PROJECT REPORT

ON

COST CUTTING & PROFIT

MAXIMIZATION IN BANKS

PRESENTED BY

POOJA BOTHRA

ROLL NO:

CBS/CHE/ BFSM/08-09/009

TABLE OF CONTENT…

Introduction…………………………………………………… 3

Relevance of Cost Cutting & Profit Maximization in Banks.... 5

Detailed Analysis…………………………………………….. 7

Cost Cutting Strategies……………………………………….. 8

Profit Maximization Strategies……..………………………… 13

Ratios…………………………………………………………. 18

Findings & Suggestions............……………….……………… 23

Conclusion……………………………………………………. 25

Bibliography…………………………………………………. 26

2

INTRODUCTION

The Industrialization of Financial Services, Banking used to be a relatively simple

business, only slightly more complex than the old industry joke that claimed the business

operated on a 3-9-3 rule: take deposits at 3 percent, lend them at 9, and get to the golf

course by three o'clock. But those days are long gone. To capture a larger share of the

market, most leading banks have extended their product portfolios, and many of the

largest banks have diversified into new lines of business that range from financial advice

all the way to insurance. At the same time, they have looked overseas and across borders

toward new markets and sought greater scale through acquisitions.

VARIOUS PHASES OF INDIAN BANKING SECTOR

Phase I

General Bank of India was set up in the year 1786

India Company established Bank of Bengal (1809)

Bank of Bombay (1840) and Bank of Madras (1843) were established as

independent units and called were called Presidency Banks.

Reserve Bank of India in the year 1935

The Banking Company Act, 1949

People as a convention had most of their savings in Post Offices

Phase II

Nationalization of imperial bank of India and formation of sate bank of

India(1955)

Nationalization of SBI and Subsidiaries(1960)

Insurance cover extended to deposits

Creation of credit guarantee corporation

Creation of regional rural banks

3

Phase III

This phase had introduced many more products and facilities in the banking sector in its

reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was

set up by his name which worked for the liberalisation of banking practices.

The country was flooded with foreign banks and their ATM stations. Efforts were being

put to give a satisfactory service to customers. Phone banking and Net banking were

introduced. The entire system became more convenient and swift. Time was given more

importance than money.

4

RELEVANCE OF THE TOPIC

With the deregulation of the financial system, globalization of financial markets, a trend

towards disintermediation and funds management, and technological advances, the Indian

Banking Sector faced a highly competitive environment since 1993. This placed pressure

on interest margins and profitability of traditional lines of business and generated

pressures for institutions to cut costs, outsource back office functions, diversify into new

activities, eliminate cross-subsidies, and increase non-interest income. Moreover, shift in

pricing strategy or an increase in services provided on traditional loan and deposit

products towards fee income would be reflected in an increased share of revenues in

transactions fees on loans and deposits, while diversification into the non-traditional

activities for banks would be reflected in a greater share of commissions and

facility fees in total revenue.

Recent trends in banking

Growth of personal banking and credit

Corporates increasing accessing bond markets for their resource requirements

Shifts in revenue stream from being interest income based to fee based and

A greater degree of consolidation to achieve economies of scale

The modern banking activity is marked by itineraries into un-chartered horizons mingled

with risks and heavy competition. The social responsibility that was entrusted upon the

Public sector Banks digress them from the profit motive. On the other hand private and

foreign banks did not make such moves. Instead, they pursued profit making as the

objective for their operations.

In 1992 the RBI launched banking sector reforms, as per the recommendations made by

the Narasimhan Committee on financial reforms to create a more profitable, efficient and

sound banking system. The reforms opened the banking sector for private players.

5

Domestic private sector banks are divided into two categories old banks which existed

with the public sector banks before the entry deregulation and the new banks that came

into existence after the reforms of 1992. The old banks are smaller in size and are

regional. In contrast the new private sector banks are much larger in size, operate

primarily in metros and are technologically superior.

The emergence of New Private Sector Banks in 1995 exposed the inefficiencies of the

public sector banks. New Private Sector Banks have set a blistering pace of growth,

easily beating the growth rate of Public Sector Banks. The business share for Private

Sector Banks is very small but their share in the total net profit of the banking system is

disproportionately high. Just like in any other business, profit in banking acts as a

stimulant factor for management to expand and improve their services. Though Profit

maximization is secondary for Public Sector Banks, adequate profit is necessary for their

survival and healthy operations because even socioeconomic obligations, like branch

expansion in rural areas and priority sector advances cannot be fulfilled without adequate

profit. Hence, from the above it can be inferred that it is very important for a bank to

reduce costs which ultimately adds up to banks profit & explore other revenue generating

areas which could maximize banks profit significantly.

6

DETAILED ANALYSIS

With pressures on the spreads and the competition in the urban markets increasing

rapidly, banks need to develop new ways to sustain profitability & reduce costs. Banks

led to a plethora of new products, hence becoming a one stop shop for all financial

solutions. Moreover, the entries of several other foreign banks in India are acting as a

strong signal to the domestic players to pull up their socks to face the new competitors.

The various Cost Cutting & Profit Maximization strategies are:

Cost Cutting Strategy

Interest on Deposits

Increasing CASA %

Short – Term Fixed Deposits

Increasing Float Funds

Bringing down other costs

Staff Costs

Cost on Technology and Utilities

Communication Cost

Stationery Cost

Transaction Cost

Profit Maximization

Increasing Interest Income

Focusing on high yielding advances

Recovery of NPA’s

Charging correct interest & periodical revision of interest rate

Auditing of Income & Expenditure of Bank

Increasing Fee Based Income

Third Party Products

Focusing on LC’s & Bank Guarantees

Increasing Merchant banking & Investment Baking business

Augmenting Foreign Exchange Profit

7

Increasing other service charges

Cost Cutting Strategy

Interest on Deposits

Increasing CASA %

For a bank with a large network, if each branch can contribute more low-cost deposits,

the bank will become cost-effective as deposits represent a very stable source of funds –

Low volatility. It is one major weapon with which banks can face the threat of any

competitor in the banking industry. While foreign banks are not constrained for funds,

public & private sector banks will have to learn to operate with lesser margins in some

transactions, and also improve cost effectiveness. It is virtually impossible to run an

effective retail bank of any size without a culture of deposit gathering and deposit

growth. Hence, the availability of these low-cost funds reduces the burden of the bank to

acquire funds at a high costs & therefore helps in reducing banks overall cost.

Short – Term Fixed Deposits

Short term fixed deposits helps bank; maximize their bottom lines by reducing their costs.

For instance, if a client makes a one-week deposit, and then extends the deposit by

another and then another week, a bank is able to use the capital for three weeks while it

only has to pay a one-week interest rate, which is always much lower a one-

month interest rate. It is also believed that if banks refuse short-term deposits, they might

miss out on idle capital. Moreover the interest rate for one-week term and less-than-one-

month term deposits is lower than the rates for medium- and long-term deposits which

favor the banks bottom line. However, ‘adjusting the interest rate curve’ will have the

following impact.

First, interest rates will be put in order: longer-term deposits will have higher

interest rates than shorter-term deposits.

Second, the low interest rates for short-term deposits will encourage clients to

make long-term deposits, thus helping banks reduce capital mobilization costs.

8

If banks can reduce capital mobilization costs, they will be able to slash lending interest

rates.

Increasing Float Funds

Increased fund availability provides more opportunities to take advantage of the float on

the electronic deposit. Banks can now leverage these additional funds by investing in

other services or financial earnings instrument. The challenge posed by banks is to learn

how to invest that money in the optimum area for increased revenue growth.

Bringing down other costs

Staff Costs

21.55

15.8917.94

13.98

10.93 10.34

20.07 19.7117.32

13.96

0

5

10

15

20

25

06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08

SBI & itsAssociates

Nationalized SCB's Foreign All Banks

Wages as % to total expenses

Wages are a major chunk of a banks cost and banks must try minimizing this by

improving productivity per employee of the bank. Foreign banks touch the peak with

19.71% of their total expenses incurred towards wages compared to 10.34% in case of

SCB’s in 2007-2008. Wages have a direct impact on the profits of the bank & a bank can

significantly improve their profits by reducing their expenditure on wages.

9

Cost on Technology and Utilities

Although most companies abandon their investments in technology altogether during

harsh times, automation can mean lower cost of human resources, less paper use and

faster operations, all resulting in substantial cost savings. Companies which can find

ways to make better use of their existing IT systems or make minimal investments with

substantial impact can create considerable cost savings through such efforts. Adoption of

Technology can lead to business transformation and cost advantage in the long term. For

instance, Oracle Financial Services Applications enable financial institutions to automate

processes to reduce finance and accounting costs, cut IT costs, manage by fact and

improve operational efficiency. State Bank of India, UTI Bank and Development Credit

Bank Ltd has successfully implemented Oracle Financial Services Applications (OFSA) in

India.

Online Banking

Online banking uses modern computer technologies to offer the users convenient banking

facilities. This facility eliminates the need of a customer to personally visit the bank’s

branch for any sort of transaction. It also eliminates the necessity of doing any paper-

based work and saves considerable time for the bank & the users. Banks largely benefit

from the online banking facilities. Besides offering their users the convenience of

banking, the online banking system means significant cost savings for the banks. With

such an automatic system in place, banks need not hire employees specialized in handling

paper work and teller interactions. This reduces the banks’ operating costs considerably,

translating into significant cost savings over the long-term.

Optimize Cash Management

Cash is, ultimately, the inventory of financial institutes, and as in all industries, effective

management of cost of inventory results in decreased costs. By optimizing levels of cash

in ATM machines and across branches as well as automating transactions as much as

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possible, banks can decrease cash handling maintenance costs as well as their opportunity

costs. 

Communication Cost

Although traditional mass marketing and advertising activities can be effective ways for

increasing overall awareness and interest, they are not the most cost effective means for

marketing. Tailored marketing activities targeted at only the relevant audience can

substantially decrease the cost of communications while boosting response rates.

Companies should move more towards targeted activities in promoting their products and

services, cutting down their marketing budgets while keeping and even improving their

effectiveness.

Communications also includes tele-communication cost which can be significantly

reduced by integrating all existing communications networks into a single integrated

network with voice over IP (VoIP) and eliminate redundant charges. The savings are

realized in four major areas:

Cost reduction of new data/voice circuits

Elimination of intercompany long distance

Reduction of local dial tone service at branches

Strategic implementation of enterprise-wide call-routing patterns

Stationery & Other Cost

Optimum utilization of stationery can considerably decrease operating costs. As an

example, Citigroup recently posted a cost-cutting memo, advising that 'staff should print

black and white and on double sided paper'. Similarly memos going out all around the

world, with reminders - to not print documents for reading, to turn off lights when

leaving office etc can result in cost cutting for banks.

Transaction Cost

Over the years, most banks treated customer channel migration as a priority, seeking out

means to decrease crowd at the branches as well as to reduce cost of transaction. With the

downturn, this has become even more critical…the cost to serve a customer via the

11

internet pales in comparison to branch service costs. Numerous methods (i.e. loyalty

program incentives, higher interest rates, etc.) can be used to drive the migration of

customers to lower cost channels. From a pure profitability point of view, not all

customers are equal, and, they should not be treated equally. Retention of high value and

high potential customers are far more critical than individual mass customers, especially

in times of economic downturn. Companies should focus their limited marketing budgets

on getting, retaining and growing these customers as much as they can. At the other end

of spectrum is the below zero customers, who have negative impact on the company

bottom-line. Companies should also consider ways for selectively 'firing' these

customers, unless they have the potential to grow into profitable customers. 

Consider Channel Close Down and Relocations

Banks should be looking into closure of their unprofitable channels, ATMs and branches,

in order to decrease cost of sales and services. With decreasing market demand and

changing customer needs, certain branches, ATMs and channels can become redundant

with limited potential, or, expensive to maintain. Relocation is also an alternative to a

close down, which can significantly decrease cost of rent and maintenance.

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Profit Maximization

Increasing Interest Income

Net Interest Margin (NIM) measures the excess income of a bank's earnings assets

(primarily loans, fixed-income investments, and interbank exposures) over its funding

costs. To the past, for banks NIM was the main source of earnings, which were therefore

directly correlated with the margin levels. But with NIM declining significantly in many

countries, banks are now trying to compensate the "lost" margins with non-fund based fee

incomes and trading income. Despite these changes, net interest income continues to

account for a significant share of the earnings of most banks.

Focusing on high yielding advances

SMEs, with the recent growth, are the new goldmine that the banks have hit upon.

With a host of services ranging from bill discounting, factoring and even venture

capital funding, banks are knocking at their doors, ready to customize offerings to

suit their needs and acquire these customers.

The under banked Indian population, as well as the high margin on retail products

makes retail a very attractive market for the banks.

The all-inclusive nature of this growth in terms of sectors covers all consumer

segments as well as product segments.

Recovery of NPA’s

The efficiency of a bank is not always reflected only by the size of its balance sheet but

by the level of return on its assets. NPA’s do not generate interest income for the banks,

but at the same time banks are required to make provisions for such NPA’s from their

current profits. NPA’s have a deleterious effect on the return on assets in several ways –

They erode current profits through provisioning requirements

They result in reduced interest income

13

They require higher provisioning requirements affecting profits and accretion to

capital funds and capacity to increase good quality risk assets in future, and

They limit recycling of funds, set in asset-liability mismatches, etc.

Charging correct interest & periodical revision of interest rate

In many cases banks fail to revise their interest rate & delight the customer by providing

them a marginally higher rate than promised on their deposits. This thus tends to have an

adverse effect on the banks profitability thus increasing their cost. However, with the

advancement of technology, banks can overcome these errors over a period of time.

Auditing of Income & Expenditure of Bank

Banks must periodically audit their incomes and expenditure rather than waiting for the

year end. These periodic audits may help the banks in minimizing their cost and provide

additional revenues to them.

Increasing Fee Based Income

The conventional view is that product diversification reduces an institution's exposure to

any particular activity and thus leads to lower risk. Hence, banks started looking at non-

fund and fee-based activities to earn more from commission, exchange, brokerage as also

from sale of assets and investments, dividends among others. The fee-based activities like

issuance of bank guarantees, opening of letters of credit, and sale of third party products,

lockers, merchant & investment banking activities also proved to be good source of non-

interest income. In addition, fee income is often believed to be more stable than interest

revenue, the latter being affected by movements in interest rates and the business cycle.

It is viewed that fee income is more stable than income from traditional banking

activities.

First, they note that high switching and information costs make it costly for

borrowers to change banks and this may lead to a relatively stable income stream

from traditional banking activities. In contrast, in some fee-based activities, such

as funds management, banks face a highly competitive market, relatively low

information costs, and less stable demand for the product.

14

Second, they argue that fee-based financial services entail a higher ratio of fixed

to variable costs (operating leverage) than traditional banking products. Thus a

given change in revenue from fees will generate a greater change in earnings than

would an equal change in interest revenues.

Finally, they note that prudential regulators do not require capital to be held

for fee-based activities. This allows banks to have greater financial leverage, and

thus higher earnings volatility, on fee-based activities.

Third Party Products

Banks are increasingly venturing into new areas and offering a wider bouquet of products

and services to satisfy the diverse needs of their customers such as:

Demat account

Lockers

Cash management

Insurance product

Mutual fund product

Taxes

Considerations for Bank

Deposit customers are the best source of cross-selling opportunity

Reduce reliance on interest spreads as the major source of income

Leverage extensive customer base

One stop shop for all Financial Services

Reduce risk based capital required for the same level of revenue

Provide integrated financial services tailored to the life cycle of customers

Increasing Merchant banking & Investment Baking business

On behalf of the bank and its clients, the primary function of the bank is buying and

selling products. Banks undertake risk through proprietary trading, done by a special set

of traders who do not interface with clients and through "principal risk", risk undertaken

by a trader after he buys or sells a product to a client and does not hedge his total

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exposure. Banks seek to maximize profitability for a given amount of risk on their

balance sheet. 

Focusing on LC’s, Bank Guarantees & Factoring Services

Letter of Credit & Bank guarantees form a part of contingent liability on a banks balance

sheet. They are a non-fund based source of finance for the banks which provides them

additional revenue in the form of a percentage, commission or fee which ultimately adds

to the banks bottom line. Banks must focus on generating additional revenue by tapping

such opportunities.

Factoring has gained importance in today's international trade since international buyers

are increasingly unwilling to enter into letter of credit-based transactions due to the

additional monetary and administrative costs involved. Currently, the rules governing

factoring activities in the country are ambiguous. If a proper regulatory framework and

guidelines are put in place, factoring services could not only provide cheap and

timely credit, but also provide a good source of fee-based income for banks.

Augmenting Foreign Exchange Profit

Forex involves several categories of stakeholders. 

First, companies those carry out international contracts and want to hedge against

fluctuations in order to assure the stability of their income

Secondly, where there are large institutional investors, through the major banks,

which carry out transactions on this market but speculative or hedging

Finally, individuals who begin to arrive enmesh in this new market

Tenders towards them have multiplied and have allowed individuals to return to this

market which was previously reserved for professionals. With this growing trend, and

banks as intermediaries, forex it a sure shot golden egg for the banks. Furthermore, with

the possible introduction of capital account convertibility in India, it will provide

16

additional inflow and outflow of foreign currency. This exposes banks to additional

exchange risk apart from providing an additional source of revenue generation.

Increasing Demand for derivatives & other risk management products

The increasingly dynamic business scenario and financial sophistication also

increase the need for customized exotic financial products.

The complex and peculiar nature of risks faced by the companies are passed onto

the banks.

Innovative financial tools and advanced risk management methods are required by

the banks to capitalize on this business opportunity.

Increasing other service charges

Increasing other service charges can prove t be an additional revenue generator for the

banks. Banks must try & utilize this opportunity. These services could include

Duplicate copy of bank statement

Charges on Cheque bounce

Account maintenance charges

Issue of Duplicate deposit receipt

Servicing of Dormant Accounts

Closure of Accounts before a specified period

Wire transfer, TT, Mail Transfer etc.

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RATIOS

Return on Asset

0.86 0.97 0.94 1.01 1.021.15

2.282.57

1.04 1.16

0

0.5

1

1.5

2

2.5

3

06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08

SBI & itsAssociates

Nationalized SCB's Foreign All Banks

Return on Assets

Inference:

Foreign Banks tend to efficiently manage their assets to generate earnings compared to

various other banks in the industry. The ROA of foreign banks is significantly high at

2.57 compared to 1.16 of all the banks in India. This very fact indicates us that foreign

banks are able to utilize their assets much better than the public & private sector banks of

India.

18

Cost of Funds

4.75

5.9

4.8

5.835.18

6.13

4.034.4

4.82

5.81

0

1

2

3

4

5

6

7

06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08

SBI & itsAssociates

Nationalized SCB's Foreign All Banks

Cost of Funds (CoF)

Source:www.rbi.org.in

Inference:

The cost of Funds is the cheapest for foreign banks at 4.4 compared to Scheduled

Commercial banks at 6.13 for the year 2007-2008. This is a key indicator for high

profitability of foreign banks.

19

Net NPA Ratio

1.321.43

0.920.77

0.971.09

0.73 0.78

1.01 1.00

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08

SBI & itsAssociates

Nationalized SCB's Foreign All Banks

Net NPA ratio

Inference:

The net NPA ratio of SBI & its associates tends to be the highest, the second highest

being SCB’s. Nationalized banks have a very lowest NPA at 0.77 as against 0.78 of

foreign banks. High levels of NPA erode the profit as they have to be written-off

completely from the balance sheet thus affecting the bottom line of banks. Banks should

aim at minimizing their NPA levels with various measures as mentioned earlier.

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% of Fee-based Income to Total Income

15% 14%11% 12%

20% 19%

28%30%

16% 16%

0%

5%

10%

15%

20%

25%

30%

35%

06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08

SBI & itsAssociates

Nationalized SCB's Foreign All Banks

% of Fee-based Income to Total Income

Inference:

Fee based incomes are an important source of revenue for banks in the present level of

globalization. Consumer needs & reducing interest spreads have forced banks to look into

other areas apart from their traditional function of lending & borrowing. As it can be seen

above foreign banks once again top the list with 30% of their total income coming from

non-traditional sources.

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Profit per Employee

2.573.62 2.87 3.77 4.65

5.72

16.13

19.97

3.484.67

02468101214161820

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SBI & itsAssociates

Nationalized SCB's Foreign All Banks

Profit per employee (in Rs. lakh)

Inference:

Profit per employee in case of foreign banks is 19.97 lakhs compared to 3.77 lakhs of

nationalized banks which is remarkable. One fact that brings this figures down for

nationalized bank & SBI is the because of the high number of branches.

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FINDINGS & CONCLUSION

Foreign banks are in a better position in terms of Return on asset, Cost of Funds,

Net NPA ratio, % of fee based income to total income and Profit per employee.

Banks can significantly improve their profits by focussing on fee based income in

relation to traditional source of income.

With the entry of new players and multiple channels, customers (both corporate

and retail) have become more discerning and less "loyal" to banks. This makes it

imperative that banks provide best possible products and services to ensure

customer satisfaction. It is far cheaper to retain an existing client than to acquire a

new customer.

They are focusing on region-specific campaigns rather than national media

campaigns as effective strategy for a diverse country like India.

Customer-centricity also implies increasing investment in technology.

Apart from the Mobile Banking, including of SMS Banking, Net Banking and

ATMs are the major steps taken by the banks in India towards modernization.

Electronic banking improves operations & reduces overall costs by reducing the

need for processing center staff, document storage, transportation of paper

documents etc.

Banking industry has been undergoing a rapid transformation. Indian Banking

Sector - Offering High Growth Opportunities

Increasingly banks began to organize and manage themselves not as a bank unit

but as a system( or set) of disparate and semiautonomous lines of business:

The trend to the specialization based on client types (corporate, retail etc).

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New lines of business appeared to be based on required specialized

expertise.

The retail business began to fragment as specialized distribution channels

began to emerge for products such as credit cards, residential mortgages

etc.

The banking industry in India, through a measured, gradual, cautious and steady process,

has undergone substantial transformation. As the economy transcends a higher growth

path, and as it is subjected to greater opening and financial integration with the rest of the

world, the banking sector will need considerable development, along with corresponding

measures to continue regulatory modernization and strengthening. Indian banks are once

again at the cross-roads of development and this report is just an indication of what lies

ahead. Regulators, policy makers and banks would have to work together for making sure

that the growth engine for Indian economy functions smoothly and paves way for the

country to become a global economic super power.

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SUGGESTIONS

Optimize mix of corporate and retail banking

Increase product offering by leveraging corporate relationships

Rationalisation of human resources and reorientation through continuous training

Improvement in technology infrastructure

Focus on fee based income to boost profitability

Leverage core competency in project financing while creating additional business

opportunities in retail & commercial banking

Banks need to manage a world of information about customers - their profiles,

location, needs, requirements, cash positions, etc. to prevent customer going to

their competitors

Customer service will be the only tool left for banks to attract customers. Hence

banks must aim at providing a delightful experience to each of their customer.

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BIBLIOGRAPHY

http://www.banknetindia.com

http://www.rbi.org.in

http://www.investopedia.com

http://www.reuters.com/

http://seekingalpha.com/

http://businessstandard.com/

http://www.mckinsey.com/

http://www.icrarating.com/

http://www.iba.org.in/

http://www.wikipedia.org/

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