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

(Amount in 000’s)As at 31-03 Current year

As at 31-03 Previous year

I. CAPITAL AND LIABILITIESCapital 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 1,78,82,99,777II. 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 yearI. INCOME

Interest earned 16,34,73,579 12,35,52,212Other income 3,05,18,627 2,11,69,261TOTAL 19,39,92,206 14,47,21,473

II. EXPENDITUREInterest expended 10,84,84,531 8,12,59,517Operating expenses 3,09,39,633 2,64,49,874

Provisions and Contingencies 2,44,94,579 1,69,18,056TOTAL 16,39,18,743 12,46,27,447

III. PROFITNet Profit for the year 3,00,73,463 2,00,94,026Add: Profit brought forward 0 54,17,591TOTAL 3,00,73,463 2,55,11,617

IV. APPROPRIATIONS

Transfer to Statutory Reserve 80,00,000 70,00,000Transfer to Revenue Reserve 99,74,714 1,50,96,101Transfer to Capital Reserve 56,92,579 4,28,209Transfer (from) / to Special Reserve - Currency Swap -9,261 29,594Interim Dividend (includeing dividend tax) 18,43,287 0Final Dividend (including dividend tax) 30,72,144 24,57,713Special Reserve (u/s Sec 36(1) (viii) of Income Tax Act, 1961 15,00,000 5,00,000Balance in Profit and Loss Account 0 0TOTAL 3,00,73,463 2,55,11,617Earnings Per Share (Rs.) 57 41

Business of Scheduled Banks in IndiaAll 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

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.

Outstanding as on

LAF (Liquidity Adjustment Facility)

MSF (Marginal Standing Facility)

Centre's Surplus Total

Previous Year        April 35,720 2,737 -28,868 9,589May 6,215 317 -7,531 -999June -74,795 317 76,431 1,953July 1,775 0 16,688 18,463August 11,815 0 20,054 31,869September -30,250 0 65,477 35,227October -1,17,660 0 86,459 -31,201November -1,03,090 0 93,425 -9,665December -1,13,415 0 1,44,437 31,022Current Year        January -76,730 0 1,18,371 41,641February -72,005 0 77,397 5,392March -1,06,005 0 16,416 -89,589April -39,605 0 -35,399 -75,004May -75,795 0 -9,544 -85,339June -96,205 0 8,339 -87,866July -48,555 0 -25,983 -74,538August -49,215 0 -21,192 -70,407September -82,645 0 -24,387 -1,07,032October -54,270 0 -32,883 -87,153

Liquidity Position of Banks in India

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.

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

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.