EXECUTIVE SUMMARY

INTRODUCTION:
The term 'profit' is an accounting concept which shows
the excess of income over expenditure viewed during a
specified period of time. Profit is the main reason for
the continued existence of every commercial
organisation. On the other hand, the term profitability is
a relative measure where profit is expressed as a ratio,
generally as a percentage. Profitability depicts the
relationship of the absolute amount of profit with
various other factors. Profitability is the most important
and reliable indicator as it gives a broad indicator of the
ability of a bank to raise its income level. Profitability of
banks is affected by a number of factors. Some of these
are endogenous, some are exogenous. Changes in
policies made by RBI are exogenous to the system.
These include changes in monetary policy, changes in
quantitative credit control like changes in cash reserve
ratio, statutory liquidity ratio, manipulation of bank
rates, qualitative credit controls like selective credit
control measures, credit deposit ratio, region-wise
guidelines on lending to priority sector, changes in
interest rates on deposits and advances, levy of tax on
interest income etc. Various other factors like careful
control of expenditure, timely recovery of loans are
endogenous. In practice executives define profits in
banks as the difference between total earnings from
all earning assets and total expenditure on managing
entire asset liabilities portfolio. In case of banks, the
main source of income is interest earned and discount
on bills discounted. Since banks accept various types of
deposits from people so interest paid to customer is an
important expenditure of the banks. The difference

between interest earned and interest paid is known as

spread and is a good indicator of bank's efficiency.
Establishment expenses covering salaries, provident
fund, allowances, and bonus and so on, form another
important component of expenditure. Profit is the very
reason for the continued existence of every commercial
organisation. The rate of profitability and volume of
profits are therefore rightfully considered as indicators
of efficiency in the deployment of resources of banks.
The study makes a profitability correlation analysis by
taking certain dependent variables like the profitability
in the one hand and independent variables like Net
Interest income, interest income, interest expended,
operating expense, NPAs.
OBJECTIVES:
To find out impact of various variables on the
profitability of public sector banks.
To examine the variables having positive and
negative relationship with the profitability of the
banks.
SCOPE OF THE STUDY
Source of information collected from secondary
data
RESEARCH DESIGN:
Analytical in nature
Secondary data:
Books
websites
database at Indian Bank
library research

CHAPTER I

LITERATUR
E REVIEW

Dr. K. Sriharsha Reddy (March 2012) has explained

the nature of banking and the important role of banks
in the economy in capital formation, banks should be
more closely watched than any other type of economic
unit in the economy. The CAMEL supervisory system in
banking sector is a substantial improvement over the
earlier systems in terms of frequency, coverage and
focus. In the present study an attempt is made to
evaluate relative performance of banks in India using
CAMEL approach. It is found that public sector banks
have significantly improved indicating positive impact
of the reforms in liberalizing interest rates, rationalizing
directed credit and Investments and increasing
competition.
Kusum W. Ketkar (2011):- In his article, he has
explained to determine the impact of various market
and regulatory initiatives on efficiency improvements
and
profitability
of
Indian
banks
since
the
implementation of financial sector reforms following the
recommendations of the Narasimham Committee in
1992 and 1997. The reform process has shifted the
focus of public sector dominated banking system from
social banking to a more efficient and profit oriented
industry. While the reform process has resulted in the
private sector replacing the government as the source
of resources for public sector banks (PSBs), the infusion
of private equity capital has led to shareholders
challenges to bureaucratic decision making. PSBs also
face increasing competition not only from private and
foreign banks but also from growing nonbanking
financial intermediaries like mutual funds and other
capital market entities. The competitive pressures to

improve efficiency in the banking sector has resulted in

a switch from traditional paper based banking to
electronic banking, use information technology and
shift of emphasis from brick and mortar banking to use
of ATMs. For instance, by March of 2007, 86% of public
sector bank branches were fully computerized and
ATMs made up approximately 48% of total bank
branches in the country.
Sultan Singh (2001) made an attempt to assess the
impact of the reforms on the operational performance
and efficiency of the commercial banks in India. The
study revealed that total income, interest earned other
income, spread, total expenses, interest expended,
operating expenses and establishment expenses are
comparatively more consistent in the post-reform
period. T. T. Ram Mohan (2002, pp. 393-97) in his
paper documented and evaluated the performance of
the public, private and foreign banks since deregulation
in absolute and in relative terms. It was observed that
the efficiency of the banking system as a whole
measured by declining spreads has improved. G P.
Kapoor (2004, pp.58-131) in her book entitled
"Commercial Banking" analysed the performance of
banks from 1981-1982 to 1999-2000 and revealed that
the deposits, advances, total business.
Income,
expenditure, net interest margin, working funds,
branches and employees of the entire PSBs registered
lower rates of growth in the post-reform period as
compared to the pre-reform period.
P.K. Gupta & Ashima Jain( 2010) have explained
how the banks operate today in a more competitive
and complex environment, which provides them
opportunities to augment revenues quickly, but also
poses huge risks. Creation of new products and
aggressive
marketing
by
banks
has
led
to

unmanageable credit risk that arises of poor credit

assessment and follows up and also credit
concentration. Financing is predominantly viewed from
borrowers perspective and researches mainly focus on
credit spreads collateral, long-term structures and
commitments between borrowers and lenders over
time. We attempt to explore the factors that are
responsible for the origination of problem loans (Nonperforming Assets) from the financier perspective. We
focus on Indian Private Sector banks as a special case,
which is relatively unexplored. We model the factors
that are responsible for problem loans in the sample
banks and suggest the policy implications for the
central bank of the country-Reserve Bank of India (RBI).
Though we find support for some explanatory variables
like liquidity, interest margins, operating efficiency etc.
in line with the earlier researches, yet some explored
variables produced converse notions

CHAPTER II

Research

Methodolo
gy

The term profit is an accounting concept which shows

the excess of income over expenditure viewed during a
specified period of time. Profit is the main reason for
the continued existence of every commercial
organization. On the other hand, the term profitability is
a relative measure where profit is expressed as a ratio,
generally as a percentage. Profitability depicts the
relationship of the absolute amount of profit with
various other factors. Profitability is a relative concept
which is quite useful in decision-making. Another main
issue here is profit planning, which consists of various
steps to be taken to improve the profitability of the
bank.

Profit is the very reason for the continued existence of

every commercial organization. The rate of profitability
and volume of profits are therefore, rightfully
considered as indicators of efficiency in the deployment
of resources of banks. Profitability indicates earning
capacity of the banks. It highlights the managerial
competency of the banks. It also portrays work culture,
operating efficiency of the bank.
Profitability is the most important and reliable indicator
as it gives a broad indication of the ability of a bank to
raise its income level. Profitability of banks is affected
by a number of factors. Some of these are endogenous,
some are exogenous and yet structural. Changes in
policies made by RBI are exogenous to the system. This
includes changes in momentary policy, changes in
quantitative credit control like changes in CRR, SLR,
manipulation of bank rates, qualitative credit controls
like selective credit control measures, C/D ratio, region
wise guidelines on lending to priority sectors, changes
in interest rates on deposits and advances, levy of tax
on interest income etc. Various other factors like careful
control of expenditure, timely recovery of loans are
endogenous.
Various
structural
factors
include
geographical spread of bank branches, decentralization
in the management and structural changes in deposits
and advances. Banking structure and profitability
structure of banking system across countries have a
bearing on the profitability of banks. The profitability of
banks is affected one way or the other by these factors,
either individually or jointly. Bank profitability is causing
concern to all. After liberalisation, profitability has
regained its lost importance. Now efforts are being
directed to achieve the profitability targets. The
profitability of public sector banks has been indicating a
fast declining trend in the past and the situation in

future may not be different if all the concerned do not

take timely preventive measures before the situation
goes out of control. Since all the banks in the country
function under similar environments, the low
performance of any bank can be attributed to a larger
extent to their managerial inefficiency and structural
deficiency. Certain populist Central Government
disregarding the basic banking principles, coupled with
lethargic attitude of the management of nationalized
banks lead to
Inefficiency, in-competency and deceleration in
performance. The major reasons for this declining
profitability can be summarized as under:
1. Non-Performing advances leading to bad debts..
2. Legal Expenses to recovers the bad debts..
3. Cut Throat competition among banks to lure
deposits.
4. Narrowing Spread.
5. Branch Expansion on unviable consideration.
6. Ineffective organizational restructuring.
7. Lack of proper management of resources.
8. More concentration on deposit orientation than profit
orientation.
9. Increasing burden of administrative expenses.
10. Increasing establishment expenses.
11. Ineffective marketing strategies resulting in
reduction in market share.
12. No turn-over strategies.
13. Ineffective cost-oriented strategies.
14. Subsidized service charges like concession granted.
15. Ineffective environment scanning.
The problem of low profitability and designing
profitability has been historical to the banking system.
The banks are virtually suffering from scissors crisis,
with a declining rate of increase in earnings and rising
costs. The profitability analysis of commercial banks

used to be a frustrating experience as the financial

statements of banks concealed much and revealed
less. But now-a-days, after liberalization under pressure
from regulatory agencies and the public, the trend has
changed. So now the profitability analysis of
commercial banks means something. The financial
statements of commercial banks are now prepared
keeping in mind are the various changes, so they reveal
each and every aspect.
Profits have been, and are under tremendous pressure.
Declining trends in profits and profitability have
become a major cause of concern for all and in order to
ensure the survival and growth of this vital sector of
economy, it becomes essential to identify various
factors which have studiedly contributed towards the
decline in bank profitability so that corrective action
can be taken and future profitability is ensured.
The major factors that have a bearing on the financial
viability of the banks are:
1. Priority Sector Lending.
2. Credit Policies.
3. Massive Geographical Expansion.
4. Industrial Sickness.
5. Growing Competition.
6. Deposit Composition.
7. Increasing Establishment Expenses.
8. Low Income from Ancillary Business.
9. Spread and Burden Their Backward Linkages and
Movements.
10. Miscellaneous Factors (Like declining credit AND
mounting overdue).
The present trend of low and declining profitability can
be arrested and reversed if the remedial measures are
tried in right direction to ease the pressure on
profitability. The profit rates obtained by using sales or

value added as denominators will therefore give us a

short-term perspective of profitability. The return on
capital employed on investments or total assets or
fixed assets as variously defined, on the other hand will
give us long-term perspective of profitability.

Thus to undertake this study, the data of all the

Public sector Banks in India was collected
through basically secondary sources. After that
the data was organized and a thorough analysis
was done of the same and the statistical tool
used for the purpose was basically the
Correlation Analysis. The following pages contain
the analysis of the determinants of the
profitability of the banks.

CHAPTER III

Analysis
and
Interpretat
ion

Correlation Analysis becomes imperative to evaluate

the overall profits and profitability performance of
commercial banks. It clearly indicates the magnitude
and direction of operations over a period of time; it also
helps to identify certain banks in respect of their level
of efficiency in operations. It shows the trend pattern in
order to identify the historical development. The study
attempts to assess the profits and profitability of banks,
through correlation analysis of the following
parameters:1. Net Profit
2. Total Income
3. Total Expenditure
4. Spread
5.Operating expense
6.NPA
1.Net Profit:
Every business exists in order to earn profit. Without
profit no commercial activity can sustain for a long
period. Similarly, profit earning has become the main
motive of commercial banks operating in India. Profit
earning and timely growth in the profit earning is an
essential feature for the continued success of a bank.
On the basis of correlation and the following data
reveals that Net profit is the independent variables and
it also correlated to `
1.Total Income

2. Total Expenditure
3. Spread
4.Operating expense
5.NPA

Correlation between Net profit and the independent

variables.
Variables

2010

2011

2012

Interest
earned

0.0910434
51

0.2589190
02

0.0170974
91

Interest
expended

0.0132385
49

0.0189294
53

0.0275027
13

NII

0.6142417
48

0.0013330
62

0.0256355
3

NPAs

0.0988578
97

0.2988595
68

0.3131133
46

Operating
Expense

0.0511631
42

0.1880272
56

0.1661138
72

1.Total Income
Years
2010

Correlation of total
income & Net profit
0.091043451

2011

0.258919002

2012

0.017097491

The total income of a bank depends upon the interest

and discount earned, commission, exchange and
brokerage and the other miscellaneous receipts. The
correlation analysis reveals that the banks income is
positively related to the net profit which is good for the
overall performance for the PSUs. On the basis of
trends in total income of the 23 PSBs under study,
there is positive correlation, this means that when the
interest income is high the net profit will be high and
vice versa.
2.Total Expenditure
Year

Correlation of total
expenditure & Net profit

2010

-0.013238549

2011

-0.018929453

2012

-0.027502713

As far as the expenditure of public sector banks is

concerned, it is fixed to a large extent because these
banks cannot reduce labour force as the other
industries can do in order to minimize their expenditure
but in the recent years banks have taken some steps in
this respect. The main components of the bank
expenditure are interest on deposit, establishment
expenditure and other expenditure. On the basis of the
correlation analysis the total expenditure also
determine the effect on the net profit of the banks,
which is quite visible. There is negative correlation, this
means that when the interest expended is high the net
profit will be low and vice versa.

3.Spread (NII)
Years
2010

Correlation of Spread
and Net profit
0.614241748

2011

0.001333062

2012

0.02563553

Spread, which is the difference between the

earned on loans and advances and interest
deposits and borrowings by the banks. It is
amount available to banks for meeting the

interest
paid on
the net
various

expenses. To make an analysis of the profitability of

commercial banks, it is necessary to make a study of
exponential growth rate of trends. Higher the value
higher wills the profit. On the basis of correlation the
spread show the positive trend. It is quite good for
evaluating the bank performance.

4.NPAs
Years
2010

Correlation of NPAs &

Net profit
-0.098857897

2011

-0.298859568

2012

-0.313113346

Nonperforming assets are the asset which ceases to

generate income. NPA is a classification used by
financial institutions that refer to loans that are in
jeopardy of default. Once the borrower has failed to
make interest or principal payments for 90 days the
loan is considered to be a non-performing asset. Nonperforming assets are problematic for financial
institutions since they depend on interest payments for
income. Troublesome pressure from the economy can
lead to a sharp increase in non-performing loans and
often results in massive write-downs. On the basis of
correlation analysis more NPAs can affect the
profitability of the banks. So its always shows the
negative trends.

5.Operating Expenses
Year
2010

Correlation of operating
expense & Net profit
-0.051163142

2011

-0.188027256

2012

-0.166113872

Operating expenses arise during the ordinary course of

running a business. Operating expense consists of
salaries paid to employees, research and development
costs, legal fees, accountant fees, bank charges, office
supplies, electricity bills, business licenses, and more. A
category of expenditure that a business incurs as a
result of performing its normal business operations.
One of the typical responsibilities that management
must contend with is determining how low operating
expenses can be reduced without significantly affecting
the firm's ability to compete with its competitors. Under
this study there is negative correlation, this means that
when the operating expense are high the net profit will
be low and vice versa.

CONCLUSION
To conclude it can be said that evaluation of banks in
terms of profitability is very essential. In order to study
the trend in independent variables like operating
expenditure, NII, NPAs, interest expenditure and
interest income affect the profitability of the public
sector banks.

ANNEXURE
List of the Public Sector Banks studied:

REFERENCES
Narinder Kaur and Reetu Kapoor 2011,
Profitability Analysis of Public Sector Banks in
India, article Indian management studies.
Dr. K. Sriharsha Reddy (2012) ,Relative
performance of commercial banks in India using
CAMEL approach.
Kusum W. Ketkar (2010) Performance and
Profitability of Indian Banks in the Post
Liberalization Period.
www.moneycontrol.com
www.rbi.gov.in