Introduction…………………………………………………… Relevance of Cost Cutting & Profit Maximization in Banks.... Detailed Analysis…………………………………………….. Cost Cutting Strategies……………………………………….. Profit Maximization Strategies……..………………………… Ratios…………………………………………………………. Findings & Suggestions............……………….……………… Conclusion……………………………………………………. Bibliography…………………………………………………. 3 5 7 8 13 18 23 25 26

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 2

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 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.

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. 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.

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 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 onemonth 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-onemonth 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. 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
Wages as % to total expenses
25 21.55 20 15 10 5 0 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks 15.89 17.94 13.98 10.93 10.34 20.07 19.71 17.32 13.96

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.

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 paperbased 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 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 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.

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 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 13

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 nonfund 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 noninterest 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.  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 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

Considerations for Bank      

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 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 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.


RATIOS Return on Asset
Return on Assets
3 2.5 2 1.5 1 0.5 0 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks 0.86 0.97 0.94 1.01 1.02 2.57 2.28




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.


Cost of Funds

Cost of Funds (CoF)
7 6 5 4 3 2 1 0 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks 4.75 5.9 4.8 5.83 5.18 4.03 4.4

6.13 4.82


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.

Net NPA Ratio


Net NPA ratio
1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks 0.92 0.77 0.97 1.32 1.43 1.09 0.73 0.78 1.01 1.00

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.

% of Fee-based Income to Total Income


% of Fee-based Income to Total Income
35% 30% 25% 20% 15% 10% 5% 0% 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks 15% 14% 11% 12% 20% 19% 16% 16% 28% 30%

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.

Profit per Employee


Profit per employee (in Rs. lakh)
20 18 16 14 12 10 8 6 4 2 0 19.97 16.13






5.72 3.48


06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 06-07 07-08 SBI & its Nationalized Associates SCB's Foreign All Banks

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.



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). 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 23

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.

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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