Page 81 - DMGT303_BANKING_AND_INSURANCE

Banking and Insurance

Notes 4.8 Factors Contributing to Sharp Decline in Profitability

As stated earlier, profitability is an important index of the performance of an organization. An
analysis of the profitability of a bank provides a close insight into its effectiveness in utilisation
of funds and its managerial efficiency. But Indian banks have seen sharp decline in profitability
during last years.
The factors contributing to this sharp decline in the profitability of the nationalised banks may
be classified in two broad groups:

1. Factors Contributing to a Decline in the Level of Earnings: Among various factors that
contributed to decline in level of earnings of the nationalised banks, monetary and credit
policies of RBI increased lending to priority and preferred sectors, mounting overdue and
incidence of sickness have been the major ones.
(i) Liquidity Policies and Credit Policies of RBI
(ii) Increased Lending to Priority and Preferred Sectors

(iii) Mounting and Overdue repayments of loans advanced
(iv) Increased incidence of industrial sickness.
2. Factors Contributing to Rise in Operational Costs: Among the various factors that
contributed to rise in cost of operations of the nationalised banks are:
(i) Changes in deposit mix (shift from current accounts to saving deposits) leads to
increased interest burden on banks

(ii) Rapid expansions of branch Network in rural areas has landed the nationalised
banks in considerable loss
(iii) Rise in establishment cost i.e., heavy expenditure on acquiring sites for building,
furnishing, salaries etc. especially in urban/metropolitan areas where there is intense
fierce competition among the banks.
In addition to the above, unwise management of funds and investment portfolio, lack of proper
costing of services, absence of appropriate systems and procedures lead to increasing bad and
doubtful debts and thereby more legal expenses. This ultimately results in losses of revenue and
increasing expenditure.

4.9 Measures Suggested to Improve Profitability of the Banks

The foregoing analysis of profitability and performance of the nationalised banks reveals that
our banks are operating today on a thin margin, which is progressively getting thinner. They
are not healthy, viable and profitable. Several factors - exogenous and endogenous - have been
responsible for the current terrible conditions.
This tendency has to be attacked without loss of time so as to save the giant financial structure
from becoming a national liability and facilitate it to serve the national objectives and priorities
efficiently. Both macro and micro level efforts will have to be made to render the banking
industry workable and profitable. A brief discussion of each of these efforts is presented below:
At the macro level,
1. The RBI should lower down the cash reserve ratio and statutory liquidity ratio so as to
increase the lendable funds of the nationalised banks and improve their profitability.

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