Functions of Banks in an Economy

Functions of Banks in an Economy

Functions Performed by Banks Link the fund-deficit organizations with fund-surplus organizations. Mobilize deposits from public and provide financial assistance to business. Reduce market imperfections. Evaluation and analysis of risks of business entities and provide the needed tools for risk reduction. Credit creation to meet surplus fund requirement. Provide upfront finance to meet business commitments.

Factors Necessitating Banker s Role in the Economy Maturity preference differentials. Risk preference differentials. Denomination preference differentials. Existence of information and search cost. Existence of transaction and contracting cost.

Unique Nature of Banking Sector Low proportion of fixed assets. Dominant financial assets. Liabilities constitute larger percentage of assets. Most of the liabilities are short-term. Returns are interest components and expenses are also interest components. Indian banks have a unique characteristic of large Non Performing Assets (NPA)!.

Balance sheet of a Hypothetical Bank Liabilities Assets 1) Share Capital 500 1) Reserves with Central Bank and Cash in hand 1200 2) Reserve Fund 1000 2) Call Money 1500 3) Saving (Demand) Deposits 4) Fixed (Time) Deposits 3500 3) Bills Discounted 4300 4000 4) Investments, Loans and Advances 2200 5) Borrowing from other banks 1000 5) Premises, Property etc. 800 Total 10,000 Total 10,000

Balance Sheet As At 31st March, Current Year (Amount in 000 s) As at 31-03 Current year As at 31-03 Previous year I. CAPITAL AND LIABILITIES Capital 52,59,146 52,59,146 Reserves & Surplus 12,96,90,067 10,06,34,764 Deposits 1,89,70,84,797 1,50,01,19,812 Borrowings 9,48,69,763 7,17,24,490 Other Liabilities and Provisions 12,81,13,898 11,05,61,565 TOTAL 2,25,50,17,671 1,78,82,99,777 II. ASSETS Cash and Balances with Reserve Bank of India 8,91,52,845 11,74,18,505 Balances with Banks and Money at Call and Short Notice 12,84,59,711 5,97,55,389 Investments 52,60,71,791 41,80,28,767 Advances 1,42,90,93,738 1,13,47,63,264 Fixed Assets 2,53,19,347 2,42,60,671 Other Assets 5,69,20,239 3,40,73,181 TOTAL 2,25,50,17,671 1,78,82,99,777

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH (Amount in 000 s) For the Year ended 31-03-Current year For the Year ended 31-03-Previous year I. INCOME Interest earned 16,34,73,579 12,35,52,212 Other income 3,05,18,627 2,11,69,261 TOTAL 19,39,92,206 14,47,21,473 II. EXPENDITURE Interest expended 10,84,84,531 8,12,59,517 Operating expenses 3,09,39,633 2,64,49,874 Provisions and Contingencies 2,44,94,579 1,69,18,056 TOTAL 16,39,18,743 12,46,27,447 III. PROFIT Net Profit for the year 3,00,73,463 2,00,94,026 Add: Profit brought forward 0 54,17,591 TOTAL 3,00,73,463 2,55,11,617 IV. APPROPRIATIONS Transfer to Statutory Reserve 80,00,000 70,00,000 Transfer to Revenue Reserve 99,74,714 1,50,96,101 Transfer to Capital Reserve 56,92,579 4,28,209 Transfer (from) / to Special Reserve - Currency Swap -9,261 29,594 Interim Dividend (includeing dividend tax) 18,43,287 0 Final Dividend (including dividend tax) 30,72,144 24,57,713 Special Reserve (u/s Sec 36(1) (viii) of Income Tax Act, 1961 15,00,000 5,00,000 Balance in Profit and Loss Account 0 0 TOTAL 3,00,73,463 2,55,11,617 Earnings Per Share (Rs.) 57 41

Business of Scheduled Banks in India All Scheduled Banks Mar-Previous Mar-Current No. of Reporting Banks 235 232 I. Liabilities to the banking system 104418 105730 (a) Demand and time deposits from banks 53134 67371 (b) Borrowings from banks 29504 32376 (c) Other demand and time liabilities 21780 5983 II. Liabilities to others in India 4379668 5076365 (a) Aggregate deposits 3952604 4635224 (i) Demand deposits 534791 660446 (ii) Time Deposits 3417813 3974778 (b) Borrowings (other than from RBI, NABARD,EXIM Bank) 115355 106191 (c) Other demand and time liabilities 311709 334950 III. Assets with the banking system 147546 166946 Money at call and short notice 26295 33135 IV. Cash in Hand & Balances with RBI 265699 316120 V. Investment in India 1205545 1437770 (a) Government securities 1193456 1428470 (b) Other approved securities 12089 9300 VI Bank Credit 2859553 3337659 (a) Loans cash credit and overdrafts 2757577 3212899 (b) Inland bills purchased 12470 12685 (c) Inland bills discounted 43987 63322 (d) Foreign bills purchased 18651 16205 (e) Foreign bills discounted 26868 32548 Reference: http://www.rbi.org.in/scripts/publications.aspx?publication=annual

Deposits with Scheduled Banks Current Deposits Savings Deposits Term Deposits Total Previous Current Previous Current Previous Current Previous Current I. Government Sector 66281 85512 62861 85932 318663 393715 447805 565158 II. Private Corporate Sector 111357 133627 3487 3317 317365 449746 432209 586690 III. Financial Sector 73223 44293 4041 7732 265648 305942 342912 357968 IV. Household Sector 183013 212673 670895 785931 1074109 1E+06 1928017 2E+06 V. Foreign Sector 15355 10394 44479 56666 107865 107622 167699 17468 Reference: http://www.rbi.org.in/scripts/publicationsview.aspx?id=13877

Composition of Deposits Current Deposits

Composition of Deposits Savings Deposits

Composition of Deposits Term Deposits

Bank Credit of Scheduled Banks Sector Amount Mining & Quarrying (including Coal) 18084 Food Processing 65677 Beverage & Tobacco 10969 Textiles 121374 Leather & Leather Products 6232 Wood & Wood Products 4371 Paper & Paper Products 19074 Petroleum, Coal Products & Nuclear Fuels 78579 Chemicals & Chemical Products 85713 Rubber, Plastic & their Products 15617 Glass & Glassware 4831 Cement & Cement Products 24722 Basic Metal & Metal Product 162929 All Engineering 73820 Vehicles, Vehicle Parts & Transport Equipment 38780 Gems & Jewellery 31751 Construction 44219 Infrastructure 379888 Industry Total 1311451 Reference: http://www.rbi.org.in/scripts/publicationsview.aspx?id=13879

Composition of Credit Deployment Credit Deployment

Market Function 3.5 Interest Income as a percentage of Non interest Income 3 2.5 2 1.5 1 2009 2010 0.5 0 SBI Nationalised banks Private banks Foreign banks Reference: http://www.rbi.org.in/scripts/publications.aspx?publication=annual

Intermediation Function Households and Corporate enterprises. Government and Corporate enterprises. Social enterprises and Government.

Credit Creation Credit creation refers to the process of creating new purchasing power out of deposits. Only the central bank and the commercial banking system have the power to create credit.

Credit Approach There is no net new economic activity without net new purchasing power. The net purchasing power is created by the central bank and the banking system. This process is called credit approach to net new economic activity. Economic term for this credit creation process is termed as liquidity. Monitoring credit creation provides the best possible way to forecast economic activity, the expected business cycle and trend in financial markets.

Broad Liquidity Aggregation of bank lending and central bank credit creation. Reference: http://www.rbi.org.in/scripts/annualreportmaindisplay.aspx

Private Liquidity Bank credit creation and credit creation in the private financial sector. Liquidity position as disclosed by Reserve Bank of India is given in the next slide.

Liquidity Position of Banks in India LAF (Liquidity Adjustment Facility) MSF (Marginal Standing Facility) Centre's Surplus Outstanding as on Total Previous Year April 35,720 2,737 28,868 9,589 May 6,215 317 7,531 999 June 74,795 317 76,431 1,953 July 1,775 0 16,688 18,463 August 11,815 0 20,054 31,869 September 30,250 0 65,477 35,227 October 1,17,660 0 86,459 31,201 November 1,03,090 0 93,425 9,665 December 1,13,415 0 1,44,437 31,022 Current Year January 76,730 0 1,18,371 41,641 February 72,005 0 77,397 5,392 March 1,06,005 0 16,416 89,589 April 39,605 0 35,399 75,004 May 75,795 0 9,544 85,339 June 96,205 0 8,339 87,866 July 48,555 0 25,983 74,538 August 49,215 0 21,192 70,407 September 82,645 0 24,387 1,07,032 October 54,270 0 32,883 87,153 Source: http://www.rbi.org.in/scripts/annualreportmaindisplay.aspx, accessed on August 28, 2011.

Use of Bank Liquidity Lead time of broad credit aggregates over the economic and equity market cycle: approximately 9 to 15 months, central lead-time 1 year. The credit or liquidity approach is recommended for strategic asset allocation decisions whose time horizon is sufficiently long.

Credit Creation A major source of bank profit is creation and supply of credit money. Transactions in credit money are much in excess of the original cash deposits that the bank receives. Banks create credit and liabilities much in excess of their cash holding. The banking business is therefore a risky activity.

Modus Operandi In their credit creation activity commercial banks go by the saving habits of their depositors. Every advance creates a deposit.

Ability of Banks to Create Credit Credit Creation by Banks Deposits Reserves Advances 01. 10,000 1,000 9,000 02. 9,000 900 8,100 03. 8,100 810 7,290 04. 7,290 729 6,561 05. 6,561 656 5,905 06. 5,905 591 5,314 07. 5,314 531 4,789 08. 4,789 478 4,305 09. 4,305 431 3,874 10. 3,874 387 3,486 ---- --- --- Final Total 1,00,000 10,000 90,000

Credit Creation in Practice Varies from 3 to 6 times of original deposits Convention Permission of the central bank General market conditions Demand for loans Alternative sources of issuing financial resources

Leakage in Credit Creation When the borrower of the loan immediately demands payment of it in cash. When depositors change their habits from investment to consumption. When the central bank reserve requirement is changed. When bankers emphasize safe business transactions to reduce their business risk.