ChapterII

Lending to Sensitive Sectors

2.35 The overall exposure of SCBs to the sensitive sectors comprising capital market, real estate and commodities³ stood at Rs.23,224 crore (3.6 per cent of total loans and advances) as at end-March 2002, showing a marginal rise of 3.1 per cent during 2001-02 as compared to that during the previous year, driven primarily by a rise in real estate lending and, to a lesser extent, advances to commodities sector (Table II.10 and Chart II.3).

Table II.10: Lending to Senstive Sectors
(Amount in Rs. crore)
Advances to		Nationalised Banks			State Bank Group			Public Sector Banks
		2000-01	2001-02	variations	2000-01	2001-02	variations	2000-01	2001-02	variations
1		2	3	4	5	6	7	8	9	10
1.	Capital Market	1,334.48	1,268.65	-4.93	116.52	166.72	43.08	1,451.00	1,435.37	-1.08
		(0.50)	(0.40)		(0.08)	(0.10)		(0.35)	(0.30)
2.	Real Estate	4,413.30	5,423.45	22.89	1,354.27	620.26	-54.20	5,767.57	6,043.71	4.79
		(1.67)	(1.72)		(0.90)	(0.38)		(1.39)	(1.26)
3.	Commodities	5,903.14	6,503.93	10.18	1,476.37	1,409.38	-4.54	7,379.51	7,913.31	7.23
		(2.23)	(2.06)		(0.98)	(0.86)		(1.78)	(1.65)
Total Advances to		11,650.92	13,196.03	13.26	2,947.16	2,196.36	-25.48	14,598.08	15,392.39	5.44
Sensitive Sectors		(4.40)	(4.17)		(1.96)	(1.33)		(3.52)	(3.20)

Advances to		New Private Sector Banks			Old Private Sector Banks			Foreign Banks			Scheduled Commercial Banks
		2000- 01	2001- 02	Varia- tions	2000- 01	2001- 02	Varia- tions	2000- 01	2001- 02	Varia- tions	2000- 01	2001- 02	Varia- tions
		11	12	13	14	15	16	17	18	19	20	21	22
1.	Capital Market	1,786.75	912.73	-48.92	545.09	194.61	-64.30	828.62	502.48	-39.36	4,611.46	3,045.19	-33.96
		(5.92)	(1.23)		(1.44)	(0.46)		(1.92)	(1.03)		(0.88)	(0.47)
2.	Real Estate	876.94	1,208.34	37.79	1,197.24	1,243.32	3.85	523.79	1,277.43	143.88	8,365.54	9,772.80	16.82
		(2.91)	(1.63)		(3.15)	(2.94)		(1.22)	(2.63)		(1.59)	(1.51)
3.	Commodities	672.73	899.65	33.73	1,199.75	1,327.56	10.65	298.89	265.04	-11.33	9,550.88	10,405.56	8.95
		(2.23)	(1.21)		(3.16)	(3.14)		(0.69)	(0.54)		(1.82)	(1.61)
Total Advances to		3,336.42	3,020.72	-9.46	2,942.08	2,765.49	-6.00	1,651.30	2,044.95	23.84	22,527.88	23,223.55	3.09
Sensitive Sectors		(11.06)	(4.07)		(7.75)	(6.54)		(3.84)	(4.20)		(4.28)	(3.60)
Note: Figures in brackets are percentage to Total Loans & Advances of the concerned bank-group.

Box II.1: Exposure Norms-Cross Country Practices The need for countries to limit risk concentration by banks is widely recognised. Large credit exposure by banks to an individual borrower, group of related borrowers or a sector of the economy may lead to extensive financial loss and even failure of the bank should that creditor or economic sector experience financial difficulties. One approach employed by bank supervisors to limit credit risk includes setting a limit on large exposures to a single borrower or a group of related borrowers. This method has been employed in several countries through setting a maximum ratio to bank’s regulatory capital for exposure to a single or a related group of borrowers or even a sectoral cap. There are several major issues that arise in the context of exposure norms. The first is the issue of appropriate level of the large exposure limit. The second is the issue of the items to be included under credit exposure. The third is the issue of group of related borrowers. The final issue is that of exposure to selected sectors. Credit Exposure The Basel Committee on Banking Supervision (BCBS) and The World Bank separately recommended that 25 per cent of a bank's capital be the limit for an individual large exposure to a private sector non-bank borrower or a closely related group of borrowers. The World Bank further recommended that the unsecured credit limit should not exceed 15 per cent of capital funds. The directives of the European Union also impose a 25 per cent limit. Internationally, most countries primarily follow a 'single borrower' limit (Table 1). Although, they do not have a separate group exposure limit, they treat a group of related borrowers (related through common ownership, control or management) as a single borrower for the purpose of exposure limit. This is in consonance with the Basel Committee recommendations that banking supervisors need not reckon exposure to a group of related counter parties (which represent a single risk to the lending institution) for determining the exposure limits. Table 1: Cross Country Limits for Loan Exposure to Single Borrower Countries Single   Borrower   (% of capital) Chile 5 China, Colombia, Mexico 10 Korea, Israel, United States*,   Argentina, India# 15 Hong Kong, Malaysia, Philippines,   Singapore, Thailand**, Brazil,   Hungary, Poland, Russia, Japan 25 Australia 30 * 10-25 per cent for state-chartered banks. ** Of tier I capital. # Since April 2002, the banks' exposure limits to single and group borrowers has been reduced to 15 per cent and 40 per cent respectively of banks capital base. For financing, infrastructure projects, the group exposure limit is extendable upto 50 per cent. The BCBS and The World Bank separately recommend that 'exposure' includes all claims and transactions, on-balance sheet as well as off-balance sheet. The differences identified among countries concern the application of the limits on a consolidated basis, whether exclusions are specified from the exposure limits and the use of risk weights. In India effective March 31, 2002, the exposure ceiling is computed in relation to total capital of banks as defined under capital adequacy standards (tier I and tier II), and includes credit exposure (funded and non-funded credit limits) and investment exposure (underwriting and similar commitments). The sanctioned limits or outstandings, whichever are higher, are reckoned for arriving at exposure limits. However, in respect of non-funded credit limits, only 50 per cent of such limits or outstanding, whichever is higher are taken into account for the purpose. Effective April 1, 2003, non-fund based exposures will be reckoned at hundred per cent. Definition of Group of Related Borrowers The Core Principles for Effective Banking Supervision of the Basel Committee has observed that "banking supervisors must be satisfied that banks have management information systems that enable management to identify concentrations within the portfolio and supervisors must set prudential limits to restrict banks’ exposures to single borrowers or groups of related borrowers" (Principle 9). The definition of group of related borrowers would thus include not only legally related companies, but also financially related companies, e.g., common ownership and physical persons (i.e., large shareholders). The international position in this regard in select countries is summarised in Table 2. In India, the task of identification of borrowers belonging to specific industrial groups was left to the perception of the banks themselves, within the overall guiding principle for identification of 'Group' being commonality of management and effective control, as banks were aware of the basic constitution of their clientele. Exposures to Selected Sectors Few countries also have had limits on exposures to certain sectors. These include, among others, the limits on property in Hong Kong until 1998, limits on the share of the outstanding advances of the previous financial year-end which Indian banks are permitted to invest in equity or convertible debt instruments, and restrictions on property or share-related loans in Singapore. In Bulgaria and Latvia, banks are expected in their internal credit rules to prescribe restrictions on concentrations of exposures to an economic region and or geographic region. In contrast, the Central Bank of Peru is prohibited from imposing sectoral or regional ratios on the composition of loan portfolios of financial institutions. In India, within the overall exposure to sensitive sectors (capital market, real estate and commodities), a bank's exposure to the capital market in all forms should not exceed 5 per cent of outstanding domestic credit (including commercial paper) as on March 31 of the previous year. The ceiling of 5 per cent would cover (i) direct investment in equity shares and convertible bonds and debentures; (ii) advances against shares to individuals for investment in equity shares (including IPOs), bonds and debentures, units of equity-oriented mutual funds; and (iii) secured and unsecured advances to stock brokers and guarantees issued on behalf of stock brokers. Apart from limiting exposure to individual or group borrowers, the banks were advised to also consider fixing internal limits for aggregate commitments to specific sectors (e.g., textiles, jute, tea, etc.) so that the exposures are evenly spread over various sectors. Table 2: Definition of Connected or Related Group Country Definition of Connected or Related Group USA Credit extended to one borrower is attributed to another when (a) proceeds used for direct benefit of the other, (b) common enterprise exist. Common enterprise exists when (a) expected source of repayment is the same and no other source of repayment exists, (b) extensions of credit made (i) to borrowers related through common control and (ii) substantial financial interdependence exists. Switzerland Two or more entities are considered as related group when (a) one directly or indirectly holds more than half the voting rights of other and exercises controlling influence (b) recognisable interdependencies exist which render it probable that if one falls into financial difficulties, the other will encounter payment difficulties and (c) they form a consortium. Australia Counter parties related where linked by cross-guarantees, common ownership, ability to control, financial interdependency or other connections, which identify the counter parties as a single risk. Canada A connection exists where two or more entities are a common risk. Common risk exists where (a) expected source of repayment is the same for each entity or (b) the entities are part of a corporate group and there is material financial interdependence between them. European Union (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and UK). Source: IMF (2001). A group of connected clients means (a) two or more persons who, unless otherwise, are a single risk because one of them, directly or indirectly, has control over the other or (b) two persons between whom there is no relationship or control but who are regarded as a single risk because they are so interconnected that if one of them were to experience financial problems, the other is likely to encounter payment difficulties. References: Hawkins, J and P.Turner (1999), 'Bank Restructuring in Practice: An Overview', in Bank Restructuring in Practice, BIS Policy Paper No.6, Basel, Switzerland. Morris, J (2001), 'Risk Diversification in the Credit Portfolio: An Overview of Country Practices', IMF Working Paper No.200.

2.36 Among bank groups, exposure to sensitive sectors was the highest for PSBs at Rs.15,392 crore (comprising 66.3 per cent of the total exposure of SCBs to sensitive sectors), followed in order by new private banks (13.0 per cent), old private banks (11.9 per cent) and foreign banks (8.8 per cent). Except for nationalised and foreign banks, the other bank groups witnessed a reduction in their exposure to sensitive sectors over the period. The maximum decline was recorded by the State Bank group, whose exposure to sensitive sectors during 2001-02 declined by 25.5 per cent to Rs.2,196 crore.

2.37 Almost all bank groups, excepting State Bank Group, unwound their exposure to the capital market during 2001-02. While nationalised banks exposure to capital markets registered a decline of 4.9 per cent to Rs.1,269 crore, the largest fall was witnessed by old private banks whose capital market exposure declined by 64.3 per cent to Rs.195 crore. Following the liberalisation of prudential requirements for housing finance for banks, lending to real estate witnessed a sharp upturn for most bank groups and the largest increase was observed in the case of foreign banks (143.9 per cent). The State Bank group was again an exception, and it lowered its real estate exposure by over 50.0 per cent to Rs.620 crore. Most bank groups witnessed modest to significant increases in their exposure to the commodities sector, with the increase for new private banks being the largest at 33.7 per cent; foreign banks, however, lowered their exposure to commodities sector.

Stock Prices of Indian Banks

2.38 The number of bank shares available for trading on the National Stock Exchange (NSE) remained constant at 31 as at end-March 2002, with no additional listings/de-listings during the year. There were 12 PSBs and 19 private sector banks whose shares were available for trading on NSE. The movements in share prices are given in Table II.11.

Table II.11: Changes in Share Prices of Banks
	Name of the Bank		Closing Price (Rs.)		Percentage
			2000-01	2001-02	Change in
					Share Price
	1		2	3	4
	Public Sector Banks
1	Andhra Bank		*	9.10	—
2	Bank of Baroda		60.45	47.60	-21.26
3	Bank of India		11.40	25.00	119.30
4	Corporation Bank		110.10	133.30	21.07
5	Dena Bank		8.75	6.70	-23.43
6	Indian Overseas Bank		7.75	8.85	14.19
7	Oriental Bank of Commerce		39.80	39.45	-0.88
8	State Bank of Bikaner & Jaipur		276.50	295.00	6.69
9	State Bank of India		201.05	219.95	9.40
10	State Bank of Travancore		240.00	275.30	14.71
11	Syndicate Bank		8.90	10.85	21.91
12	Vijaya Bank		7.15	8.45	18.18
	Private Sector Banks
1	Bank of Punjab Ltd.		14.55	13.90	-4.47
2	The Bank of Rajasthan Ltd.		12.30	11.45	-6.91
3	Centurion Bank Ltd.		11.45	11.85	3.49
4	City Union Bank Ltd.		23.80	24.25	1.89
5	The Federal Bank Ltd.		45.85	104.40	127.70
6	Global Trust Bank Ltd.		35.70	26.30	-26.33
7	HDFC Bank Ltd.		228.35	236.60	3.61
8	ICICI Bank Ltd.		166.50	123.90	-25.59
9	IDBI Bank Ltd.		17.05	28.00	64.22
10	IndusInd Bank Ltd.		14.00	16.70	19.29
11	The Jammu & Kashmir Bank Ltd.		37.30	73.35	96.65
12	The Karur Vysya Bank Ltd.		273.65	384.55	40.53
13	The Karnataka Bank Ltd.		70.30	127.90	81.93
14	The Laxmi Vilas Bank Ltd.		48.55	61.10	25.85
15	The Nedungadi Bank Ltd.		92.00	38.65	-57.99
16	The South Indian Bank Ltd.		22.05	43.95	99.32
17	United Western Bank Ltd.		32.00	22.00	-31.25
18	UTI Bank Ltd.		24.95	39.85	59.72
19	Vysya Bank Ltd.		121.35	237.15	95.43

Source :		National Stock Exchange.
Notes:		1. *Trading in the shares of Andhra Bank started on April 04, 2001.
		2. Closing price figures are of the last trading day of the financial year.
		3. Punjab National Bank was listed on April 26, 2002.

2.39 As Table II.11 reveals, PSBs scrips have recorded a mixed reaction. The contribution of the bank scrips to the NSE total turnover increased from 1.0 per cent in 2000-01 to 1.3 per cent in 2001-02 (Table II.12). The turnover of the top 5 banks at Rs.5,690 crore in 2001-02 was lower than the previous year.

Table II.12: Turnover Details of Bank Shares
	(Amount in Rs. crore)
Item	Turnover
	2000-01	2001-02
1	2	3
All Banks	13,992	6,804
Top 5 Banks	12,226	5,690
NSE Total (including
bank shares)	13,39,511	5,13,167
Per cent share of all
Banks to NSE Total	1.00	1.33
Per cent share of top 5 Banks
to All Banks	87.38	83.63
Source: National Stock Exchange.

3. Financial Performance of Scheduled Commercial Banks

2.40 During the year 2001-02, there was a significant improvement in the profitability of the SCBs owing to the rise in trading profits attributable to the softer interest rate regime coupled with the containment in operating expenses, notwithstanding the higher provisions and contingencies (Table II.13 and Chart II.4).

Table II.13: Bank Group-wise Select Indicators of Financial Performance (As percentage of Total Assets)

Bank Group/	Operating	Net	Income	Interest	Other	Expen-	Interest	Operating		Provisions	Spread
Year	Profit	Profit		Income	Income	diture	Expended	Expenses		and Cont-	(Net
								Total	of which	ingencies	Interest
									Wage Bill		Income)
1	2	3	4	5	6	7	8	9	10	11	12
Scheduled Commercial Banks
2000-01	1.53	0.49	10.20	8.88	1.32	9.70	6.03	2.64	1.79	1.03	2.85
2001-02	1.94	0.75	9.84	8.27	1.57	9.08	5.70	2.19	1.42	1.19	2.57
Public Sector Banks
2000-01	1.34	0.42	10.05	8.85	1.20	9.63	5.99	2.72	2.03	0.92	2.86
2001-02	1.88	0.72	10.14	8.71	1.43	9.43	5.98	2.29	1.65	1.16	2.73
Nationalised Banks
2000-01	1.29	0.33	10.23	9.09	1.14	9.90	6.19	2.76	2.10	0.95	2.90
2001-02	1.83	0.69	10.26	8.78	1.48	9.58	6.03	2.40	1.74	1.15	2.74
State Bank Group
2000-01	1.42	0.55	9.77	8.47	1.30	9.21	5.68	2.66	1.93	0.87	2.79
2001-02	1.94	0.77	9.96	8.62	1.34	9.19	5.91	2.11	1.50	1.17	2.71
Old Private Sector Banks
2000-01	1.75	0.59	10.76	9.53	1.23	10.16	7.02	1.99	1.24	1.15	2.51
2001-02	2.70	1.08	11.74	9.36	2.38	10.67	6.97	2.08	1.26	1.62	2.39
New Private Sector Banks
2000-01	1.74	0.81	9.52	8.17	1.35	8.71	6.03	1.75	0.32	0.93	2.14
2001-02	1.21	0.44	5.66	4.48	1.18	5.22	3.33	1.12	0.25	0.77	1.15
Foreign Banks
2000-01	3.05	0.93	11.74	9.27	2.47	10.81	5.64	3.05	0.97	2.12	3.63
2001-02	3.13	1.33	11.56	8.65	2.91	10.23	5.40	3.03	1.00	1.80	3.25
Note : The ratios are compiled from the balance sheets of the respective banks and include the impact of merger, wherever applicable.

Income

2.41 The income of SCBs increased by 14.4 per cent during 2001-02 to Rs.1,51,026 crore. This was higher than the average growth rate of 11.7 per cent registered during the period 1997-2001. Among bank groups, while the increase in income for PSBs was 13.3 per cent, the same for old private and foreign banks increased by 20.4 per cent and 8.1 per cent, respectively. For new private sector banks, total income increased by 31.7 per cent [Appendix Table II.5(A) to (G)].

2.42 Owing to the higher growth in assets vis-à-vis the growth in income, the ratio of income to total assets of SCBs declined from 10.2 per cent in 2000-01 to 9.8 per cent in 2001-02. Except the PSBs group and old private sector banks, other bank groups, recorded declines in this ratio. The decline was most significant in the case of new private sector banks from 9.5 per cent to 5.7 per cent.

Interest Income

2.43 The interest income of SCBs witnessed a rise of 10.3 per cent. A large chunk of the interest income was accounted for by interest on advances (39.3 per cent in 2001-02), which was followed by income on investments, on account of valuation of the stock of investments held by banks as also on account of trading of such investments actively in the market (Box II.2)

Box II.2: Securities Trading and Profitability of Commercial Banks Investments, especially in government securities, constitute a considerable portion of assets of the SCBs in India. As on March 31, 2002, investments accounted for nearly two-fifths of the total assets of SCBs. Since yield-to-maturity (YTM) and security price are inversely related, a fall in YTM would, therefore, engender an increase in security price and vice versa. In line with general softening in interest rates since the late 1990s, YTM on government and other approved securities has declined substantially. On a point-to-point basis, the fall in YTM during 2001-02 of more than 300 basis points has been particularly remarkable and this has substantially boosted the profits of SCBs. The net profits of SCBs during 2001-02 at Rs. 11,572 crore increased by 81 per cent over the previous year, of which the gains on account of securities trading have been significant. Bank-wise data on securities trading during 2001-02 indicate that gains on such account emanated from sale of existing securities as well as increased turnover of trading in such securities. Gains from securities transactions, however, were not uniform across bank groups. In terms of absolute amounts, nationalised banks profited the most from such transactions, while in percentage terms, the gains were the highest for Indian private sector banks. The gains on securities trading during 2001-02 have also been supplemented by large reduction in staff expenses of PSBs.

2.44 Despite the rise in interest income, the ratio of interest income to total assets for SCBs stood lower at 8.3 per cent in 2001-02 as compared to 8.9 per cent in 2000-01. The increased asset growth of SCBs due to the impact of merger during the year outweighed this rise in interest income. Such ratios for PSBs and foreign banks decreased from 8.9 per cent and 9.3 per cent, respectively in 2000-01 to 8.7 per cent for both groups in 2001-02.

Other Income

2.45 Other income of SCBs witnessed a rise of nearly 41.6 per cent in 2001-02 to Rs.24,056 crore. Among bank groups, the increase was 33.6 per cent for PSBs, with a significant increase being recorded by nationalised banks (47.0 per cent) reflecting the increased diversification undertaken by them for fee-based activities. Old private sector banks recorded a massive increase in other income of 114.0 per cent to Rs.2,221 crore. Likewise new private sector banks also witnessed a substantial increase of 93.1 per cent. Commission, exchange and brokerage, which comprise a major share of 'other income' witnessed only a marginal rise of 3.7 per cent for SCBs over the previous year. With the result, its share in other income, declined to 38.3 per cent in 2001-02 from 52.3 per cent in the previous year.

2.46 The ratio of other income to total assets for SCBs stood at 1.6 per cent in 2001-02 as compared with 1.3 per cent in 2000-01. Most of the bank groups recorded increases in this ratio and the increase was more in respect of nationalised banks (1.5 per cent as compared with 1.1 per cent in 2000-01) and foreign banks (2.9 per cent as compared with 2.5 per cent in 2000-01).

Expenditure

2.47 Total expenditure of SCBs witnessed a rise of 11.0 per cent in 2001-02 to Rs.1,39,454 crore. This growth rate, however, was lower than the average growth rate of 11.9 per cent recorded over the period 1997-2001. Among bank groups, the increase in expenditure growth was the lowest for foreign banks (3.9 per cent) and the highest (32.6 per cent) for new private sector banks. In the PSBs category, the growth rate was higher for State Bank group at 11.2 per cent, whereas for nationalised banks, it was 9.0 per cent.

2.48 As a result of the containment in expenses, the ratio of expenditure to total assets for SCBs stood lower at 9.1 per cent in 2001-02 as compared with 9.7 per cent in 2000-01. While most bank groups recorded a decline in this ratio, old private sector banks registered an increase from 10.2 per cent in 2000-01 to 10.7 per cent in 2001-02.

Interest Expended

2.49 The major component of total expenditure was interest expenses, comprising nearly 63.0 per cent of the total expenses of SCBs. For SCBs as a whole, the rise in interest expenses was of the order of 12.0 per cent to Rs.87,516 crore. This was primarily due to an increase in the interest paid on deposits, which witnessed a rise of 12.3 per cent to Rs.80,570 crore. Foreign banks recorded the lowest growth in interest expenses (5.1 per cent) due to very low rise in interest paid on deposits (2.9 per cent). Among other bank groups, the interest paid on deposits increased by 16.6 per cent for State Bank group resulting in 16.0 per cent rise in interest expenditure.

2.50 The ratio of interest expended to total assets for SCBs declined to 5.7 per cent in 2001-02 from 6.0 per cent in 2000-01. The decline was also observed in the case of foreign banks .

Operating Expenses

2.51 The operating expenditure of SCBs witnessed a decline of 1.4 per cent in 2001-02, driven, to a large extent, by the decline in wage costs. It is significant that except the PSBs group, all other bank groups recorded a rise in operating expenses. In the case of PSBs, operating expenses declined by 5.7 per cent to Rs.26,422 crore, with a more pronounced reduction in the case of the State Bank group (11.6 per cent) vis-à-vis the nationalised banks (2.0 per cent). In contrast, other bank groups witnessed an upturn in this component of expenditure, with a noticeable increase in case of old private sector banks (14.9 per cent) and new private sector banks (41.4 per cent). In view of the overwhelming share of PSBs in the operating expenses of SCBs (about 78.0 per cent in 2001-02), this had the effect of exerting a downward pressure on operating expenses of SCBs as a whole.

2.52 During the period, the ratio of operating expenses to total assets for SCBs declined to 2.2 per cent in 2001-02 from 2.6 per cent in 2000-01. Concomitantly, such ratios for various categories of banks (except old private sector banks) also recorded declines.

Wage Bill

2.53 The major component of operating expenditure for SCBs, viz., wage bill witnessed a decline of 6.2 per cent in 2001-02. The decline was observed among the nationalised banks as well as the State Bank group (Chart II.5). For PSBs, the reduction in wage costs was of the order of Rs.1,884 crore on account of the VRS scheme introduced in the previous year (Box II.3). This has had a salutary effect on improving the profit parameters of PSBs.

Box II.3: Impact of Voluntary Retirement Scheme for PSBs With a view to optimise utilisation of human resources, 26 out of the 27 PSBs introduced voluntary retirement schemes (VRS) in 2000-01. As on March 31, 2002 implementation of the scheme involved a total cost of Rs. 12,300 crore for PSBs and resulted in nearly 12 per cent reduction in staff strength. The RBI permitted PSBs to amortise VRS related expenditure over a period of five years. The guidelines for such amortisation were set out in consultation with competent professional bodies. During 2000-01 and 2001-02, PSBs charged Rs. 3,007 crore and Rs. 2,346 crore, respectively, on their profit and loss account on account of VRS and as on March 31, 2002 the balance of deferred revenue expenditure related to VRS was Rs. 6,947 crore. The staff costs, as proportion of total costs declined during 2001-02, inspite of the apportionment for VRS. The business per employee and profitability (as measured by return on assets) for PSBs has increased during 2001-02.

2.54 With the lowering of wage costs, the ratio of wage bill to total assets of SCBs declined from 1.8 per cent in 2000-01 to 1.4 per cent in 2001-02. The decline was visible within both the subcategories of PSBs. The ratio for old private sector banks and foreign banks, however, witnessed marginal upward movements in tandem with the increase in their wage expenses.

Provisions and Contingencies

2.55 Provisions and contingencies (P & C) of SCBs witnessed a rise of 36.6 per cent in 2001-02. The sharp increase in P & C, especially provisioning for NPAs, in the light of the gradual tightening of prudential norms, reflects the growing awareness on the part of banks to set aside larger quantum against impaired assets. Among bank groups, such expenditure for PSBs increased by nearly 41.0 per cent, while that for new private sector banks witnessed the maximum rise of 83.3 per cent. Foreign banks, however, registered a decline in such expenditure owing to lowering of provisions for taxation.

2.56 A major component of P & C was the provisions for non-performing assets (NPAs), which for SCBs, increased by 40.5 per cent over the previous year. Even though there was increase in such provisions for all categories of banks, foreign banks registered the lowest increase.

2.57 During the review period, the ratio of provisions and contingencies to total assets of SCBs increased from 1.0 per cent in 2000-01 to 1.2 per cent in 2001-02. The trend was the same for all bank groups, except new private sector and foreign banks.

Operating Profit

2.58 As on March 31, 2002, the operating profits of SCBs increased by 51.0 per cent to Rs.29,814 crore over the previous year. Out of this, the operating profits of PSBs increased by 57.0 per cent, with an observed increase of 52.0 per cent and 61.0 per cent for the State Bank group and nationalised banks, respectively. Old private sector banks and foreign banks also registered notable increases in their operating profits. The increase for new private banks stood at 54.0 per cent [(Appendix Tables II.5 (A) to (G)].

Net Profit

2.59 Notwithstanding the increased provisions and contingencies by almost all bank groups (foreign banks were an exception), there was a marked increase in net profit by 80.7 per cent for SCBs during the year (excluding the impact of the merger, the increase in net profit was 80.6 per cent). The increase was significant in respect of most bank groups. The increase for PSBs was of the order of 92.3 per cent. Excluding the impact of the merger, the increase in net profit for new private banks was 19.9 per cent.

2.60 Driven by the improved profitability, the ratio of net profits to total assets for SCBs increased from 0.5 per cent in 2000-01 to 0.8 per cent in 2001-02. In case of PSBs, the ratio increased from 0.4 per cent to 0.7 per cent and was more than double for nationalised banks from 0.3 per cent to 0.7 per cent. Other bank groups also witnessed appreciable increases in the ratio; although an exception was the new private sector bank group for which the ratio declined from 0.8 per cent to 0.4 per cent (Chart II.6).

2.61 The increase in profits of PSBs was observed in the case of both the State Bank group and the nationalised banks. The breakup of profits of PSBs revealed that trading profits increased more than two-fold from Rs.2,250 crore in 2000-01 to Rs.5,999 crore in 2001-02, with several banks witnessing three to four-fold increase in such profits. Forex profits also registered an increase of 13.3 per cent to Rs.1,547 crore in 2001-02 (Table II.14).

Table II.14: Break-up of Profit of Public Sector Banks

Rs. crore
Sr.	Name of the Bank		Trading Profit		Forex Profit		Net Profit
No.			2000-01	2001-02	2000-01	2001-02	2000-01	2001-02
1	2		3	4	5	6	7	8
I.	Nationalised Banks		1,690	4,965	926	998	2,095	4,852
1	Allahabad Bank		48	193	29	29	40	80
2	Andhra Bank		65	136	13	16	121	202
3	Bank of Baroda		102	415	134	117	275	546
4	Bank of India		196	427	105	124	252	505
5	Bank of Maharashtra		81	167	23	12	45	145
6	Canara Bank		201	663	124	129	285	741
7	Central Bank of India		144	318	31	29	46	163
8	Corporation Bank		67	135	37	53	262	308
9	Dena Bank		37	201	16	16	-266	11
10	Indian Bank		60	226	48	55	-274	33
11	Indian Overseas Bank		53	257	42	52	116	230
12	Oriental Bank of Commerce		95	311	38	39	203	321
13	Punjab & Sind Bank		69	126	24	25	13	23
14	Punjab National Bank		242	438	94	92	464	562
15	Syndicate Bank		67	74	36	29	235	251
16	UCO Bank		73	346	18	25	33	165
17	Union Bank of India		34	160	90	114	155	314
18	United Bank of India		51	281	2	3	19	119
19	Vijaya Bank		3	90	24	37	71	131
II.	State Bank Group		560	1,034	439	549	2,222	3,449
20	State Bank of India		342	352	304	408	1,604	2,432
21	State Bank of Bikaner & Jaipur		18	77	23	21	105	165
22	State Bank of Hyderabad		40	105	35	35	150	226
23	State Bank of Indore		63	174	8	9	64	125
24	State Bank of Mysore		28	76	13	21	26	66
25	State Bank of Patiala		22	95	21	20	161	233
26	State Bank of Saurashtra		16	80	10	10	14	82
27	State Bank of Travancore		30	75	26	25	97	121
III.	Public Sector Banks (I+II)		2,250	5,999	1,365	1,547	4,317	8,301

---

Notes:		1. Trading Profit - Net Profit on Sale of Investment.
		2. Forex Profit - Net Profit on Exchange Transaction.
Source :		Balance Sheet of respective banks.

Off-Balance Sheet Activities

2.62 Off-balance sheet activities of SCBs, comprising forward exchange contract, guarantees, acceptances and endorsements, etc., registered a rise of 17.7 per cent in 2001-02 (Table II.15). The ratio of contingent liabilities to total liabilities of SCBs witnessed a marginal decline from 58.1 per cent in 2000-01 to 57.7 per cent in 2001-02. Forward exchange contracts, which account for the highest share of contingent liabilities, increased by 10.4 per cent to Rs.6,35,095 crore. The highest growth, however, was recorded by acceptances, endorsements, etc., which increased by over 56.9 per cent during the year.

Table II.15: Off-Balance Sheet exposure of Scheduled Commercial Banks in India

(Rs.crore)
Item	State Bank Group			Nationalised Banks			Public Sector Banks
	2000-01	2001-02	Variations	2000-01	2001-02	Variations	2000-01	2001-02	Variations
1	2	3	4	5	6	7	8	9	10
1. Forward exchange	61,945.87	70,280.40	13.45	1,37,619.48	1,38,960.22	0.97	1,99,565.35	2,09,240.62	4.85
Contract	(15.37)	(15.63)		(21.95)	(19.68)		(19.38)	(18.0)
2. Guarantees given	17,336.27	17,727.41	2.26	26,656.95	30,423.26	14.13	43,993.22	48,150.67	9.45
	(4.30)	(3.94)		(4.25)	(4.31)		(4.27)	(4.17)
3. Acceptances,	25,122.48	38,575.42	53.55	30,054.08	33,311.44	10.84	55,176.56	71,886.86	30.29
Endorsements, etc.	(6.23)	(8.58)		(4.79)	(4.72)		(5.36)	(6.22)
Total Contingent	1,04,404.62	1,26,583.23	21.24	1,94,330.51	2,02,694.92	4.30	2,98,735.13	3,29,278.15	10.22
Liabilities	(25.91)	(28.16)		(30.99)	(28.7)		(29.00)	(28.49)

Item	New Private Sector Banks			Old Private Sector Banks			Foreign Banks			All SCBs
	2000-01	2001-02	Varia-tions	2000-01	2001-02	Varia-tions	2000-01	2001-02	Varia-tions	2000-01	2001-02	Varia-tions
1	11	12	13	14	15	16	17	18	19	20	21	22
1. Forward exchange	41,243.39	47,697.38	15.65	18,451.56	17,390.79	-5.75	3,15,988.13	3,60,766.65	14.17	5,75,248.43	6,35,095.44	10.40
contract	(52.34)	(27.34)		(21.83)	(18.65)		(309.47)	(321.84)		(44.41)	(41.36)
2. Guarantees given	7,087.08	14,503.54	104.65	2,958.29	3,302.63	11.64	17,296.43	18,298.13	5.79	71,335.02	84,254.97	18.11
	(8.99)	(8.31)		(3.50)	(3.54)		(16.94)	(16.32)		(5.51)	(5.49)
3. Acceptances,	10,954.72	23,979.72	118.90	3,242.50	3,295.87	1.65	36,398.39	66,837.80	83.63	1,05,772.17	1,66,000.25	56.94
endorsements, etc.	(13.90)	(13.75)		(3.84)	(3.54)		(35.65)	(59.63)		(8.17)	(10.81)
Total Contingent	59,285.19	86,180.64	45.37	24,652.35	23,989.29	-2.69	3,69,682.95	4,45,902.58	20.62	7,52,355.62	8,85,350.66	17.68
Liabilities	(75.24)	(49.40)		(29.16)	(25.73)		(362.05)	(397.78)		(58.08)	(57.66)
Notes : 1. Figures in brackets are percentages to Total Liabilities of the concerned bank group. 2. Variation indicates the percentage variation in 2001 02 over 2000 01 of the concerned item.

2.63 Foreign banks were particularly active in off-balance sheet activities. With the result, the ratio of off-balance sheet activity to total liabilities of foreign banks rose to 397.8 per cent in 2001-02 as compared with 362.1 per cent in 2000-01. Among PSBs, such ratio for the State Bank group was 28.2 per cent in 2001-02.

Spread

2.64 With the increase in interest income outpacing interest expense, the interest spread of SCBs increased by 6.8 per cent to Rs.39,454 crore in 2001-02. While most of the bank groups registered a rise in spreads, there was a decline of 1.6 per cent in the interest spread of foreign banks. New private sector banks, recorded a 19.3 per cent increase in spreads in 2001-02 (Chart II.7). Bank-wise details of select parameters of PSBs, private sector banks and foreign banks are furnished in Appendix Tables II.6 (A) to 6 (I), II.7(A) to 7(H) and II.8(A) to 8 (H), respectively.

2.65 During the review period, there was a decline in the ratio of spread to total assets for SCBs from 2.9 per cent in 2000-01 to 2.6 per cent in 2001-02. The decline was reflected across all bank groups. For instance, for PSBs, the ratio declined from 2.9 per cent in 2000-01 to 2.7 per cent in 2001-02. Some of the factors impacting on spreads are given in Box II.4.

Box II.4: Spreads in the Banking Sector A central objective of financial deregulation is to encourage competition among financial institutions in order to improve the efficiency and the stability of the financial system. In this context, the difference between the interest rate charged to borrower and the interest rate paid to depositors, which reflects the cost of intermediation, is an important indicator of efficiency. A high differential may adversely affect domestic savings and jeopardize economic growth. Financial deregulation, by enhancing competition, is expected to narrow this gap. Financial systems in developing countries typically exhibit significantly high and persistent spreads (Barajas et al., 2000). These high margins have persisted even though most countries have undertaken financial liberalisation. It has been observed that in many sub-Saharan African countries, the range of financial products remain extremely limited, interest rate spreads are wide, capital adequacy ratios insufficient, and the share of non-performing loans quite high. Similarly, Brock and Rojas-Suarez (2000) remark that most policymakers in Latin America have been disappointed by the fact that spreads have failed to converge to international levels. Several arguments have been advanced for the same. First, high interest rates may persist if financial sector reforms do not significantly alter the structure within which banks operate. Several studies have noted that competitive pressures that arise from conditions of free entry and competitive pricing will tend to raise the functional efficiency of intermediation by decreasing the spread. More recent studies on bank spreads also tend to support the hypothesis that intermediation margins are positively related to market power (Barajas et al., 1999). Second, in many developing countries without an explicit deposit insurance mechanism, banks are subject to high reserve requirements, even post liberalisation. While such requirements might be dictated by the need for protection of depositors' interests, the availability of a pool of resources allows for financing high fiscal deficits through an implicit financial tax, thereby creating an environment that can promote rising inflation and persistent high intermediation margins. Barajas et al. (2000) for instance, find evidence of a positive and significant relationship between spreads and liquidity reserves in the Columbian banking system. Third, the removal of credit controls during financial liberalisation may worsen the quality of loans that may, in turn, lead to increased risks of systemic crisis. Testimony for the same is empirically evidenced in the work of Brock and Rojas-Suarez (2000) and Barajas et al. (2000) who note that the cost of poor quality loans is shifted to bank customers through higher spreads. Fourth, there is overwhelming evidence that high non-financial costs also act as a source of persistent and wide intermediation spreads in developing countries. Non-financial costs reflect variations in physical capital costs, employment and wage levels. Demirgic-Kunt and Huizinga (1999) find evidence of a positive relation between net interest margin and overhead costs. Similarly, Brock and Rojas-Suarez (2000) also find significant evidence of a positive relation between spreads and wages or non-financial costs. Fifth, Saunders and Schumacher (2000) note that the capital which banks hold to cushion themselves against expected and unexpected risks may lead to higher spreads. The cost of high regulatory and/or endogenously determined capital ratios may be covered through widening the spread between lending and deposit rates. Sixth, macroeconomic instability and the policy environment may also affect the pricing behaviour of commercial banks. In order to capture the effects of the macroeconomic and policy environment, spread equations include, among others, inflation and growth of industrial output as control variables. For instance, there is evidence to suggest that inflation is positively associated with intermediation spreads, particularly in developing countries with high and variable inflation rates (Demirgic-Kunt and Huizinga, 1999; Mlachila and Chirwa, 2002). In summary, while financial liberalisation should generally lead to a lowering of spreads, whether they actually decline or not ultimately depend upon a number of factors. Generally, lending rates relative to deposit rates can increase or remain high, depending on the level of reserve requirements, the competitiveness of the banking system, the cost structure of the market, and the macroeconomic environment. On the other hand, if the banking system is characterised by excess liquidity, deposit rates are unlikely to increase much following financial liberalisation because the marginal cost of mobilising resources is high, while the marginal profit is negligible. Thus, the spread may actually rise, rather than fall, after financial liberalisation. References: Barajas, A., R.Steiner and N.Salazar (1999), 'Interest Spreads in Banking in Columbia, 1974-96', IMF Staff Papers, 46, pp.196-224. Barajas, A., R.Steiner and N.Salazar (2000), 'The Impact of Liberalisation and Foreign Investment in Columbia's Financial Sector', Journal of Development Economics, 36, pp.157-196, 2000. Brock, P.L. and Rojas-Suarez, L (2000), 'Understanding the Behavior of Bank Spreads in Latin America', Journal of Development Economics, 63, pp. 113-134. Demirgic-Kunt, A. and H.Huizinga (1999), 'Determinants of Commercial Bank Interest Margins and Profitability: Some International Evidence', World Bank Economic Review, 13, pp.379-408. Mlachila, M and E.Chirwa (2002), 'Financial Reforms and Interest Rate Spreads in the Commercial Banking System in Malawi', IMF Working Paper No.6, IMF:Washington. Ramaiah, M. and S.Ghosh (2002), 'Understanding the Behaviour of Bank Spreads in India: An Empirical Analysis', Prajnan, 31, pp. 7-19. Saunders, A. and L.Schumacher (2000), 'The Determinants of Bank Interest Rate Margins: An International Study', Journal of International Money and Finance, 19, pp.813-832.

4. Non-performing Assets

2.66 The gross non-performing assets (NPAs)⁴ of SCBs stood at Rs.70,904 crore as on March 31, 2002 as compared with Rs.63,741 crore at the end of the previous year. The gross NPAs for end-March 2002 includes an amount of Rs. 4,512 crore on account of merger. During the same period, net NPAs increased by 9.5 per cent to Rs.35,546 crore from Rs.32,461 crore at end-March 2001. For PSBs, gross NPAs stood at Rs.56,507 crore as at end of March 2002, comprising 79.7 per cent of the sticky loans of SCBs (Table II.16).

Table II.16: Gross and Net NPAs of Scheduled Commercial Banks - Bank Group-wise (As at end-March)
										(Amount in Rs. crore)
Bank Group/Year				Gross NPAs					Net NPAs
			Gross	Amount		Per cent	Per cent	Net	Amount	Per cent	Per cent
			Advances			to Gross	to total	Advances		to Net	to total
						Advances	Assets			Advances	Assets
1			2	3		4	5	6	7	8	9
Scheduled Commercial Banks
1999			3,99,436	58,722		14.7	6.2	3,67,012	28,020	7.6	2.9
2000			4,75,113	60,408		12.7	5.5	4,44,292	30,073	6.8	2.7
2001			5,58,766	63,741		11.4	4.9	5,26,329	32,461	6.2	2.5
2002			6,80,958	70,904	#	10.4	4.6	6,45,859	35,546	5.5	2.3
Public Sector Banks
1999			3,25,328	51,710		15.9	6.7	2,97,789	24,211	8.1	3.1
2000			3,79,461	53,033		14.0	6.0	3,52,714	26,187	7.4	2.9
2001			4,42,134	54,672		12.4	5.3	4,15,207	27,977	6.7	2.7
2002			5,09,368	56,507		11.1	4.9	4,80,681	27,958	5.8	2.4
Old Private Sector Banks
1999			28,979	3,784		13.1	5.8	26,017	2,332	9.0	3.6
2000			35,404	3,815		10.8	5.2	33,879	2,393	7.1	3.3
2001			39,738	4,346		10.9	5.1	37,973	2,771	7.3	3.3
2002			44,057	4,850		11.0	5.2	42,286	3,005	7.1	3.2
New Private Sector Banks
1999			14,070	871		6.2	2.3	13,714	611	4.5	1.6
2000			22,816	946		4.1	1.6	22,156	638	2.9	1.1
2001			31,499	1,617		5.1	2.1	30,086	929	3.1	1.2
2002			76,901	6,822	#	8.9	3.9	74,187	3,663	4.9	2.1
Foreign Banks in India
1999			31,059	2,357		7.6	3.1	29,492	866	2.9	1.1
2000			37,432	2,614		7.0	3.2	35,543	855	2.4	1.0
2001			45,395	3,106		6.8	3.0	43,063	785	1.8	0.8
2002			50,631	2,726		5.4	2.4	48,705	920	1.9	0.8
# The gross NPAs for end-March 2002 include an amount of Rs. 4,512 crore on account of merger.
Notes:	1.	Constituent items may not add up to the totals due to rounding off.
	2.	The figures furnished in the table may not tally with the data in table II.18 due to different sources of data collection.
Source:		Balance sheets of respective banks.
		Returns submitted by respective banks.