed from the earned interest through the assets to the paid interest on the deposits. While comparing banks, certain bank s net interest income is fluctuating in nature. It can differ due to a number of factors, such as the nature of assets and liabilities. When comparing banks with higher variable rate assets and liabilities with fixed assets and liabilities, it is noted that banks with variable rates are more prone to fluctuations in interest rates of assets and liabilities. Those banks that undergo frequent repricing on assets are to be affected more in contrast by the interest rate charges. The NPA i.e., Non-Performing Asset talk about cataloguing for the lending the amount that is imbibed on the financial institution's pages in the book that are in evasion or are in arrears on the listed payments of principal or interest. Most of the time, debt is categorized as nonperforming when loan payments are due i.e. for quantifiable terms quoted and prescribed as 90 days. If one fails to pay out the debt within those 90 days which is considered as the normal slot then the asset is regarded and classified as nonperforming. The time period may be a varying contingent and might change for each loan as per specification and clause that it comes with. The disturbed or yet to be settled amount as per the loan accounts in the bank 2564

7 books along with other sources excluding interest which has already been verified but not deducted is termed as the Gross Non-Performing Asset commonly known by the short form i.e., Gross NPA. 4. Analysis The globalization of operations and advancement of new technology opened up various sources of income for the banking sector. In this aspect, we examine if there has been a shift in income generation by commercial banks in India from the core interest income to other avenues. There has been a lot of studies done on understanding and analyzing the profitability of banks. Here an attempt is made to understand a shift of profit from one source to another. During the data analyses some of the data has been coded; which include Year, ownership of bank as Private and Nationalized. These are dummy variables. From the regression table, it is quite evident that ROA, Commission on sale of insurance and ownership are statistically significant and other factors like the ROE and Capital Adequacy ratio are statically insignificant. Since the study has taken the confidence interval as 95%, the significant value should be less than.05.also, analyzing the dependency of years, the regression shows a positive effect on Net profit but the sigma value is greater than.05 for all the years and thus we can t consider year as a significant variable. The beta value for Commission on sale of insurance is On a conclusive note, we can infer that Commission on sale of insurance is the most noteworthy determining factor which is to be opted for. The NPA is having a negative relation with Net profit. When there is rise in Net NPA the Net profit decreases. Net NPA has a strong negative effect on Net profit. Looking into the ownership of banks, both Nationalized and Private banks share 2565

8 positive and close value of.003 and.005. They do have slight impact on the dependent variable Net Profit. 5. Conclusion Our research is focused on analyzing the impact of bancassurance on banks profitability and efficiency of fourteen banks of India for the period from through which our aim was to understand the shift of profit from one source to another. Comparatively private banks are generating more non-core income than public sector banks. Furthermore, the contribution in bancassurance business has considerably optimistic effects on the increasing performance and higher profitability as testified by the returns. The outcomes display that there exists positive correlation amid bancassurance and ROA than ROE, capital adequacy which in turn points that banks with the superior association in bancassurance have a better profitability than the other banks. References [1] Chen, Z., & Tan, J. (2011). Does bancassurance add value for banks? - Evidence from mergers and acquisitions between European banks and insurance companies. Research [2] Epstein, G. (2005). Introduction: Financialization and the World Economy. Financialization and the World Economy, [3] Fan, C. K., & Cheng, C. L. (2011). An examination of key factors influencing bancassurance success - Taiwan and mainland China evidence. Service Industries Journal, 31(11), [4] Joy, J. (2015). Third Party Products by banks Challenges & Prospects in Insurance and Mutual funds. International Journal of Commerce, Business and Management, 4(5), [5] Pani, L. K., & Swain, S. (2013). Bancassurance and Indian Banks. Journal of Business and Management, 2(3), [6] Peng, J. L., Jeng, V., Wang, J. L., & Chen, Y. C. (2017). The impact of bancassurance on efficiency and profitability of banks: Evidence from the banking industry in Taiwan. Journal of Banking and Finance, 80, [7] Purohit, S. (2016). Bancassurance as a Catalyst for Growth of Insurance in India. Journal of the Insurance Institute of India, (March), [8] Sanya, S., & Wolfe, S. (2011). Can Banks in Emerging Economies Benefit from Revenue Diversification? Journal of Financial Services Research, 40(1), [9] Y V Reddy. (2005). Banking sector reforms in India - an overview. Central Bank Articles and Speeches, BIS Review, (May). 2566

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