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
3500 3)
Bills Discounted
4300
4) Fixed (Time)
Deposits
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
As at 31-03
As at 31-03
(Amount in 000’s)
Current year
Previous year
Capital
I. CAPITAL AND LIABILITIES
52,59,146
Reserves & Surplus
Deposits
Borrowings
Other Liabilities and Provisions
TOTAL
52,59,146
12,96,90,067
1,89,70,84,797
9,48,69,763
12,81,13,898
2,25,50,17,671
10,06,34,764
1,50,01,19,812
7,17,24,490
11,05,61,565
1,78,82,99,777
8,91,52,845
11,74,18,505
12,84,59,711
52,60,71,791
1,42,90,93,738
2,53,19,347
5,69,20,239
2,25,50,17,671
5,97,55,389
41,80,28,767
1,13,47,63,264
2,42,60,671
3,40,73,181
1,78,82,99,777
II. ASSETS
Cash and Balances with Reserve Bank of
India
Balances with Banks and Money at Call
and Short Notice
Investments
Advances
Fixed Assets
Other Assets
TOTAL
PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH
(Amount in 000‘s)
Interest earned
Other income
TOTAL
Interest expended
Operating expenses
Provisions and Contingencies
TOTAL
Net Profit for the year
Add: Profit brought forward
TOTAL
Transfer to Statutory Reserve
Transfer to Revenue Reserve
Transfer to Capital Reserve
Transfer (from) / to Special
Reserve - Currency Swap
Interim Dividend (includeing
dividend tax)
Final Dividend (including dividend
tax)
Special Reserve (u/s Sec 36(1)
(viii) of Income Tax Act, 1961
Balance in Profit and Loss
Account
TOTAL
Earnings Per Share (Rs.)
For the Year ended 31-03-Current year For the Year ended 31-03-Previous year
I. INCOME
16,34,73,579
12,35,52,212
3,05,18,627
2,11,69,261
19,39,92,206
14,47,21,473
II. EXPENDITURE
10,84,84,531
8,12,59,517
3,09,39,633
2,64,49,874
2,44,94,579
1,69,18,056
16,39,18,743
12,46,27,447
III. PROFIT
3,00,73,463
2,00,94,026
0
54,17,591
3,00,73,463
2,55,11,617
IV. APPROPRIATIONS
80,00,000
99,74,714
56,92,579
70,00,000
1,50,96,101
4,28,209
-9,261
29,594
18,43,287
0
30,72,144
24,57,713
15,00,000
5,00,000
0
3,00,73,463
57
0
2,55,11,617
41
Business of Scheduled Banks in India
All Scheduled Banks
Mar-Previous
235
Mar-Current
232
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
534791
660446
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
26295
33135
265699
316120
V. Investment in India
1205545
1437770
(a) Government securities
1193456
1428470
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
No. of Reporting Banks
I. Liabilities to the banking system
(i) Demand deposits
(ii) Time Deposits
Money at call and short notice
IV. Cash in Hand & Balances with RBI
(b) Other approved securities
Reference: http://www.rbi.org.in/scripts/publications.aspx?publication=Annual
Deposits with Scheduled Banks
Current Deposits
I. Government
Sector
II. Private
Corporate Sector
III. Financial Sector
IV. Household
Sector
V. Foreign Sector
Savings Deposits
Term Deposits
Total
Previous
Current
Previous
Current
Previous
Current
Previous
Current
66281
85512
62861
85932
318663
393715
447805
565158
111357
133627
3487
3317
317365
449746
432209
586690
73223
44293
4041
7732
265648
305942
342912
357968
183013
212673
670895
785931
1074109
1E+06
1928017
2E+06
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
Mining & Quarrying (including Coal)
Food Processing
Beverage & Tobacco
Textiles
Leather & Leather Products
Wood & Wood Products
Paper & Paper Products
Petroleum, Coal Products & Nuclear Fuels
Chemicals & Chemical Products
Rubber, Plastic & their Products
Glass & Glassware
Cement & Cement Products
Basic Metal & Metal Product
All Engineering
Vehicles, Vehicle Parts & Transport Equipment
Gems & Jewellery
Construction
Infrastructure
Industry Total
Amount
18084
65677
10969
121374
6232
4371
19074
78579
85713
15617
4831
24722
162929
73820
38780
31751
44219
379888
1311451
Reference: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13879
Composition of Credit Deployment
Credit Deployment
Market Function
Interest Income as a percentage of Non-interest
Income
3.5
3
2.5
2
2009
1.5
2010
1
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
Outstanding as on
Previous Year
April
May
June
July
August
September
October
November
December
Current Year
January
February
March
April
May
June
July
August
September
October
LAF (Liquidity MSF (Marginal
Adjustment Standing
Centre's
Facility)
Facility)
Surplus
Total
35,720
6,215
-74,795
1,775
11,815
-30,250
-1,17,660
-1,03,090
-1,13,415
2,737
317
317
0
0
0
0
0
0
-28,868
-7,531
76,431
16,688
20,054
65,477
86,459
93,425
1,44,437
9,589
-999
1,953
18,463
31,869
35,227
-31,201
-9,665
31,022
-76,730
-72,005
-1,06,005
-39,605
-75,795
-96,205
-48,555
-49,215
-82,645
-54,270
0
0
0
0
0
0
0
0
0
0
1,18,371
77,397
16,416
-35,399
-9,544
8,339
-25,983
-21,192
-24,387
-32,883
41,641
5,392
-89,589
-75,004
-85,339
-87,866
-74,538
-70,407
-1,07,032
-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
01.
10,000
1,000
02.
9,000
900
03.
8,100
810
04.
7,290
729
05.
6,561
656
06.
5,905
591
07.
5,314
531
08.
4,789
478
09.
4,305
431
10.
3,874
387
Final Total
Advances
9,000
8,100
7,290
6,561
5,905
5,314
4,789
4,305
3,874
3,486
----
---
---
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.