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 LiabilitiesAssets 1)Share Capital 500 1)Reserves with Central Bank and Cash in hand )Reserve Fund )Call Money1500 3)Saving (Demand) Deposits )Bills Discounted )Fixed (Time) Deposits 40004)Investments, Loans and Advances )Borrowing from other banks 10005)Premises, Property etc.800 Total10,000Total10,000

Balance Sheet As At 31st March, Current Year (Amount in 000’s) As at Current year As at Previous year I. CAPITAL AND LIABILITIES Capital52,59,146 Reserves & Surplus12,96,90,06710,06,34,764 Deposits1,89,70,84,7971,50,01,19,812 Borrowings9,48,69,7637,17,24,490 Other Liabilities and Provisions12,81,13,89811,05,61,565 TOTAL2,25,50,17,6711,78,82,99,777 II. ASSETS Cash and Balances with Reserve Bank of India8,91,52,84511,74,18,505 Balances with Banks and Money at Call and Short Notice12,84,59,7115,97,55,389 Investments52,60,71,79141,80,28,767 Advances1,42,90,93,7381,13,47,63,264 Fixed Assets2,53,19,3472,42,60,671 Other Assets5,69,20,2393,40,73,181 TOTAL2,25,50,17,6711,78,82,99,777

PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31ST MARCH (Amount in 000‘s) For the Year ended Current yearFor the Year ended Previous year I. INCOME Interest earned16,34,73,57912,35,52,212 Other income3,05,18,6272,11,69,261 TOTAL19,39,92,20614,47,21,473 II. EXPENDITURE Interest expended10,84,84,5318,12,59,517 Operating expenses3,09,39,6332,64,49,874 Provisions and Contingencies2,44,94,5791,69,18,056 TOTAL16,39,18,74312,46,27,447 III. PROFIT Net Profit for the year3,00,73,4632,00,94,026 Add: Profit brought forward054,17,591 TOTAL3,00,73,4632,55,11,617 IV. APPROPRIATIONS Transfer to Statutory Reserve80,00,00070,00,000 Transfer to Revenue Reserve99,74,7141,50,96,101 Transfer to Capital Reserve56,92,5794,28,209 Transfer (from) / to Special Reserve - Currency Swap-9,26129,594 Interim Dividend (includeing dividend tax)18,43,2870 Final Dividend (including dividend tax)30,72,14424,57,713 Special Reserve (u/s Sec 36(1) (viii) of Income Tax Act, ,00,0005,00,000 Balance in Profit and Loss Account00 TOTAL3,00,73,4632,55,11,617 Earnings Per Share (Rs.)5741

Business of Scheduled Banks in India All Scheduled Banks Mar-PreviousMar-Current No. of Reporting Banks I. Liabilities to the banking system (a) Demand and time deposits from banks (b) Borrowings from banks (c) Other demand and time liabilities II. Liabilities to others in India (a) Aggregate deposits (i) Demand deposits (ii) Time Deposits (b) Borrowings (other than from RBI, NABARD,EXIM Bank) (c) Other demand and time liabilities III. Assets with the banking system Money at call and short notice IV. Cash in Hand & Balances with RBI V. Investment in India (a) Government securities (b) Other approved securities VI Bank Credit (a) Loans cash credit and overdrafts (b) Inland bills purchased (c) Inland bills discounted (d) Foreign bills purchased (e) Foreign bills discounted Reference:

Deposits with Scheduled Banks Current DepositsSavings DepositsTerm DepositsTotal PreviousCurrentPreviousCurrentPreviousCurrentPreviousCurrent I. Government Sector II. Private Corporate Sector III. Financial Sector IV. Household Sector E E+06 V. Foreign Sector Reference:

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) Food Processing Beverage & Tobacco Textiles Leather & Leather Products 6232 Wood & Wood Products 4371 Paper & Paper Products Petroleum, Coal Products & Nuclear Fuels Chemicals & Chemical Products Rubber, Plastic & their Products Glass & Glassware 4831 Cement & Cement Products Basic Metal & Metal Product All Engineering Vehicles, Vehicle Parts & Transport Equipment Gems & Jewellery Construction Infrastructure Industry Total Reference:

Composition of Credit Deployment Credit Deployment

Market Function Reference:

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:

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.

Outstanding as on LAF (Liquidity Adjustment Facility) MSF (Marginal Standing Facility) Centre's SurplusTotal Previous Year April35,7202,737-28,8689,589 May6, , June-74, ,4311,953 July1,775016,68818,463 August11,815020,05431,869 September-30,250065,47735,227 October-1,17,660086,459-31,201 November-1,03,090093,425-9,665 December-1,13,41501,44,43731,022 Current Year January-76,73001,18,37141,641 February-72,005077,3975,392 March-1,06,005016,416-89,589 April-39, ,399-75,004 May-75,7950-9,544-85,339 June-96,20508,339-87,866 July-48, ,983-74,538 August-49, ,192-70,407 September-82, ,387-1,07,032 October-54, ,883-87,153 Liquidity Position of Banks in India Source: 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.

Credit Creation by Banks DepositsReservesAdvances 01.10,0001,0009, , , , , , , , , , , , , , , , , , , Final Total 1,00,00010,00090,000 Ability of Banks to Create Credit

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.