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Name: Rohit AkiwatkarRoll no: 151

Date Submitted: 6/11/2013

Course: Commercial Banking and Insurance

Assignment: Article Review

Title:An Alternative Route towards Bank Profitability and TurnaroundHow far Suitable

for Commercial Banks of Different Sizes in India?Author: Subrato Bhadury

Source: www.ebscohost.com

Introduction:

The article explores the popular belief that diversification may not be beneficial for all banks.

Commercial banking system in India partly because of its diversification strategy and partly

due to volatility reduction effort is gradually inclining towards other income earning

activities. Although this strategic shift is welcome in view of the global recessionary

tendency, there is always a hidden danger in any diversification that its overemphasis may

lead to higher volatility in bank revenue and lower risk adjusted profits while the banks main

earning (interest income) may remain grossly neglected. Popular belief is that the small and

medium sized banks with limited resource base may be most hard hit unlike their bigger

counterpart if not diversification in this route is taken judiciously since they have lesser shock

absorption capacity. This paper takes a re-look into this aspect with empirical data for post

liberalization period. For this purpose, the paper used panel-based dataset for different

commercial bank groups and linear regression analysis was applied to find the diversity

among the groups.

Objectives:

This study makes an empirical investigation of the contribution of off balance sheetincome components of smaller banks vis--vis large commercial banks during post

liberalization period (1991-2010).

It undertakes a detailed study of the different aspects of this other income componentfor each commercial bank both at the individual bank and at the group level while

examining whether relatively small and medium banks could leverage the situation

equally with large banks. The study focused on the other income component and made comparisons with

interest income component as well for the same banks wherever relevant.

Methodology

Panel data based regression technique is used to analyze the online dataset. Initially LM test

is used to identify whether Ordinary Least Square (OLS) estimates without group dummy

variables are appropriate or Fixed/Random Effect model is more suitable. PSBs, both under

SBI group and nationalized group have the biggest banking network even in rural areas,which leads to high market coverage and as a consequence they have better knowledge of

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local markets and rich experience in niche market segments. In contrast, foreign banks and

private sector banks possess superior knowledge in technology and automation, prompt

decision-making aptitude, well-established risk management system, advanced product

innovation and customized service and better human resource policy framework.

It can be concluded that profitability of different banks in the private group at the

individual level was positively influenced by other income earnings. As a proportion of totalincome it has positively contributed towards the profitability of most of the small and

medium banks in the private sector group. Among them, the result is most significant for

Tamil Nadu Mercantile Bank and least significant for Sangli Bank.

So the estimated results show great divergence among the foreign banks in generating

profitability via non-conventional route like other income activities. From the panel data

results it appears that the adjusted R-squared for banks is 0.49, which means that the

explanatory variables explain the dependent variable or profitability by about 49 per cent.

However, these figures may be slightly more if absolute data would have been taken. The

Durbin Watson statistic is 1.58, which means that there is no auto correlation in the data. Of

the components of other income, commission exchange brokerage showed declining trend for

all banks but net revaluation investment and net exchange went up for all fourteen banks inthis group. The trend analysis of foreign bank group validated the hypothesis that other

income as a proportion of total income and as a proportion of interest income both have

gradually increased over time under study for all foreign banks.

Conclusion:

It appears from the results that expansion of other income generating activity is a

beneficial proposition for small and medium private banks and foreign banks as well just like

large SBI group of banks. However, for the SBI group, for SBI only diversifications are

lucrative, but for the rest of the banks in this group, this activity may not be that much profit

enhancing. This result does not corroborate to our hypothesis. Interestingly group-wise

growth effect revealed that one-thirds of the total number of banks (three in private bank

group and four in foreign bank group) showed negative correlation between interest income

and other income indicating strong potential for diversification in income generation.

Moreover, the study reveals that although all bank groups had not followed the same

diversification route and that too in the same manner and their direction and magnitude both

vary to this effect but it helped to augment their profits. This is in contrary to our popular

belief that for small and medium banks this route of diversification is not beneficial.

However, there is a need to have a proper guideline for diversification related activities of the

commercial banks that can give a boost to their portfolio expansion into this non-core area.