3 & 4 profit planning proces

8/3/2019 3 & 4 Profit Planning Proces

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Profitability PlanningProfitability PlanningModuleModule --22Session No. 3 & 4Session No. 3 & 4


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Need for profitNeed for profit

Builds up the capital of the bank throughBuilds up the capital of the bank throughinternal generation of the fundsinternal generation of the funds

Offsets the losses arising from operationsOffsets the losses arising from operations

It helps pay for expensesIt helps pay for expenses

It helps expand productsIt helps expand products

It satisfies shareholders expectationsIt satisfies shareholders expectations

It helps asset expansionIt helps asset expansion

Enables the bank to pay better remunerationEnables the bank to pay better remuneration


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BANK PROFITABILITY EQUATIONBANK PROFITABILITY EQUATION

11 Gross interest IncomeGross interest Income

22 Gross interest expensesGross interest expenses3 (13 (1--2)2) Net interest incomeNet interest income (Spread)(Spread)

44 Provision for loan lossesProvision for loan losses

5 (35 (3--4)4) NII after loan losses ( NII after PLL)NII after loan losses ( NII after PLL)66 Non interest incomeNon interest income

77 Non interest expensesNon interest expenses

8 (68 (6--7)7) Net nonNet non--interest incomeinterest income ( Burden)( Burden)

9 (5+8)9 (5+8) Net operating incomeNet operating income

1010 Profit/losses from investmentProfit/losses from investment

1111 Profit before taxProfit before tax


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BANK PROFITABILITY EQUATIONBANK PROFITABILITY EQUATION

(continued)(continued)

1212 Extra ordinary itemsExtra ordinary items

1313 TaxesTaxes

14 ( 1114 ( 11--1212--13)13) Net ProfitNet Profit

1515 Dividend paidDividend paid

1616 Retained profitRetained profit


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SpreadSpread

Net interest income ( also known as NII)Net interest income ( also known as NII)

Major part in operating incomeMajor part in operating income

Interest incomeInterest income interest expenseinterest expense Provides contribution to banks profitProvides contribution to banks profit

Is large if the banks has quality loans &Is large if the banks has quality loans &investmentsinvestments

Is large if bank has more CASAIs large if bank has more CASA Is large if bank has high interest earningIs large if bank has high interest earning

assetsassets


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BurdenBurden

Non interest incomeNon interest income non interestnon interest

ExpensesExpenses Major part in operating expensesMajor part in operating expenses

Banks can increase its profit throughBanks can increase its profit through

increase in the fee income (NFNI)increase in the fee income (NFNI) savings on operating costsavings on operating cost


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Impact of NPA on profitabilityImpact of NPA on profitability

NPA ceases to generate incomeNPA ceases to generate income Drag on NIIDrag on NII

NPA requires provisionNPA requires provision

Further drag on NIIFurther drag on NII Interest and charges booked need to beInterest and charges booked need to be

reversedreversed Further drag on NIIFurther drag on NII

Concept of earning assetsConcept of earning assets Non earning loan & investments ( NPA)Non earning loan & investments ( NPA)

Non earning assets (Fixed assets)Non earning assets (Fixed assets)


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To conclude:To conclude:

Enhancing profitability of the bank isEnhancing profitability of the bank isessentially about managing spread andessentially about managing spread and

burdenburden Improve spreadImprove spread

Reduce burdenReduce burden


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Bank profitability ManagementBank profitability Management

Operating ProfitabilityOperating Profitability

Assets utilizationAssets utilization

Sources of fundingSources of funding


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Operating ProfitabilityOperating Profitability

Net ProfitNet Profit

Profitability RatioProfitability Ratio

Profit marginProfit margin Gross yieldGross yield

LeverageLeverage

Net interest MarginNet interest Margin

Operating expenses/operating revenueOperating expenses/operating revenue(productivity ratio)(productivity ratio)


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Break down of bank profitabilityBreak down of bank profitability

Du Pont formulaDu Pont formula

ROE =ROE =

Net ProfitNet Profit TotalTotalincomeincome

AssetsAssets

Total incomeTotal income AssetsAssets EquityEquity

ROE =ROE = Profit Margin X Assets utilization XProfit Margin X Assets utilization XFinancial LeverageFinancial Leverage

ROA=ROA= Profit Margin X Assets utilizationProfit Margin X Assets utilization

FL =FL = Assets/equityAssets/equity

X X


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Measure of bank profitabilityMeasure of bank profitability

Return on assetsReturn on assets

Efficiency of using resourcesEfficiency of using resources

Return on equityReturn on equity Share holders view pointShare holders view point

Profit marginProfit margin

Ability to control costsAbility to control costsAsset utilizationAsset utilization

Ability to utilize assetsAbility to utilize assets


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Assets utilizationAssets utilization

Measured through total income/assetsMeasured through total income/assets It is also called gross yield or revenue per rupee of assetsIt is also called gross yield or revenue per rupee of assets Asset compositionAsset composition

Size of earning assetsSize of earning assets CRR/SLR complianceCRR/SLR compliance Other income generating capacityOther income generating capacity

Revenues by segmentsRevenues by segments RetailRetail CorporateCorporate Whole saleWhole sale Investment bankingInvestment banking International bankingInternational banking


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Sources of fundingSources of funding

Sources of funds and their costSources of funds and their cost Retails depositsRetails deposits

Wholesale depositsWholesale deposits

Stability of depositsStability of deposits Reaction to interest rate cycleReaction to interest rate cycle

Bank equityBank equity Regulatory complianceRegulatory compliance

Price movement of sharesPrice movement of sharesAssets/equityAssets/equity

Financial leverageFinancial leverage


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Measures of costsMeasures of costs

Sources of funds and their costSources of funds and their cost

Average cost of depositsAverage cost of deposits

Average cost of borrowingsAverage cost of borrowings Deposit mixDeposit mix

CASA as % of total depositsCASA as % of total deposits

Uses of funds and their yieldsUses of funds and their yields Average yield on advancesAverage yield on advances

Average yield on investmentsAverage yield on investments


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Study of Ashish DasStudy of Ashish Das

Rs. 13 lakh crores parked with banks in SBRs. 13 lakh crores parked with banks in SBdeposit and Rs. 4.5 lakh crores in currentdeposit and Rs. 4.5 lakh crores in currentaccountaccount

92% money is not withdrawn although92% money is not withdrawn althoughdeposit is on demanddeposit is on demand

Banks save around 36000 crores inBanks save around 36000 crores in

interest paymentinterest payment Recommended to pay interest as per repoRecommended to pay interest as per repo

raterate


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Sustaining profitability modelSustaining profitability model

Profit marginProfit margin NIMNIM

BurdenBurden

CASA depositCASA deposit Average cost of depositAverage cost of deposit

Gross yieldGross yield Average yield on advancesAverage yield on advances

% of NPA% of NPA LeverageLeverage

Dividend pay outDividend pay out


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Sustaining profitability modelSustaining profitability model

Objectives

To develop an internally consistent strategy for bankCapital growth.

.while recognizing several constraints'

Profit margin and gross yield generating capabilities

Desired level of financial leverage

Target dividend pay out ratio

Issues

What is the maximum growth rate that a bank cansustain on the basis of internally generated capital

And without altering its financial leverage or dividendpayout ratio.


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Forces that influence bank profitForces that influence bank profit

TRICKTRICKTechnologyTechnologyRiskRisk

Business is now technology drivenBusiness is now technology driven

High cost & High obsolescenceHigh cost & High obsolescence

Investment decisions have to made nowInvestment decisions have to made now

RegulatoryRegulatoryRiskRisk

Deregulation is moving fastDeregulation is moving fast

Competition from local as well as foreign banksCompetition from local as well as foreign banks

Business choices have to made nowBusiness choices have to made now

Interest rateInterest rateRiskRisk

Interest rate environment is volatileInterest rate environment is volatile

Impact of monetary policyImpact of monetary policy

ALM need to be addressed consistentlyALM need to be addressed consistently

CompetitionCompetition Entry of new playersEntry of new players Removal of barriers for NBFCRemoval of barriers for NBFC

KapitalKapital Compliance to capital adequacy standardsCompliance to capital adequacy standards Basel III accordBasel III accord

Problems of Public Sector BanksProblems of Public Sector Banks


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Trade off between risk & returnTrade off between risk & return

LiquidityLiquidityriskrisk

A very liquid bank is less risky and may be lessA very liquid bank is less risky and may be less

profitableprofitable

InterestInterest

rate riskrate risk

A bank with ALM matching is less risky and lessA bank with ALM matching is less risky and less

profitableprofitable

SolvencySolvencyriskrisk

A bank with high leverage is more risky and moreA bank with high leverage is more risky and moreprofitable.profitable.

Credit riskCredit risk A bank with no credit risk or little credit risk is lessA bank with no credit risk or little credit risk is lessrisky and less profitablerisky and less profitable

Over headOver headriskrisk

A bank low cost structure is less risky and lessA bank low cost structure is less risky and less

profitable.profitable.


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Balance sheet of xyz bank as on 31Balance sheet of xyz bank as on 31stst

March 2010March 2010Liabilities (Resources)Liabilities (Resources) Assets (uses)Assets (uses)

Share capitalShare capital 30003000 3%3% CashCash 29002900 3%3%

ReservesReserves 60006000 6%6% Money at callMoney at call

and short noticeand short notice

40004000 4%4%

CurrentCurrentDepositsDeposits

2800028000 28%28% InvestmentsInvestments 3000030000 30%30%

SavingsSavingsdepositsdeposits

3000030000 30%30% Loans andLoans andadvancesadvances

2000020000 20%20%

Time depositsTime deposits 3000030000 30%30% Bills discountedBills discounted 2000020000 20%20%

BorrowingsBorrowings 30003000 3%3% Term LoansTerm Loans 2000020000 20%20%

Fixed assetsFixed assets 31003100 3%3%

100000100000 100100 100000100000 100100


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Profit & Loss of XYZ bankProfit & Loss of XYZ bank

for year ended March, 2010for year ended March, 2010ExpensesExpenses IncomeIncomeInterest paid on depositsInterest paid on deposits 36003600 Interest on investmentsInterest on investments 19001900

Interest paid onInterest paid onborrowingsborrowings

120120 Interest on loan andInterest on loan andadvancesadvances

50005000

Other expensesOther expenses 20002000 Other IncomeOther Income 5050

TotalTotal 57205720

Operating ProfitOperating Profit 12301230

Tax paidTax paid 400400 TotalTotal 69506950

Net profitNet profit 830830


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Calculation of interest incomeCalculation of interest income

Assets Assets Amount Amount Yield Yield IncomeIncome

Cash balanceCash balance 29002900 0%0%

Money at call and shortMoney at call and shortnoticenotice

40004000 5%5% 200200

InvestmentsInvestments 3000030000 5%5% 15001500

Loans and advancesLoans and advances 2000020000 9%9% 18001800

Bills discountedBills discounted 2000020000 8%8% 16001600

Term LoansTerm Loans 2000020000 9%9% 18001800

Fixed assetsFixed assets 31003100 0%0%

Total Interest IncomeTotal Interest Income 69006900


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Calculation of interest costCalculation of interest cost

LiabilitiesLiabilities Amount Amount CostCost ExpensesExpenses

Share capitalShare capital 30003000 NANA

ReservesReserves 60006000 NANACurrent DepositsCurrent Deposits 2800028000 0%0%

Savings depositsSavings deposits 3000030000 3.5%3.5% 10501050

Time depositsTime deposits 3000030000 8.5%8.5% 25502550

BorrowingsBorrowings 30003000 4%4% 120120

Total interest paidTotal interest paid 37203720


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Bank profitability equationBank profitability equation

Net interest income

Non interest income

Non-interest expenses

taxes

Net Profit

+

-

-

=

(Interest income minus interest expenses= NII )

(From fee based activities and other incomes )

(Salaries, staff benefits, stationery, Rentadvertisement and publicity, repair & maintenance,postage and telephone, insurance and depreciationon assets, provision and contingencies)

(to government)

( to pay dividend out of profits)

Also known as SPREAD

Retained profits

-( appropriation to statutory & other reserves and

dividend payment)

3 & 4 profit planning proces

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