Profitability of Regional Rural Banks: a study of post liberalisation period.
IntroductionBanks play an important role in mobilization and allocation of resources in an economy. The gains to an economy depend on how efficiently the banks perform. Like other commercial organization, the efficiency of banks is also judged among others by their profitability. In India, the priorities in banking operations underwent far reaching changes since the banking sector reforms have been set in motion. There had been a shift of emphasis form development or social banking to commercially viable banking. Profitability became the main consideration and the prime mover of the financial strength and performance of banks. Unlike in the past, all banking operations gradually came to be measured in terms of their ability to generate profits.
Regional Rural Banks (RRBs) were established in our country in 1975 essentially for taking banking to the doorsteps of rural masses, particularly in areas without banking facilities. RRBs, were expected to operate as State sponsored, region based and rural-oriented commercial banks. RRBs were expected to mobilize resources from rural areas and play a significant role in developing agriculture and rural economy by deploying mobilized resources in rural sectors for the needy not conversed by other formal credit institutions.
In the wake of introduction of financial sector reforms in 1991-92, the commercial viability of RRBs emerged as the most crucial factor in deciding about their desired role due to their limited business flexibility with hardly any scope of expansion/diversification, smaller size of loans with higher exposure to risk-prone advances and professional inefficiency in financial deployment. To strengthen RRBs and improve their performance many initiatives have been taken by the Government and the Reserve Bank of India. As a part of comprehensive restructuring programme, recapitalization of RRBs was initiated in the year 1994-95. The process continued till 1999-00 and covered 187 RRBs with aggregate financial support of Rs. 2188.44 crore from the shareholders, viz. Government of India, State Governments and sponsor banks in the ratio of 50:15:35. Further, the branch licensing policy for RRBs has been liberalized. Under the new norms, empowered committees at the regional offices of RBi clear RRB application to open new branches. The branches of RRBs may undertake government business including conducting foreign exchange business with the prior approval of the concerned Government authority and RBI. These banks have also been allowed to open extension counters at the premises of the institutions of which they are principal bankers after obtaining license from the concerned regional office of the RBI. The RRBs need not to obtain permission of RBI for installation of ATMs at branches and extension counters for which they hold licenses issued by RBI. They are also permitted to open off-site ATMs after assessing the cost and benefit. As against the earlier policy of opening a large number of branches in far flung rural areas, RRBs have been permitted to merge/close down their unviable branches and the branch licensing policy for RRBs is almost at par with that for commercial banks.
As indicated in the Mid-Term Review of Annual Policy statement for 2004-05, RRBs have to adhere to good governance practices and comply with prudential regulations. In view of their importance as providers of rural credit, the union budget 2004-05, emphasized that the sponsor banks would be accountable for the performance of their RRBs. Sponsor banks have been advised by the Reserve Bank to provide support to their sponsored RRBs in matters relating to efficient management, training of staff, computerization and networking of their activities (RBI, Report on Trend and Progress of Banking, 2004-05: p. 104.).
Thus, in response to the financial sector reforms, the Indian banking system has moved far away from the conditions and compulsions that were prevailing at the time of advent of the RRBs in 1975. Further, in Punjab, the RRBs were established between the years 1983 and 1986. These banks have already functioned for more than 20 years. However, several changes have taken place in the focus and operations of these banks in the wake of financial sector reforms in the country and various measures have been taken by the government to improve the commercial viability of RRBs since 1994-95. So, it has been considered appropriate to study the impact of reforms on the profitability position of these banks. Hence, an attempt has been made in this paper to analyse the profitability of RRBs operating in Punjab and compare it with RRBs operating in India. The indicators selected to study the profitability and financial efficiency of the banks are return of funds, return on advances, cost of funds, cost of deposits, financial margin, non-interest income, operating cost, risk cost, net margin, credit deposit ratio, coverage ratio and gross NPA ratio. The study covers the period from 1994-95 to 2005-06 and is based on secondary data collected from annual reports of the banks and various publication of NABARD. Percentage analysis has been applied to calculate various profitability and efficiency indicators.
Return of Funds
Return of funds represent the interest earning capability of the bank assets. It is measured by the ratio of interest earned to average working funds. Interest income of banks depends upon the size of asset portfolio, the rate of interest and the percentage of standard assets. Interest income includes interest and discount income of the banks. Further, the average working funds represent the sum total of average assets. Average assets include cash and bank balances with RBI, investments, loans and advances and other assets like fixed assets. The working funds here are the average of monthly average working funds of the RRBs as reported by them to the NABARD. Table-1 shows the ratio of interest income to the average working funds (return of funds) of the RRBs during the period 1994-95 to 2005-06.
Table-1 reveals that return of funds of RRBs in India decreased from 8.60 per cent in 1994-95 to 6.61 per cent in 2005-06. In Punjab, the return of funds of RRBs decreased from 10.30 per cent in 1994-95 to 7.34 per cent in 2005-06. The decline in return of funds was mainly due to fall in general level of interest rates during the period. However, the RRBs in Punjab were having higher percentage of financial return than the all-India average for RRBs throughout the period of study.
Return on Advances
Return on advances indicates the ratio of interest earned on advances to total advances. Return on advances shows the average yield on advances. The higher level of return on advances reflects greater financial efficiency.
Table-2 indicates that return on advances for RRBs in India increased from 8.14 per cent in 1994-95 to 9.79 per cent in 2003-04. In Punjab, the return on advances for RRBs decreased from 9.59 per cent in 1994-95 to 9.18 per cent in 2003-04 and 6.47 percent in 2005-06. Return on advances for RRBs in Punjab was lower than that in India during the period 2001-02 to 2003-04.
Cost of Funds
Cost of funds in an important indicator of profitability in a bank. Cost of funds refers to interest expended as percentage of average working funds and is inversely related to the financial efficiency of the bank. Interest expended relates to the funds raised by the banks and includes interest incurred on deposits and on borrowings.
Table-3 shows the cost of funds in RRBs during the period 1994-95 to 2005-06. The Table highlights that financial cost of RRBs in India decreased from 6.02 per cent in 1994-95 to 3.52 in 2005-06. In Punjab, the financial cost of RRBs decreased from 6.60 per cent in 1994-95 to 3.12 per cent in 2005-06. Further, the percentage of cost of funds for RRBs remained lower in Punjab as compared to the all-India average during the period 1998-99 to 2005-06.
Cost of Deposits
Cost of deposits in another parameter used in banks to measure their efficiency. Cost of deposits represents the ratio of interest expended on deposits to deposits mobilized. The higher level of cost of deposits means lower financial efficiency.
Table-4 depicts that cost of deposits of RRBs in India decreased from 5.78 per cent in 1994-95 to 5.31 per cent in 2003-04. In Punjab, the cost of deposits of RRBs decreased from 5.92 per cent in 1994-95 to 4.69 per cent in 2003-04 and further fell to 3.44 per cent in 2005-06.
Financial Margin
Financial margin represents difference between financial return and financial cost. Thus, it shows the net interest income as percentage of average working funds. Higher positive value of financial margin signifies higher financial efficiency and a negative value of financial margin means financially inefficient concern.
Table-5 shows the financial margin in RRBs during the period 1994-95 to 2005-06. The financial margin of RRBs in India increased form 2.58 per cent in 1994-95 to 3.09 per cent in 2005-06. In Punjab, the financial margin of RRBs increased from 3.70 for RRBs throughout the period of study.
Non-Interest Income
Banks earn fee based income by way of providing various non-fund services. Non-interest income forms significant part of total income in a progressive rate these days. Table-6 shows the non-interest income earned as percentage of average working funds in RRBs during the period 1994-95-2005-06.
Table-6 depicts that non-interest income as percentage of average working funds of RRBs in India increased from 0.54 per cent in 1994-95 to 1.13 per cent tin 2003-04 and then decreased to 0.48 per cent in 2005-06. In Punjab, the non-interest income of RRBs increased from 0.77 per cent in 1994-95 to 1.42 per cent in 2003-04 and then decreased to 0.60 per cent in 2005-06. The non-interest income in RRBs of Punjab was found to be higher when compared with all-India average during the period 2000-01 to 2005-06. However, the proportion of non-interest income in RRBs seems to be very low as compared to interest income. This is because these banks are able to provide only few non-fund based services to their customers as a result of restrictive policy of the Government.
Operating Cost
Operating cost is also called establishment cost or transaction cost. It is incurred for maintaining the staff, premises, etc. and for carrying out day to day operations. A bank can increase its margin through saving on operating costs. Thus, the lower level of operating cost reflects greater operation efficiency in a bank.
Table-7 shows the operating cost as percentage of average working funds in RRBs during the period 1994-95 to 2005-06. The Table indicates that the operating cost of RRBs in India decreased from 5.02 per cent in 1994-95 to 2.45 per cent in 2005-06. In Punjab, the operating cost declined from 4.40 per cent in 1994-95 to 1.94 per cent in average for RRBs throughout the period of study.
Risk Cost
Banks usually make provisions for loan losses. The provision for loan losses is an important component in the total expenditure of a bank. Thus, level of provisions had direct impact on the profits of a bank and causes risk to the profitability of the bank. So risk cost is recognized in banks and is measured by relating provisions made to the average working funds of the bank. A higher level of risk cost has adverse impact on the profitability of the bank. Table-8 shows risk cost in RRBs for the period 1994-95 to 2005-06.
Table-8 brings out that the risk cost of RRBs in India decreased from 0.96 per cent in 1994-95 to 0.36 per cent in 2005-06. In Punjab, the risk cost reduced from 1.38per cent in 1994-95 to 0.20 per cent in 2005-06. The risk cost of RRBs operating in Punjab was lower when compared with all-India average for RRBs during the period 1999-00 to 2005-06.
Net margin
Net margin is measured as percentage of net profit to average working funds. Net margin indicates efficiency of a bank in recovering its costs. Thus, it shows the efficiency of the bank in using its resources and reflects net profitability. A higher level of net margin means the higher profitability.
Table-9 shows the net margin in RRBs during the period 1994-95 to 2005-06. The Table ndicates that the net margin in RRBs of India and Punjab was negative for the years 1994-95-95 to 1996-97. This was due to negative values of gross margin for those years and the high risk cost which further reduced the net margin. The net margin of RRBs in India increased from 0.28 per cent in 1997-98 to 1.23 per cent in 2003-04 and then reduced to 0.76 per cent in 2005-06. In Punjab, the net margin of RRBs increased from 2.14 per cent in 1997-98 to 3.61 per cent in 2004-05 and then reduced to 2.68 per cent in 2005-06. The net margin in RRBs of Punjab was higher when compared with all-India average for RRBs throughout the period of study.
Credit Deposit Ratio
The credit deposit ratio of the bank indicates the creation of credit out of the deposit mobilized.
Table-10 shows credit deposit ratio in RRBs. The Table shorts that credit deposit ratio in RRBs of India decreased from 56.42 per cent in 1994-95 to 40.94 per cent in 1999-00 and then increased to 55.68 per cent in 2005-06. In Punjab, the credit deposit ratio of RRBs fell down from 53.86 per cent in 1994-95 to 36.40 per cent in 2000-01 and then went up to 54.18 per cent in 2005-06. The credit deposit ratio in RRBs of Punjab remained lower than all-India average for RRBs throughout the period of study except the year 1997-98 were slightly higher.
Coverage Ratio
The coverage ratio is generally used as an indicator of capital adequacy. It measures how much the assets value may decline before the position of depositors and creditors is jeopardized. The coverage ratio shows the surplus of owned funds less accumulated losses as percentage of average working funds. The higher coverage ratio represents greater cushion to the bank to support its credit risks and withstand unforeseeable developments. Thus, it contributes to greater financial viability.
Table-11 highlights that the coverage ratio for RRBs in India has improved progressively since the reforms have been set in motion and became positive (0.15 per cent) in the year 1999-00 and further increased to 5.08 per cent in the year 2005-06. In Punjab, the coverage ratio had been positive since 1996-97 (2.88 per cent) and continuously increased except in 2005-06 when it slightly decreased and was 18.61 per cent in that year. Further, the coverage ratio for RRBs in Punjab remained much higher when compared with all-India average throughout the period of study. Thus, the capital adequacy levels of RRBs in Punjab seem to be higher than the average level for RRBs in India.
Gross NPA Ratio
Gross NPA ratio is the ratio of gross non-performing assets to gross advance. Rising NPA ratio in a bank means vulnerability to the earnings of the bank. In a bank, an asset becomes non-performing assets are inevitable burden on the banks. And the success of a bank depends upon the management of NPAs so they have to be kept within the tolerance level.
Table-12 shows that gross NPA ratio for RRBs in India was 44.00 per cent in 1994-95, which gradually declined to 7.28 per cent in 2005-06. In Punjab, the ratio progressively reduced from 49.27 to 2.52 per cent during the same period. Thus, the RRBs of Punjab have performed better than the all-India average level for RRBs during the period of study.
Conclusion
The performance of RRBs in India as well as in Punjab improved in the post liberalization period. The loss making RRBs of Punjab became profit earning banks after the introduction of reforms. The RRBs in Punjab performed better than that in India for most of the profitability indicators like return of funds, cost of Funds, cost of deposits, financial margin, operating cost, risk cost, net margin, coverage ratio and gross NPA ratio. However, the RRBs in Punjab performed below the national average for RRBs as far as CD ratio and return on advances is concerned. Further, non-interest income in RRBs of Punjab remained fluctuating during the period of study and its proportion was very low as compared to interest income. Improvement in CD ratio by disbursing more loans among rural masses, addition of more non-fund based services and adoption of latest technology in line with commercial banks can further help in improving the profitability of RRBs operating in Punjab.
References
Annual Reports of the banks (1994-95 to 2005-06)
GOI (2002): Report of the Working Group to Suggest Amendments in the RRB Act, 1976, Ministry of Finance, New Delhi.
GOI (2006): The Regional Rural Banks Act, 1976: Ministry of Law and Company Affairs, New Delhi, P. 1&10.
Indian Institute of Banking and Finance (2004): Bank Financial Management, Taxman Publications Pvt. Ltd., New Delhi.
NABARD, Financial Analysis of Regional Rural Banks (1994-95 to 2005-06), Bombay.
RBI, Report on Trend and Progress in Banking 2004-05, Bombay.
RBI, Report on Trend and Progress in Banking 2005-06, Bombay.
Table 1: Return of Funds in RRBs Year RRBs in Punjab RRBs India 1994-95 10.30 8.60 1995-96 9.96 8.59 1996-97 11.56 9.73 1997-98 11.76 10.07 1998-99 12.27 10.73 1999-00 11.82 10.79 2000-01 11.59 10.89 2001-02 11.22 10.55 2002-03 10.52 9.62 2003-04 9.35 8.83 2004-05 8.37 8.20 2005-06 7.34 6.61 Table 2: Return on Advances in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 9.59 8.14 1995-96 7.76 7.06 1996-97 8.92 8.71 1997-98 10.03 9.75 1998-99 11.3 10.01 1999-00 11.02 10.50 2000-01 10.75 10.65 2001-02 10.47 10.66 2002-03 10.08 10.22 2003-04 9.18 9.79 2004-05 8.27 NA 2005-06 6.47 NA Note: NA = Not available. Table 3: Cost of Funds in RRBs Year RRBs in Punjab RRBs in India 1994-95 6.60 6.02 1995-96 6.83 6.41 1996-97 7.55 6.88 1997-98 7.06 6.81 1998-99 6.73 6.91 1999-00 6.58 7.02 2000-01 6.41 6.98 2001-02 6.01 6.74 2002-03 5.43 6.14 2003-04 4.45 5.36 2004-05 3.75 4.59 2005-06 3.12 3.52 Table 4: Cost of Deposits in RRBs Year RRBs in Punjab RRBs in India 1994-95 5.92 5.78 1995-96 6.26 6.05 1996-97 7.36 7.04 1997-98 7.45 6.86 1998-99 6.79 6.90 1999-00 6.70 7.04 2000-01 6.34 6.90 2001-02 6.23 6.68 2002-03 5.49 6.15 2003-04 4.69 5.31 2004-05 3.90 NA 2005-06 3.44 NA Note: NA = Not available. Table 5: Financial Margin in RRBs Year RRBs in Punjab RRBs in India 1994-95 3.70 2.58 1995-96 3.13 2.18 1996-97 4.02 2.85 1997-98 4.70 3.26 1998-99 5.54 3.82 1999-00 5.24 3.78 2000-01 5.17 3.91 2001-02 5.21 3.81 2002-03 5.10 3.48 2003-04 4.90 3.47 2004-05 4.62 3.61 2005-06 4.22 3.09 Non-Interest Income Table 6: Non-Interest Income in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 0.77 0.54 1995-96 0.67 0.55 1996-97 0.65 0.52 1997-98 0.55 0.58 1998-99 0.41 0.51 1999-00 0.48 0.58 2000-01 0.76 0.55 2001-02 0.78 0.75 2002-03 0.98 0.76 2003-04 1.42 1.13 2004-05 1.18 0.67 2005-06 0.6 0.48 Operating Cost Table 7: Operating Cost in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 4.40 5.02 1995-96 3.39 4.35 1996-97 2.79 3.76 1997-98 2.71 3.26 1998-99 2.83 3.21 1999-00 2.40 2.89 2000-01 2.29 2.74 2001-02 2.39 2.98 2002-03 2.27 2.98 2003-04 2.13 2.88 2004-05 2.01 2.81 2005-06 1.94 2.45 Table 8: Risk cost in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 1.38 0.96 1995-96 1.09 0.95 1996-97 3.26 3.46 1997-98 0.40 0.30 1998-99 0.32 0.28 1999-00 0.26 0.29 2000-01 0.23 0.30 2001-02 0.13 0.34 2002-03 0.05 0.34 2003-04 0.43 0.49 2004-05 0.18 0.38 2005-06 0.20 0.36 Table 9: Net Margin in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 -1.31 -2.86 1995-96 -0.68 -2.57 1996-97 -1.38 -3.85 1997-98 2.14 0.28 1998-99 2.80 0.84 1999-00 3.06 1.18 2000-01 3.41 1.42 2001-02 3.47 1.24 2002-03 3.76 0.92 2003-04 3.76 1.23 2004-05 3.61 1.09 2005-06 2.68 0.76 Table 10: Credit Deposit Ratio in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 53.86 56.42 1995-96 51.32 52.90 1996-97 45.61 48.48 1997-98 44.48 44.44 1998-99 40.62 41.96 1999-00 37.50 40.94 2000-01 36.40 41.33 2001-02 38.22 41.83 2002-03 41.88 44.23 2003-04 45.99 46.34 2004-05 52.25 52.89 2005-06 54.18 55.68 Table 11: Coverage Ratio in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 -3.25 -10.31 1995-96 -0.75 -10.03 1996-97 2.88 -9.35 1997-98 4.90 -5.82 1998-99 7.60 -2.93 1999-00 9.43 0.15 2000-01 11.24 1.59 2001-02 12.38 3.00 2002-03 14.84 3.51 2003-04 17.18 4.32 2004-05 20.44 5.01 2005-06 18.61 5.08 Table 12: Gross NPA Ratio in RRBs (in per cent) Year RRBs in Punjab RRBs in India 1994-95 49.27 44.00 1995-96 37.00 43.07 1996-97 36.84 36.79 1997-98 31.88 32.84 1998-99 23.24 27.84 1999-00 14.28 23.13 2000-01 9.45 18.83 2001-02 6.90 16.46 2002-03 5.24 14.44 2003-04 4.77 12.63 2004-05 3.02 8.53 2005-06 2.52 7.28
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| Author: | Dhaliwal, Navkiranjit Kaur; Arora, R.S. |
|---|---|
| Publication: | Political Economy Journal of India |
| Article Type: | Report |
| Geographic Code: | 9INDI |
| Date: | Jan 1, 2009 |
| Words: | 3441 |
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