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Chapter III

Sources and Uses of

Funds in a Bank
After readi ng this chapter, you will be conversant with:
A Banks Balance Sheet
Sources and Uses of Funds in a Bank
A Banks Profit and Loss Account
Books of Accounts in Banks
Sources and Uses of Funds i n a Bank
Banks are vital links between the economic policies of the government and the
various economic factors. In the era of market-oriented economies banks have, by
almost any measure, become the most important financial intermediaries. They act
as mirrors that reflect the performance of the economy as a whole.
To analyze the performance of the banks, it is instructive to take a brief overview
of the principal assets and liabilities as presented in the banks balance sheet and
also its revenues and expenses fromthe income statement. Our objective in this
chapter is to examine the balance sheet and the income statement of the bank in a
manner to familiarize with the sources and uses of the funds and the revenues and
expenses of the banks. This familiarity will further aid in understanding the
various banking concepts.
According to Section 29 of the Banking Regulation Act, 1949 banks will have to
prepare the Balance Sheet and Profit and Loss Account in the format set out in the
third schedule of the Act. The items that appear in the banks balance sheet and
profit and loss account will be shown under different schedules.
FormA is the formof the balance sheet of a bank and has 12 schedules under
which the various assets and liabilities are classified.
Schedule Liabilities Schedule Assets
01 Capital 06 Cash and Balances with
02 Reserves and Surplus 07 Balances with Banks and
Money at Call and Short
03 Deposits 08 Investments
04 Borrowings 09 Advances
05 Other Liabilities and
10 Fixed Assets
12 Contingent Liabilities 11 Other Assets
Source: ICFAI Research Center.
FormB or the formof Profit and Loss Account has 4 schedules and gives the
details of the income and expenditure of banks. The schedules for the items of the
profit and loss account are:
Schedule Income Schedule Expenses
13 Interest Earned 15 Interest Expended
14 Other Income 16 Operating Expenses
Source: ICFAI Research Center.
In addition to these, Schedule 17 and Schedule 18 relate to the Notes on Accounts
and the Significant Accounting Policies respectively. The Schedule Three of the
Banking Regulation Act, 1949, also gives the RBI guidelines relating to the
computation of Financial Statements. A detailed description of the items appearing
in these schedules is given below.
Similar to the balance sheet of any other firm, the banks balance sheet also has
assets that represent uses of funds to generate revenue for the bank and liabilities
and net worth that formthe sources of the banks funds.
However, within this framework, there are significant differences in the basic
composition of the assets and the liabilities and how they contribute towards the
revenues and expenses of the bank.
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Sources of Funds Banks Liabilities
The sources of funds for the lending and investment activities constitute the
liabilities side of the banks balance sheet. The various sources through which the
bank raises funds for its business are broadly classified into the following:
Reserves and Surplus
Other Liabilities and Provisions.
Within this broad classification lie the different liabilities of the bank. A discussion
on the same follows.
Box 1: The New Basel Capital Accord
More than a decade has passed since the Basel Committee on Banking
Supervision (the Committee) introduced its 1988 Capital Accord (the Accord).
The business of banking, risk management practices, supervisory approaches,
and financial markets each have undergone significant transformation since
then. In J une 1999 the Committee released a proposal to replace the 1988
Accord with a more risk-sensitive framework, on which more than 200
comments were received. Reflecting these comments, in January 2001 the Basel
Committee on Banking Supervision issued a proposal for a New Basel Capital
Accord that, once finalized, will replace the current 1988 Capital Accord. In
April 2001 the Committee initiated a Quantitative Impact Study (QIS) of banks
to gather the data necessary to allow the Committee to gauge the impact of the
proposals for capital requirements. A further study, QIS 2.5, was undertaken in
November 2001 to gain industry feedback about potential modifications to the
Committees proposals. The Committee expects the new accord to be
implemented in 2004.
Rationale for a New Accord: Need for more Flexibility and Risk Sensitivity
The existing Accord
The proposed new Accord
Focus on a single risk
More emphasis on banks own internal
methodologies, supervisory review, and market
One size fits all Flexibility, menu of approaches, incentives for
better risk management
Broad brush structure More risk sensitivity
Structure of the New Accord
Three pillars of the new Accord
Minimum capital requirement
Supervisory review process
Market discipline.

The RBI has provided guidelines for the capital requirement of the banks. The
capital of the nationalized banks, which is fully contributed by the government,
will also include the contributions made by the government for participating in the
World Bank projects. For banks that are incorporated outside India, and have
branches in India, the capital will be the amount they bring in by way of start-up
capital as prescribed by the RBI. Also shown under this head is the amount of
Sources and Uses of Funds i n a Bank
deposit kept with the RBI under Section 11(2) of the Banking Regulation Act,
1949. According to this section, if the bank is not incorporated in India, it will
have to maintain a deposit with the RBI either in cash or in the form of
unencumbered approved securities or partly in cash and partly in such securities.
New banks will have to be incorporated under the Indian Companies Act and have
a minimum capital requirement of Rs.100 crore. The old private sector banks
which are also incorporated under Indian Companies Act are, however, exempted
fromthe minimumcapital requirement of Rs.100 crore. Banks will have to show
in their capital account the authorized, issued, subscribed and called-up capital.
The capital account will, however, be represented by the paid-up capital which
will be arrived at after deducting the calls-in-arrears and adding up the paid-up
value of forfeited shares to the called-up capital.
The components under this item of the banks liability will include statutory
reserves, capital reserves, share premium, revenue and other reserves and balance
in profit and loss account. These items are discussed below:
i. Statutory Reserves: Section 17 of the Banking Regulation Act, 1949, which
deals with the reserve fund account of the bank provides that every banking
company incorporated in India shall create a reserve fund out of the balance
of profit of each year as disclosed in the profit and loss account. This transfer
of funds will be before any dividend is declared and the amount will be
equivalent to not less than 20 percent of the profit.
ii. Capital Reserves: The surplus arising due to revaluation will be considered
as the capital reserve. It will not include any amount that is regarded as free
for distribution through the profit and loss account. As stated earlier, if there
is excess depreciation on investments and the bank intends to reverse it, then
it shall be taken to capital reserve. Similarly, profit made on sale of
permanent investments shall also be taken to capital reserves.
iii. Share Premium: This itemwill show the premiumon the issue of share
capital by the bank.
iv. Revenue and Other Reserves: All other reserves other than the capital
reserve will appear under this category of reserve funds. Excess provision for
depreciation in investments will have to be appropriated to Investment
Fluctuation Reserve Account and be shown under this head. This amount will
be considered for Tier-II capital and can be utilized for the depreciation
requirement on investment in securities, in the future.
v. Balance in Profit and Loss Account: The profits remaining after the
appropriations are considered under this heading.
The equity capital and reserves of a bank formrelatively a small proportion of the
total liabilities. Banks are highly leveraged organizations, relying mainly on debt
and the chief source of funds are the deposits that are raised. These deposits are
grouped into various types depending on the purpose and the maturity.
The deposits are broadly classified as deposits payable on demand and deposits
accepted for a termand hence payable on a specified date. Deposits payable on
demand consist of current deposits and savings deposits. However, the
classification of these deposits for balance sheet purpose will be as demand
deposits, savings bank deposits and termdeposits.
i. Demand Deposits: These include balances in current account and term
deposits which have become due for payment but have not been paid yet.
These funds represent interest-free balances. These accounts will be in the
formof an operating account primarily for a business concern.
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ii. Savings Deposits: These represent balances payable on demand which are in
the formof an operating account catering to non-commercial purposes such
as individuals, trusts, etc.
iii. Term Deposits: Deposits that are repayable after a specified term are
included here. The minimum and maximummaturity periods for which term
deposits can be accepted are 15 days to 10 years and in case of deposits of
Rs.15 lakh and above. This period can be relaxed in certain specific cases.
This may happen when a deposit is in the name of a minor and would take
more than 10 years for repayment or when the court has decided the maturity
period to be greater than 10 years in any disputed case.
These termdeposits which can be raised from banks and others will include fixed
deposit, cumulative and recurring deposits, cash certificates, certificates of
deposits, annuity deposits, deposits raised under various schemes, ordinary staff
deposits, FCNR deposits, etc. The deposits under special schemes which are
included here will have to be shown as demand deposits when they mature for
All the deposits mentioned above will be classified into those frombanks and from
others. The deposits frombanks will include deposits from the banking systemin
India, co-operative banks, foreign banks which may or may not have operations in
India. The termbanking system includes all banks and other institutions that are
considered as a part of the banking system viz. Discount and Finance House of
India (DFHI), Securities Trading Corporation of India Ltd. (STCI), Primary
Dealers, etc.
The balance sheet will also present the deposits segregating theminto those raised
by branches in India and those raised by overseas branches.
Borrowings of the bank will be shown as those made within India and those made
in the overseas markets. Borrowings in India will consist of borrowings/refinance
obtained from the RBI, commercial banks (including co-operative banks) and
other institutions and agencies like IDBI, EXIM Bank of India, NABARD etc. The
borrowings made outside India will include the overseas borrowings made by the
Indian branches and the borrowings of the foreign branches. The amount borrowed
in the money market will be shown under borrowings fromother banks and other
institutions depending on the lender.
These borrowings will not include interoffice transactions. Further, the funds
raised by the foreign branches by way of CDs, notes, bonds, etc., should be
segregated into deposits, borrowings, etc., based on the documentation.
The secured borrowings made in the above two categories i.e. within and outside
India will be shown separately under this head.
The other liabilities of the bank are grouped into the following categories:
Bills Payable: This includes drafts, telegraphic transfers, travelers cheques,
mail transfers payable, payslips, bankers cheques and other miscellaneous
Interoffice Adjustments: As mentioned earlier, while discussing the assets
side of the balance sheet, the credit balance of the net interoffice adjustments
will appear on the liabilities side of the banks balance sheet.
Interest Accrued: The interest accrued but not due on deposits and
borrowings is entered under this heading. Interest accrued and due is usually
credited to the deposit account and hence such amounts usually do not get
reflected here.
Sources and Uses of Funds i n a Bank
Others: The other liability items include the net provision for income tax
after deducting the advance payment, tax deducted at source, etc., and other
taxes like interest tax. It also includes the surplus in aggregate in provisions
for bad debts account and for depreciation in securities. The contingency
funds which are not disclosed as reserves but are actually in the nature of
reserves, the proposed dividend/transfer to government, unexpired discount,
outstanding charges like rent, conveyance, etc., other liabilities that do not
appear under any other head such as unclaimed dividend, provisions and
funds kept for specific purposes and certain types of deposits like staff
security deposits, margin deposits, etc., where the repayment is not free,
should also be included under this head.
Appl ication of Funds Banks Assets
The funds mobilized by the bank, through various sources will be deployed into
the various assets. The assets side of a banks balance sheet consists of various
items that fall into the following broad categories:
Cash and Balances with the Reserve Bank of India
Balances with Banks and Money at Call and Short Notice
Fixed Assets
Other Assets.
Within the broad classification given above, lie a variety of assets, a detailed
description of which is given as follows:
All cash assets of the banks are listed under this account and it forms the most
liquid account held by any bank. Cash is held by banks to cover deposit
withdrawals, meet emergency expenses and handle unexpected credit demands
fromcustomers. The cash assets consist of the following:
i. Cash in Hand: This asset itemincludes cash in hand, including foreign
currency notes and cash balances in the overseas branches of the bank. These
are held on the banks premises to meet customer requests for withdrawal and
loan demands at short notice.
ii. Balances with the RBI: Cash account also includes the balances held by
each bank with the RBI in order to meet the statutory Cash Reserve
Requirements (CRR). Cash will also be held by banks in current account with
various offices of the RBI. Cash maintained by a bank in the currency chest
is also reflected here as an integral part of the balances. A currency chest is
an office, which is treated as a representative office of the RBI, but is actually
maintained by a bank in terms of specific approval given to the bank by the
RBI. Hence, cash balances with currency chest is treated as if the cash is
deposited with the RBI and hence is accounted for the purpose of CRR.
Primarily, assets under this category will be shown separately as those maintained
in India and abroad. The bank balances include the amount held by the bank in the
current accounts and termdeposit accounts of other banks. The bank balances in
both these types of accounts, i.e. the current account and other term deposit
accounts, both within and outside India should be shown separately. The bank
accounts within India will include all balances with banks, including co-operative
banks. Likewise, the balances with banks outside India will include balances held
by the domestic/foreign branches of the bank with other banks, which are located
outside India. However, the balances maintained by the branches in India with
their foreign branches will be considered as interbranch balances and shall not be
classified here.
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The other sub-class of asset that appears under this category is, Money at Call and
Short Notice. All loans made in the interbank call money market that are
repayable within 15 days notice are included here. All loans that are made outside
India and which are classified as money at call and short notice in those markets
will also be included. These secondary reserves (CRR and SLR form the primary
reserves), which are in the form of call loans and loans payable at short notice,
serve as a first line of defense when the bank needs funds to meet withdrawal
requirements at short notice. The funds deployed in call market are shown
separately depending on whether they are deployed in India or abroad.
A major asset itemin the balance sheet of a bank is investments in various kinds of
securities. Banks investments are classified into six different baskets depending
upon the nature of security. These include:
Government Securities
Approved Securities
Debentures and Bonds
Subsidiaries and/or JVs
Other Investments.
While the above-mentioned categories refer to the investments made in the
domestic market, banks can also invest in overseas markets. The overseas
investments will include foreign government securities, subsidiaries and/or JVs
and other investments.
The most important asset item on the banks balance sheet are advances. These
advances, which represent the credit, extended by the bank to its customers, forma
major part of the assets for all the banks. This asset account will be presented in
the balance sheet of a bank in three different formats. In the first format,
categorization will be based on the type/nature of the asset, in the second format,
advances will be categorized into secured and unsecured advances and the third
format will consist of a categorization based on the sectoral credit disbursements.
The total advances of all the three formats will be equal since the same advances
are presented in different ways.
As in the case of investments, the balance under the advances is reflected in the
balance sheet after reducing the provisions. It will be helpful to know the
following to understand the numbers under this category.
i. Net Bank Credit: This represents the total credit outstanding in the books of
the bank.
ii. Gross Bank Credit: Net Bank Credit plus Bills Rediscounted by the bank
The bank will have to make provisions depending on the level of NPAs. The
figures reflected in the balance sheet are net of provisions. It means that the figures
in the balance sheet will be net bank credit less provisions. The provisions on
account of NPAs are usually less than NPAs since in most of the cases the
Sources and Uses of Funds i n a Bank
provisions are not made to the extent of 100 percent. The following illustration
will clarify the position:
Consider the following data:
(Rs. in crore)
Outstanding credit in the books of bank = 2,780
Bills rediscounted with IDBI/SIDBI = 220
Outstanding balances in NPAs = 320
Provisions made on account of NPAs = 60
Net Bank Credit = 2,780
Gross Bank Credit = 2,780 +220
= 3,000
Gross NPA = 320
Net NPA = 320 60
= 260
Amount reflected in the balance sheet = 2,780 60
= 2,720
Amount reflected in contingent items = 220
Type/Nature of Advance (Format I): Given below is the classification of
advances based on the nature/type of the credit extended.
Bills purchased and discounted: The amount that is shown against this
itemin the balance sheet will be the bills discounted/purchased by
banks from the client irrespective of whether they are
clean/documentary or domestic/foreign.
Cash credits, overdrafts and loans repayable on demand: Items under
this category represent advances which are repayable on demand though
they may have a specific due date.
Term loans: All term loans extended by the bank including their
outstanding balances are shown here. These advances also have a
specific due date, but they will not become payable on demand.
Secured/Unsecured Advances (Format II): Based on the underlying
security, advances are classified into the following categories:
Secured by Tangible Assets: All advances or part of advances,
within/outside India, which are secured by tangible assets will be
considered as secured assets.
Covered by Bank/Government Guarantees: Advances in India and
outside India to the extent they are covered by guarantees of Indian and
foreign governments/banks and DICGC and ECGC will be included here.
Unsecured Advances: All advances that do not have any security and
which do not appear in the above two categories will come under this
Sectoral Advances (Format III): Sectoral segregation will be done
separately for advances within and outside India.
Advances in India will be classified into the following:
Priority sector represents advances made to those sectors which are
classified as priority sectors by the RBI.
Public sector advances are those advances that are made to central and
state government and other government undertakings. Advances
extended to public sector which are eligible to be classified as priority
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sector should be shown under the category of priority sector and not as
public sector advances.
All advances made to the banking sector including the co-operative
banks will come under the head of banks.
All the residual advances will appear under the head of others. This
includes non-priority advances given to the private, joint and co-operative
Further, if the advances provided by the banks are on a consortiumbasis, the
amount to be considered will be net of the share from other participating
Advances that are made outside India will be classified into those extended to
banks and those extended to others. Advances to others are classified as bills
purchased and discounted, syndicated loans and others.
Fixed assets of the bank are classified into premises and other fixed assets which
include furniture and fixtures. Premises which are wholly or partly owned by the
bank for business/residential purpose will be shown after considering the additions
or deductions made during the year and writing off the depreciation. Further, if there
is any write-off on reduction of capital and revaluation of assets, then the revised
figures must be shown in the subsequent balancesheets for a period of five years.
All fixed assets other than premises will appear as other assets. These include,
furniture, fixtures and motor vehicles. Cost of the assets as given in the preceding
years balance sheet will be adjusted for any additions and deductions made during
the year and the write-offs due to depreciation.
The remainder of the items on the assets side of the banks balance sheet are
categorized as Other Assets. The miscellaneous assets that appear here are:
Interoffice Adjustments: This shows the net position of the interoffice
accounts, domestic as well as overseas. The debit balance obtained after
aggregating all the interoffice accounts will appear in this account. This will
generally include items in transit and unadjusted items. If the net balance
shows a credit, it will be shown on the liability side. Since 1998-99, banks
are required to make 100 percent provision for the net debit position in their
inter-branch accounts arising out of the unreconciled entries (both credit and
debit) outstanding for more than 3 years as on March 31, every year.
Interest Accrued: Interest that can be realized in the ordinary course will be
considered. Included in this will be the interest accrued, but not due on
investments and advances and interest due, but not collected on investments.
Interest on advances which are in the formof loans, overdrafts and cash
credits is debited to the respective accounts and hence no such amount
usually gets classified here. However, interest accrued on bills
purchased/discounted gets classified here. Hence, the major itemunder this
category will be interest on investments.
Tax Paid in Advance/Tax Deducted at Source: The amount of tax
deducted at source on securities and the advance tax paid to the extent that
they are not set-off against relative tax provisions will appear under this item.
Stationery and Stamps: Bulk purchase of stationery which will be written
off over a period of time will be considered under this head of account.
Non-banking Assets Acquired in Satisfaction of Claims: Items under this
account include immovable properties/tangible assets which are acquired by
the bank in satisfaction of banks claims on others.
Sources and Uses of Funds i n a Bank
Others: Other items primarily include claims that are in the formof clearing
items, unadjusted debit balances representing additions to assets and
deductions to liabilities and advances provided to the employees of the bank.
Losses that are incurred over and above the capital, reserves and surplus will
also appear under this item. In respect of public sector banks, losses incurred
can be set-off with capital without the prior approval of the government.
Hence, all the accumulated losses are reflected under the item Other Assets
irrespective of whether losses are in excess of capital or not. In all such cases
it will be appropriate to reduce the accumulated losses shown on the assets
side fromthe total of the balance sheet to arrive at working funds/earning
assets/total assets. Working Funds, Earning Assets and Total Assets represent
the same itemand are used interchangeably.
The assets and liabilities noted above will generate revenues and create expenses
for the bank. Banks will thus have to balance their revenues against their expenses
in such a way that there is adequate net income for themto sustain profitably in
that business.
The banks income is broadly classified as interest income and other income while
the expenses are classified as interest expenses and other expenses.
The difference between interest income and interest expense is referred to as
Spread. The difference between other income and other expenditure is known as
Burden as it is normally a negative figure. Spread of the bank should be adequate
to leave certain profits for it after having adjusted the burden. To have a fairly
detailed view of banks revenues and expenses that form a part of the income
statement is particularly important as it provides information on the bottom line
the net income frombank operations.
The sources of revenue for banks can essentially be segregated into two main
categories the interest income and other income. The former represents the
interest earned by the bank on its advances, investments and other avenues where
funds are deployed while the other income represents all non-interest income that
the bank earns. A detailed break up of the items from which the bank derives its
revenues is provided below.
Like in any lending business, interest income forms the major and most important
revenue itemfor a bank. The bank thrives on the income earned under this head as
the spreads are essentially generated out of this income.
Interest/Discount on advances/bills: This item includes interest and
discount on all types of loans and advances like cash credit, demand loans,
overdrafts, export loans, termloans, domestic and foreign bills purchased and
discounted/rediscounted, overdue interest and interest subsidy, if any,
relating to such advances/bills.
Income on investments: The dividend and interest income earned on the
investment portfolio of the bank is entered under this head.
Interest on balances with RBI and other interbank funds: This item
includes the interest earned by the bank on balances with RBI and other
banks, call loans, money market placements, etc.
Others: All other types of interest/discount income, that are not included
above will appear in this head of income.
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Apart fromthe interest income, banks will also have certain income in the formof
fees, commission, exchange, etc. The banks other income will mostly be derived
in the following ways:
Commission, Exchange and Brokerage: Remuneration on services such as
commission on collections, letters of credit and guarantees, government
business and other permitted agency business including consultancy and
other services. It also includes remuneration on letting out lockers,
commission/exchange on remittances and transfers, brokerage, etc. on
Profit on Sale of Investments: The net position of profit on sale of
investments will be considered under this head. The items that are included
here are profit/loss on sale of securities, furniture, land and buildings, motor
vehicles, gold, silver, etc.
Profit on Revaluation of Investments: The net position that appears after
the revaluation of investments will be considered here. In case there is a loss
after netting the profits against the losses, it will be shown as a deduction.
Profit on Sale of Land, Building and Other Assets: The net profit/loss on
revaluation of assets is included under this head.
Profit on Exchange Transactions: The profits shown here will be after
deducting the loss incurred in the exchange transactions. The items that are
included here will be profit/loss on dealing in foreign exchange, all income
earned by way of foreign exchange, commission and charges on foreign
exchange transactions excluding interest which will be shown under interest.
Income Earned by way of Dividends, etc.: This will include the dividends
fromsubsidiaries/companies and/or joint ventures abroad or in India.
Miscellaneous Income: The miscellaneous income will comprise recoveries
fromconstituents for godown rents, income from banks properties, security
charges, insurance, etc. If any income under this heading exceeds one percent
of total income, particulars of the same will have to be provided as notes.
While the various sources of revenues of a bank have been mentioned above, the
contribution made by each of themwill however, depend on the policy of the bank
and its nature of activity. For example, if the bank concentrates mostly on its
investment activity, it will have most of its income generated as the interest earned
fromits investment portfolio. Whatever may be the banks policy, majority of
banks will have a large chunk of their income coming from the interest earned.
The key issues related to the banks profitability will be interest yield on
investments, interest yield on credit and proportion of non-interest income to total
The expenses of the bank can be broadly classified into interest expenses and other
operating expenses. The detailed break up of these expenses is provided below.
Since a bank will have to mobilize funds regularly to meet the credit demands, its
major expenses arise fromthe interest expended on deposits and borrowings.
a. Interest on deposits: Interest paid on all types of deposits raised by the bank
fromother banks, institutions and others will appear under this head.
b. Interest on RBI/interbank borrowings: This includes the discount/interest
on all borrowings/refinance fromRBI and other banks.
c. Others: Discount/interest on all borrowings/refinance from FIs and other
payments like interest on participation certificates, penal interest, etc. are
included here.
Sources and Uses of Funds i n a Bank
The operating expenses will generally include the costs of running the bank.
Components of the operating expenses are listed below:
a. Payments to and Provisions for Employees: A major part of the operating
expenses of the bank will be in the form of the staff salaries/wages,
allowances, bonus, other staff benefits like provident fund, pension fund,
gratuity, liveries to staff, leave fare concessions, staff welfare, medical and
house rent allowance to staff, etc.
b. Rent, Taxes and Lighting: This expense itemincludes rent paid by the
banks on buildings and vehicles, municipal taxes and other taxes (excluding
income tax and interest tax) and other charges on electricity, etc.
c. Printing and Stationery: Books and forms and stationery used by the bank
and other printing charges, which are not incurred by way of publicity
expenditure are included here.
d. Advertisement and Publicity: All expenditures incurred by a bank for
advertisement and publicity and the related printing charges will be included
in this type of expenditure.
e. Depreciation on Banks Property: Included here is the amount of
depreciation on banks own property, motor cars and other vehicles,
furniture, electric fittings, vaults, lifts, leasehold properties, non-banking
assets, etc.
f. Directors Fees, Allowances and Expenses: Expenses included here are the
sitting fees and all other expenditures incurred on behalf of directors, the
daily allowance, hotel charges, conveyance charges, including those which
are to be reimbursed and similar expenses of local committee members.
g. Auditors Fees and Expenses: Fees paid to the statutory/branch auditors for
their professional services and all expenses incurred for performing their
duties including those which are in the nature of reimbursement will be
entered under this expense account. This itemincludes the branch auditors
fees and expenses also.
h. Law Charges: All legal expenses and reimbursement of related expenses are
considered under this heading.
i. Postage, etc.: Postal charges like stamps, telegrams, telephones, etc. will be
appearing under this head.
j. Repairs and Maintenance: Repairs to banks property, their maintenance
charges, etc. are included here.
k. Insurance: This includes insurance charges on banks property, insurance
premium paid to Deposit Insurance and Credit Guarantee Corporation
(DICGC), etc. to the extent they are not recovered fromother concerned
l. Other Expenditure: Other expenses that are not covered under any of the
above heads like, fees and expenses incurred on the external auditors
appointed by banks themselves for internal inspections and audits and other
services, license fees, donations, subscriptions to papers, periodicals,
entertainment expenses, travel expenses, etc. are all included here. If the
amount of expense for any of the items in this category exceeds one percent,
particulars of the same will have to be given in the notes.
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Provisions and Contingencies
Provisions made for bad and doubtful debts, taxation, diminution in the value of
investments, transfers to contingencies and other similar items will be appearing
under this category of expenses.
Unlike the balance sheet of a company the payment of tax is included under the
itemprovisions and is not shown separately. Having prepared the balance sheet
and P&L account, the bank is required to submit the same along with the auditors
report to RBI under Section 31 of the Banking Regulation Act, 1949. Schedule 17
of the Banks Financial Statement relates to the Notes to Accounts and will
comprise details relating to Capital Adequacy Ratio, Valuation of Investments,
Provisions and Contingencies debited to P&L, Profitability and Productivity
Performance based on certain ratios. In addition to these, fromthe year ending
March, 2000 (the time frame was later extended to March 2001) banks will have to
disclose the following additional information in the Notes to Accounts:
Maturity pattern of loans and advances
Maturity pattern of investments in securities
Foreign currency assets and liabilities
Movements in NPAs
Maturity pattern of deposits
Maturity pattern of borrowings
Lending to sensitive sectors.
Under significant accounting policies i.e. schedule 18, banks will have to give
details on the basis of accounting expenses and incomes, investments, foreign
exchange transactions, advances, fixed assets, net profit etc. Mentioned above
were the details relating to the presentation of the final accounts of a bank.
However, prior to appearing in the final accounts, the various transactions that the
bank enters into while extending its services, appear in other books of accounts.
A broad classification of the books of accounts of a bank are as follows:
Principal Books of Accounts
Subsidiary Books
Other Subsidiary Registers
Other Memoranda Books
Statistical Books.
Details relating to the recording of transactions in the various books of accounts
are provided below.
Principal Books of Accounts
The principal books of accounts of a bank consist of the General Ledger and the
Profit and Loss ledger.
a. General Ledger: It contains all personal ledger accounts, profit and loss
account and different assets accounts. The Balance sheet can be readily
prepared fromthe general ledger. Contra accounts which have no direct
effect on the banks position are kept with a view to control such
transactions, e.g. letters of credit opened, bills received or sent for collection,
guarantees given etc.
b. Profit and Loss Ledger: Some banks maintain separate detailed profit and
loss accounts other than the one maintained in the general ledger. These are
Sources and Uses of Funds i n a Bank
columnar books having separate columns for each revenue or expense head.
Some banks maintain separate books for debits and credits. Entries are posted
in these books directly fromthe vouchers. The total of debits and credits
posted are entered into the Profit and Loss account in the general ledger.
Some banks maintain revenue accounts in the general ledgers itself, while
other banks maintain broad revenue heads in the general ledger and its details
in subsidiary ledgers.
Box 2: Asset-Liability Management
Banks can neither do without profits nor risks. Mere acceptance of risks to
remain profitable does not suffice. Banks have to face risk in order to be
profitable. Apart from losses incurred due to risks, there is also an ultimate
danger that the bank itself may fail. Unlike other sectors, the problems in
banking sector have a contagious effect on the entire financial system.
The question that arises at this point is what should the bank do in order to
take risks for greater returns and at the same time not end up in losses? Risk
management is one solution to such situations.
In order to tackle the risks, banks require to have a strong risk management
systemto cover:
1. assets, liabilities and off-balance sheet risks,
2. information and scientific risk management techniques and
3. dedicated asset-liability managers or committee (ALCO).
Asset-Liability Management as a means of risk management technique is an
important function of a bank. It primarily focuses on how various functions of
the bank are adequately coordinated in essentially covering planning, directing,
and controlling the levels, changes and mixes of the various balance sheet
Purpose of ALM
Considerable research in the field of risk management particularly in banks is
being done by analysts world over. Asset Liability Management (ALM) is one
of the techniques that has evolved in this direction.
The enhanced level of importance of ALM has now led to changes in the nature
of its functions. It is no longer a stand-alone analytical function. While there are
macro and micro-level objectives of ALM, it is, the micro-level objectives that
however, hold the key for attaining the macro-level objectives. At the macro-
level, ALM leads to the formulation of critical business policies, efficient
allocation of capital and designing of products with appropriate pricing
strategies. And at the micro-level, the objective functions of the ALM are two-
fold. It aims at profitability through price matching while ensuring liquidity by
means of maturity matching. Price matching basically aims to maintain spreads
by ensuring that the deployment of liabilities is at a rate higher than the costs.
Similarly, liquidity is ensured by, grouping the assets/liabilities based on their
maturity profiles. The gap is then assessed to identify the future financing
requirements. This ensures liquidity. However, maintaining profitability by
matching prices and ensuring liquidity by matching the maturity levels is not a
simple task.
The main reasons behind the growing significance of ALM are:
Volatility in operating environment,
Product innovations,
Regulatory prescriptions,
Enhanced awareness of the top management.
Overvi ew of Banki ng
ALM Explained
ALM is associated with strategic balance sheet management that takes into
account risks caused by changes in the interest rates, exchange rates and the
liquidity position of the banks. By holding the right combination of assets and
liabilities, a bank can minimize its risks. This strategy was initiated by the
American pension funds, and was soon followed by banks, insurance companies
and other finance companies. It is a very good tool to manage interest rate risk
as well as price risk. It is also possible to manage exchange rate risk,
commodity price risk and share price risk through ALM. The asset-liability
management in the Indian banking sector is still in its nascent stage.
The guidelines of RBI on ALM are primarily aimed at enabling banks to tackle
the liquidity risk and interest rate risk. For liquidity risk management, the assets
and liabilities of the bank are segregated into different groups based on their
maturity profile. Banks will have to prepare the Statement of Structural Liquidity
based on the maturity profile. And to monitor the short-termliquidity, the banks
are required to prepare the Statement of Short-termDynamic Liquidity. To
manage these risks, banks will have to develop suitable models based on their
product profile and operational styles. Some of the models are listed below:
a. Gap analysis: It is the basic technique used for analyzing the interest rate
risk. Based on the sensitivity of assets and liabilities to the interest rate
fluctuations, they are classified under different maturity buckets. The Rate
Sensitive Gap (RSG), which is the difference between the rate sensitive
assets (RSAs) and the rate sensitive liabilities (RSLs), enables banks to
assess the impact of rate fluctuations on their net interest margin (NIM).
The model can also be extended to target an RSG so as to attain a positive
impact on the NIM. An elaborate MIS at the micro-level is an essential
ingredient for this purpose. In the case of currency risk management,
banks in India have been given the discretion to maintain overnight open
positions subject to maintenance of adequate capital. As the name
suggests, this technique helps to find out the gap between banks assets
and liabilities, maturing after certain time periods.
b. Duration analysis: This technique helps to estimate the average amount
of time required before the discounted value or the present value of all
cash flows can be recovered by an asset-holder, that includes the bank's
depositor. This concept can be used for all assets, liabilities and off-
balance sheet items.
c. Value-at-Risk (VaR) model: VaR estimates the maximumpotential loss in a
position for a given holding period for agiven confidence level.
d. Simulation model: attempts to determine whether the model adequately
captures the banks current and projected cash flows, taking into account
the different interest rates and market price scenario. Simulation model is
simply an interactive process and is not an optimization model.
The interest rate gap is the difference between Rate Sensitive Assets (RSA) and
Rate Sensitive Liabilities (RSL) for each time bucket. The positive Gap
indicates that it has more RSAs than RSLs whereas the negative Gap indicates
that it has more RSLs. The Gap reports indicate whether the institution is in a
position to benefit from rising interest rates by having a positive Gap (RSA >
RSL) or whether it is in a position to benefit fromdeclining interest rates by a
negative Gap (RSL >RSA). The Gap can, therefore, be used as a measure of
interest rate sensitivity.
Sources and Uses of Funds i n a Bank
Focus of ALM
ALM includes management of the following types of risks:
Interest rate
Funding and capital planning
Profit planning and growth projection.
While targeting any one parameter, it is essential to observe its impact on the
other parameters also. It is not possible to completely eliminate the volatility in
both income and market value, simultaneously. If the bank lays down an
exclusive focus on the short-term profits, it may have an adverse impact on the
long-termprofits of the bank and vice versa. Thus, ALM is a critical exercise in
balancing the risk profile with the long/short-termprofits while ensuring its
long run sustenance.
Source: ICFAI Research Center.
Subsidiary Books
Apart from the principal books, there are other subsidiary books maintained in the
formof Personal Ledgers and Bills Registers.
Personal Ledgers: Department ledgers for different types of accounts for example
Current Accounts, Fixed Deposits, Cash Certificates, Loans, Overdrafts, etc. are
maintained by the bank. These ledgers are directly posted fromthe vouchers and
all the vouchers entered in each ledger in a day are summarized into voucher
summary sheets.
The voucher summary sheets are prepared in the department in which the
transaction is originated by persons other than those who write the ledgers. They
are subsequently checked with the vouchers by different persons generally
unconnected with the writing up of ledgers on the voucher summary sheets.
Bills Registers: Details of Bills of different types like bills purchased, inward bills
for collection, outward bills for collection, are entered on a day-to-day basis in
separate registers. Party-wise details of bills purchased or discounted are kept in
normal ledger form. Entries in this register are made fromthe original document.
A voucher prepared for the total amount of the transaction each day is entered in
the Day Book. When a bill is returned or realized its original entry in the register is
marked off. A daily summary of such realizations or returns is prepared in separate
register whose totals are taken to the vouchers which are posted in the day book.
Contra vouchers reflecting both sides of the transactions are prepared at the time of
the original entry in respect of bills for collections, and this is reversed on
realization. Outstanding entries are summarized frequently, and their total is
agreed with the balance of the respective control accounts in the general ledger.
Other Subsidiary Regi sters
There are different registers for various types of transactions. Their actual number,
volume and details will vary according to the requirements of the bank.
The following are some such registers:
1. Bills for Collection Register
2. Demand Draft Register
3. Share Security Register
4. Jewellery Register
Overvi ew of Banki ng
5. Safe Custody Register
6. Letters of Credit Register
7. Safe Deposit Vault Register
8. Standing Order Register
9. Letter of Guarantee Register.
Entries into these registers are made from original documents which are also
summarized on vouchers every day, and these vouchers are posted into the Day Book.
Box 2: Contingent Liabilities
Yet another significant component of the banks balance sheet is the contingent
liability. Many banks, particularly the largest banking institutions generate
income by aiding customers without directly affecting their balance sheets.
Prominent examples include issuing standby credit guarantees on behalf of
constituents in India and outside India and accepting obligations in the formof
acceptances, endorsements in the formof letters of credit and bills accepted by
the bank on behalf of its customers. Other contingent liabilities include claims
against the bank not acknowledged as debts, liability for partly paid-up
investments, liability on account of outstanding forward exchange contracts and
other items like arrears of cumulative dividends, bills rediscounted,
underwriting commitments, estimated amount of contracts remaining to be
executed on capital account and not provided for, etc.
Source: ICFAI Research Center.
A journal is maintained by each department of the bank to note the transfer entries
passed by it. These journals are memoranda books only, as all the entries made
there are also made in the day book through voucher summary sheets. Their
purpose is to maintain a record of all the transfer entries originated by each
department. Two vouchers are usually made for each transaction by transfer entry,
one for debit and the other for credit. The vouchers are generally made by and
entered into the journal of the department which is affording credit to the other
Other Memoranda Books
Besides, the books mentioned above, various departments of the bank maintain a
number of memoranda books to facilitate their work.
Some of the important books are as follows:
Cash Department: The main cash book is maintained by persons other than
the cashiers. The important books maintained in the cash department are
receiving cashiers cash book, paying cashiers cash book, main cash book,
cash balance book.
Quick Payment System: To ensure quick service, banks have introduced the
teller system. Under this system the teller keeps cash as well as ledger cards
and the specimen signature cards of each customer in respect of Current and
Saving Bank Accounts. A teller is authorized to make payment up to a
particular amount, say, Rs.8,000. On receipt of a cheque he/she checks it,
passes it for payment, makes payment to the customer and enters it in the
ledger card. The teller also receives cash deposited in these accounts.
Outward Clearing: A Clearing Cheque Received Book is for entering
cheques received fromcustomers for clearing.
Inward Clearing: Cheques received are checked with the accompanying
lists. They are then sent to the concerned department, and the number of
cheques given to each department is noted down in a Memo Book. When the
cheques are passed and posted into the ledgers, their number is independently
agreed with the Memo Book. If any cheques are unpayable, they are returned
back to the clearinghouse. The cheques themselves serve as vouchers.
Sources and Uses of Funds i n a Bank
a. Registers for shares and other securities held on behalf of each customer.
b. Summary books of securities giving details of Government securities, shares
of individual companies.
c. Godown registers maintained by the godown keepers of the bank.
d. Price register giving the wholesale price of the commodities pledged with the
e. Overdraft sanction register.
f. Drawing power book.
g. Delivery order book
h. Storage book.
a. Account opening and closing register.
b. Rate register for fixed deposits giving analysis of deposits according to rates.
c. Due date diary.
d. Specimen signature book
a. Salary and allied registers, such as attendance register, leave register, overtime
b. Register of fixed assets.
c. Stationery register.
d. Old records register.
Signature book of bank officers
Private telegraphic code and cyphers.
Statistical Books
Statistical records are kept by the banks as per their requirements. Some of the
common books maintained are as follows:
For average balances in loans and advances
Number of cheques paid
Number of cheques, bills and other items collected
Box 4: Sources of Funds Unique to a Bank
Being one of the earliest of present day financial intermediaries and possibly the
safest as well, banks have a privileged access to a few more instruments than
accessed by the other intermediaries. These instruments owe their origin partly to
the dearth of viable financial instruments in earlier era and partly to the mode of
working of the bank. Some of the instruments are listed below.
Participation Certificates: A participation certificate is an instrument arising
fromsecured loan extended by the bank. This is an instrument whereby a bank
can sell or transfer to a third party who could be another client. The instrument,
which represents a share in the loan extended by the holder of the certificate, who
also has a title to the borrowers pledged assets, is guaranteed by the bank. A
buyer of this instrument would know the entity to which the loan has been
extended, while a bank depositor will never know to what specific use his
deposits have been put by his bank. The banks issue participation certificates
against the working capital advances granted to the industrial concerns.
Overvi ew of Banki ng
These advances are earmarked in favor of the holder of certificates. These
instruments were discontinued as they distort the credit deployment of banks.
The banks which purchased the certificates were required to show the amount
under Advances to banks and were required to report the funds in weekly return
under Section 42(2) of the RBI Act under Demand and time deposits from
banks (for liabilities to banking system) and under Other demand and time
liabilities (for liabilities to others). The Working Group on the Money Market
(Vaghul Committee) had recommended that interbank Participation Certificates
which had been phased out should be reintroduced in modified form. This
instrument would be revived after the Indian Banks Association evolves a
satisfactory documentation and after the Reserve Bank issues detailed guidelines
on the operation of the scheme.
Bank Deposits: One of the most essential aspects in the functioning of a bank is
accepting deposits. A bank basically has three types of deposits: Time Deposits,
Current Deposits and Savings Deposits. Time deposits are those funds that are
deposited by savers on the basis of obtaining the same on the maturity of certain
period of time. A current account is a running account. This account does not
provide any interest and therefore provides no limit on the number of
withdrawals from this account. Savings bank account is normally maintained by
individuals and carries a nominal interest.
Foreign Deposit Accounts: A bank normally offers the following foreign
a. NRO Account (Non-Resident Ordinary)
b. NRE Account (Non-Resident External)
c. FCNR Account (Foreign Currency Non-Resident)
d. QA 22 Account
Source: ICFAI Research Center.
Being in the business of financial intermediation, it goes without saying that the
management of banks revolves around two important functions
a. the ability of the intermediary to raise funds and
b. to deploy them.
As discussed above there are various sources of funds that are available to a bank.
Further, there are also various factors that it needs to consider before utilizing such
avenues. Hence these two factors are to be balanced for a bank to achieve success
in its business. These activities determine the profitability as well as the sustenance
of the financial intermediaries.
Banks, acting as vital links between the economic policies of the government
and the various economic factors have become the most important financial
The analysis of the financial statements of a bank is important in the context
that these are the largest mobilisers of funds in the economy and hence the
way it acquires and uses the funds holds importance in the economy.
According to Section 29 of the Banking Regulation Act, 1949 banks will have
to prepare the Balance Sheet and Profit and Loss Account in the format set out
in the third schedule of the Act.
The various sources through which a bank raises funds for its business are
Capital, Reserves and Surplus, Deposits and Borrowings. These items
constitute the liabilities side of the balance sheet.
Sources and Uses of Funds i n a Bank
The assets side of a banks balance sheet consists of various items that fall
into the broad categories like Cash and Balances with Reserve Bank of India,
Balances with Banks and Money at Call and Short Notice, Investments,
Advances, Fixed Assets and Other Assets.
The sources of revenue for banks can essentially be segregated into two main
categories the interest income and other income.
Apart from the interest income, banks will have certain income in the form of
fees, commission, exchange, etc. which come under the head, other income.
The expenses of the bank can be broadly classified into interest expenses and
other operating expenses.
Books of accounts of a bank are Principal Books of Accounts, Subsidiary
Books, Other Subsidiary Registers, Other Memoranda Books, Statistical
The profitability as well as the sustenance of the financial intermediaries like
banks will depend upon the two factors viz. the ability of the intermediary to
raise funds and the ability to deploy them efficiently.
Overvi ew of Banki ng
Camels Rating for Banks
During the normal course of conducting its business, banks assume risks notably
credit and liquidity risks. If the risks are controlled properly, banks create
economic value by attracting savings to finance investment. In cases of
mismanagement and misallocation of their resources, banks fail. The effects of
bank failure are rapidly transferred through the entire financial systemof the
Presently banks are subjected to Annual Financial Inspections (AFI) by RBI with
the main accent on the assessment of the banks financial position and senior
officials of the RBIs Department of Supervision (DoS) to look into the
nonfinancial aspects i.e. management and systems.
The system of inspection of banks by the RBI was reviewed in 1991 by a Working
Group chaired by Shri S. Padmanabhan. The committee suggested that banks be
placed in the following two categories, for the purpose of examination, depending
on their known and reported condition in financial, operational and management
and compliance terms:
1. those that need to be examined on an annual cycle and
2. those that may be examined on a wider time scale say within two years from
the date of last examination.
In other words, the committee suggested that supervisory examinations should be
discriminating as between banks, based on defined parameters of soundess
financial, managerial and operational (related mainly to risk management and
internal control systems) systems. It was recommended that intervals between
examinations in respect of banks without known or reported problems be widened,
when the weaker banks may be subjected to frequent examinations by lessening
the intervals between two examinations.
For evaluation and rating of Indian Banks, the committee has suggested six key
parameters viz Capital Adequacy, Asset Quality, Management, Earning
performance, Liquidity and Systems (CAMELS Acronym). This is on the lines
of rating model (CAMEL) employed by the Supervisory Authorities in U.S.A.
Considering growing supervisory concerns on the need for adequate systems of
risk management and operational controls in banks operating in India, especially
with the increase of market risk in bank portfolio, an additional parameter of
system has been added to the CAMEL in India.
With regard to operating in India the committee considered that some parameters
like management earnings, liquidity are not of much significance and are clearly of
lesser concern with regard to branch operations from the view point of a host
country supervision and excluded these factors for the evaluation purpose. On the
other hand, keeping in mind the serious aberrations that surfaced in the operations
of some foreign banks in the recent past, the committee, recommended to include
compliance (Regulatory compliance) factor for inclusion for evaluation.
Therefore, for foreign banks operating in India, the factors for examination would
be (1) Capital Adequacy (2) Asset Quality (3) Compliance and (4) Systems
(CACS Acronym).
Sources and Uses of Funds i n a Bank
Component Ratings
Each of the six components in CAMELS (for Indian Banks) or four components in
CACS (for foreign banks operating in India) are assigned a rating on a scale
of 1 to 5 in order of performance.
Composite Ratings
Once the component ratings are determined, a COMPOSITE (CAMELS or CACS)
rating is assigned as a summary and is used by the supervisors as the prime
indicator of bank condition. Composite rating is not determined by calculating an
average of the separate components but is rather based on an independent
judgment of the overall condition of the bank.
Composite ratings are assigned on a scale of A to E. Composite rating of A
indicates that an institution is of least supervisory concern while composite rating
of E indicates an institution to be of the most supervisory concern.