• INTRODUCTION:
A commercial bank is a commercial entity that deals with banking in order to make a profit. Every commercial bank aims to make a profit in such a way that it does not compromise its liquidity objective, which is vital to its own safety.
• Sense:
Since a commercial bank has to make a profit in such a way that its liquidity remains intact, it diversifies its funds across various assets. A well-diversified and balanced portfolio of assets ensures its strong and successful operation. Several factors play an important role in determining the profitability and liquidity of commercial banks. These factors are taken into account when creating the banks’ asset portfolio.
• EXPLANATION:
A) FACTORS AFFECTING THE PROFITABILITY OF COMMERCIAL BANKS:
1) Amount of working funds:
The funds deployed by a bank in profitable assets are the bank’s working funds. The profitability of a company is directly proportional to the amount of working funds deployed by the bank.
2) Cost of funds:
The cost of funds is the expenses incurred to obtain funds from various sources in the form of equity, reserves, deposits and loans. Therefore, it generally refers to interest expense. The lower the cost of funds, the higher the profitability.
3) Return on funds;
The funds raised by the bank through various sources are deployed in various assets. These assets generate income in the form of interest. So, the higher the interest, the higher the profitability.
4) Propagation:
The spread is defined as the difference between interest received (interest income) and interest paid (interest expense). A higher spread indicates a more efficient financial intermediate and a higher net income. Therefore, a higher spread leads to higher profitability.
5) Operating costs:
Operating costs are the expenses incurred in running the bank. Excluding cost of funds, all other expenses are operating costs. Lower operating costs lead to higher profitability for banks.
6) Cost of risk:
This cost is associated with the probable annual loss of assets. They include provisions for bad debts and bad debts. Lower risk costs increase the profitability of banks.
7) Income other than interest:
They are the income derived from non-financial assets and services. Includes commission and brokerage of the rencitance facility, rental of the locker facility, subscription fees and financial guarantees, etc. This income adds to the profitability of the banks.
8) Technology level:
The use of improved technology typically leads to a decrease in banks’ operating costs. This improves the profitability of banks.
9) Level of doubtful assets (NPA):
The profitability of a bank is inversely related to the level of NPA. Therefore, over the years, the NPAs of commercial banks have decreased considerably.
10) Level of competence:
Increased competition generally leads to higher operating costs. This leads to lower profitability.
B) FACTORS THAT DETERMINE THE LIQUIDITY OF COMMERCIAL BANKS:
1) STATUTORY REQUIREMENTS:
The extent of the liquid reserves held by banks depends on the legal requirements of the Central Bank (i.e. the RBI) According to the RBI, commercial banks must maintain a certain CRR (cash reserve ratio) and SLR (liquidity ratio legal) Higher CRR and SLR result in lower liquidity.
2) Banking habits of people:
The nature of the economy has an impact on people’s banking habits. In developing countries, check transactions are limited to business. Individuals rely more on cash transactions. Therefore, the need for liquidity is comparatively greater.
3) Monetary transactions:
The number and magnitude of monetary transactions determine the liquidity of banks. A higher monetary transaction leads to higher liquidity.
4) Nature of the money market:
In the case of fully developed money markets, banks buy and sell securities easily. Therefore, the liquidity requirement is lower.
5) Structure of the banking system:
The branch banking system requires less liquidity as cash reserves can be centralized at the head office. The unit banking system requires a higher degree of liquidity.
6) Number and size of deposits:
The number and size of deposits influence the liquidity of banks. Increasing the number and size of deposits will require greater liquidity.
7) Nature of deposits:
Deposit trading with banks is of various types, such as time deposits, demand deposits, short-term deposits, etc. larger demand deposits / short-term deposits need more liquidity
8) Liquidity policies of other banks:
Several banks can operate in the same area Therefore, the liquidity policies of other banks also have an impact on the liquidity of a bank to generate goodwill among depositors.
• CONCLUSION:
SO, several factors determine the liquidity and profitability of commercial banks. Therefore, these factors are taken into account when creating the asset portfolio of commercial banks. These factors influence the reconciliation of profitability and liquidity that leads to a solid and successful banking system.