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Chapter III

Sources and Uses ofFunds in a Bank

After readi ng this chapter, you w il l be conversant with:

A Bank’s Balance Sheet

Sources and Uses of Funds in a Bank

A Bank’s Profit and Loss Account

Books of Accounts in Banks




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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 bank’s balance sheet and

also its revenues and expenses from the 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 bank’s balance sheet and

profit and loss account will be shown under different schedules.

Form ‘A’ is the form of 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 withRBI

02 Reserves and Surplus 07 Balances with Banks and

Money at Call and Short Notice

03 Deposits 08 Investments

04 Borrowings 09 Advances

05 Other Liabilities and

Provisions

10 Fixed Assets

12 Contingent Liabilities 11 Other Assets

Source: ICFAI Research Center.

Form ‘B’ or the form of Profit and Loss Account has 4 schedules and gives thedetails 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


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.

A BANK’S BALANCE SHEET – STATEMENT OF SOURCES AND USES

Similar to the balance sheet of any other firm, the bank’s balance sheet also has

assets that represent uses of funds to generate revenue for the bank and liabilities

and net worth that form the sources of the bank’s funds.

However, within this framework, there are significant differences in the basic

composition of the assets and the liabilities and how they contribute towards therevenues and expenses of the bank.




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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, exemptedfrom the minimum capital 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.

RESERVE AND SURPLUS

The components under this item of the bank’s 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 item will show the premium on 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 fordepreciation 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.

DEPOSITS

The equity capital and reserves of a bank form relatively 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 depositsaccepted for a term and 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 term deposits.

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

form of an operating account primarily for a business concern.



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ii. Savings Deposits: These represent balances payable on demand which are inthe form of 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 maximum maturity 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 term deposits 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

repayment.

All the deposits mentioned above will be classified into those from banks and from

others. The deposits from banks will include deposits from the banking system in

India, co-operative banks, foreign banks which may or may not have operations in

India. The term banking 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 them into those raised

by branches in India and those raised by overseas branches.

BORROWINGS

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 borrowedin the money market will be shown under borrowings from other 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.

OTHER LIABILITIES AND PROVISIONS

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

items. 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 bank’s 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.




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Others: The other liability items include the net provision for income tax

after deducting the advance payment, tax deducted at source, etc., and othertaxes 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 ofreserves, the proposed dividend/transfer to government, unexpired discount,

outstanding charges like rent, conveyance, etc., other liabilities that do notappear under any other head such as unclaimed dividend, provisions and

funds kept for specific purposes and certain types of deposits like staffsecurity deposits, margin deposits, etc., where the repayment is not free,

should also be included under this head.

Appl ication of Funds – Bank’s AssetsThe funds mobilized by the bank, through various sources will be deployed intothe various assets. The assets side of a bank’s 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

Investments

Advances

Fixed Assets

Other Assets.

Within the broad classification given above, lie a variety of assets, a detailed

description of which is given as follows:

CASH AND BALANCES WITH THE RBI 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 depositwithdrawals, meet emergency expenses and handle unexpected credit demands

from customers. The cash assets consist of the following:

i. Cash in Hand: This asset item includes cash in hand, including foreigncurrency notes and cash balances in the overseas branches of the bank. These

are held on the bank’s 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 ReserveRequirements (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 isan 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 theRBI. 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.

BALANCES WITH BANKS AND MONEY AT CALL AND SHORT NOTICE 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 term deposit 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.

INVESTMENTS

A major asset item in 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

Shares

Debentures and Bonds

Subsidiaries and/or JVs

Other Investments.

While the above-mentioned categories refer to the investments made in the

domestic market, bank’s can also invest in overseas markets. The overseas

investments will include foreign government securities, subsidiaries and/or JVs

and other investments.

ADVANCES

The most important asset item on the bank’s balance sheet are advances. These

advances, which represent the credit, extended by the bank to its customers, form amajor 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

with IDBI/SIDBI.

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




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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 = 2,780Bills 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 ofadvances based on the nature/type of the credit extended.

– Bills purchased and discounted: The amount that is shown against this

item in the balance sheet will be the bills discounted/purchased by

banks from the client irrespective of whether they areclean/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 aspecific 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 beconsidered as secured assets.

– Covered by Bank/Government Guarantees: Advances in India and

outside India to the extent they are covered by guarantees of Indian andforeign 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 thiscategory.

Sectoral Advances (Format III): Sectoral segregation will be doneseparately 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 andstate government and other government undertakings. Advances

extended to public sector which are eligible to be classified as priority



Overview of Banking

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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-operativesectors.

Further, if the advances provided by the banks are on a consortium basis, the

amount to be considered will be net of the share from other participating

banks/institutions.

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

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 thereis any write-off on reduction of capital and revaluation of assets, then the revised

figures must be shown in the subsequent balance sheets 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

year’s balance sheet will be adjusted for any additions and deductions made during

the year and the write-offs due to depreciation.

OTHER ASSETS

The remainder of the items on the assets side of the bank’s 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 afteraggregating all the interoffice accounts will appear in this account. This will

generally include items in transit and unadjusted items. If the net balanceshows 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 theirinter-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 form of loans, overdrafts and cash

credits is debited to the respective accounts and hence no such amountusually gets classified here. However, interest accrued on bills

purchased/discounted gets classified here. Hence, the major item under thiscategory will be interest on investments.

Tax Paid in Advance/Tax Deducted at Source: The amount of taxdeducted 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 writtenoff 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 bythe bank in satisfaction of bank’s claims on others.




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Others: Other items primarily include claims that are in the form of 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 from the total of the balance sheet to arrive at working funds/earning

assets/total assets. Working Funds, Earning Assets and Total Assets represent

the same item and 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 them to sustain profitably in

that business.

A BANK’S PROFIT AND LOSS ACCOUNT

The bank’s 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 bank’s 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 from bank operations.

Revenues

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.

INTEREST EARNED

Like in any lending business, interest income forms the major and most important

revenue item for 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, term loans, 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.



Overview of Banking

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OTHER INCOME Apart from the interest income, banks will also have certain income in the form of

fees, commission, exchange, etc. The bank’s other income will mostly be derived

in the following ways:

– Commission, Exchange and Brokerage: Remuneration on services such ascommission on collections, letters of credit and guarantees, government

business and other permitted agency business including consultancy andother services. It also includes remuneration on letting out lockers,

commission/exchange on remittances and transfers, brokerage, etc. onsecurities.

– 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, motorvehicles, 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 afterdeducting 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 foreignexchange transactions excluding interest which will be shown under interest.

– Income Earned by way of Dividends, etc.: This will include the dividends

from subsidiaries/companies and/or joint ventures abroad or in India.

– Miscellaneous Income: The miscellaneous income will comprise recoveriesfrom constituents for godown rents, income from bank’s properties, security

charges, insurance, etc. If any income under this heading exceeds one percentof 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 them will however, depend on the policy of the bank

and its nature of activity. For example, if the bank concentrates mostly on itsinvestment activity, it will have most of its income generated as the interest earned

from its investment portfolio. Whatever may be the bank’s policy, majority of banks will have a large chunk of their income coming from the interest earned.

The key issues related to the bank’s profitability will be interest yield oninvestments, interest yield on credit and proportion of non-interest income to total

income.

ExpensesThe 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.

INTEREST EXPENSES

Since a bank will have to mobilize funds regularly to meet the credit demands, its

major expenses arise from the interest expended on deposits and borrowings.a. Interest on deposits: Interest paid on all types of deposits raised by the bank

from other banks, institutions and others will appear under this head.

b. Interest on RBI/interbank borrowings: This includes the discount/interest

on all borrowings/refinance from RBI 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.




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OPERATING EXPENSES

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 item includes 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 Bank’s Property: Included here is the amount of

depreciation on bank’s own property, motor cars and other vehicles,

furniture, electric fittings, vaults, lifts, leasehold properties, non-banking

assets, etc.

f. Director’s 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 item includes the branch auditor’sfees 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 bank’s property, their maintenance

charges, etc. are included here.

k. Insurance: This includes insurance charges on bank’s property, insurance

premium paid to Deposit Insurance and Credit Guarantee Corporation

(DICGC), etc. to the extent they are not recovered from other concerned

parties.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.



Overview of Banking

58

Provisions and ContingenciesProvisions made for bad and doubtful debts, taxation, diminution in the value of

investments, transfers to contingencies and other similar items will be appearingunder this category of expenses.

Unlike the balance sheet of a company the payment of tax is included under the

item ‘provisions’ and is not shown separately. Having prepared the balance sheetand P&L account, the bank is required to submit the same along with the auditor’s

report to RBI under Section 31 of the Banking Regulation Act, 1949. Schedule 17

of the Bank’s 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, from the 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 givedetails 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.

BOOKS OF ACCOUNTS IN BANKS

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 accountsare provided below.

Principal Books of AccountsThe principal books of accounts of a bank consist of the General Ledger and theProfit 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 from the general ledger. Contra accounts which have no direct

effect on the bank’s 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




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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 from the 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

system to 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

accounts.

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.



Overview of Banking

60

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 companiesand 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-term liquidity, the banks

are required to prepare the Statement of Short-term Dynamic 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 maximum potential loss in a

position for a given holding period for a given 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) andRate 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 from declining interest rates by a

negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure of

interest rate sensitivity.




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Focus of ALM

ALM includes management of the following types of risks:

Liquidity

Interest rate

Trading

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-term profits of the bank and vice versa. Thus, ALM is a critical exercise in

balancing the risk profile with the long/short-term profits while ensuring its

long run sustenance.


Subsidiary BooksApart from the principal books, there are other subsidiary books maintained in theform of 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 from the 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. Theyare 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 billsfor 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 from the original document.A voucher prepared for the total amount of the transaction each day is entered inthe 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 i s 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 ofthe original entry in respect of bills for collections, and this is reversed on

realization. Outstanding entries are summarized frequently, and their total isagreed with the balance of the respective control accounts in the general ledger.

Other Subsidiary Registers

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



Overview of Banking

62

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 alsosummarized on vouchers every day, and these vouchers are posted into the Day Book.

Box 2: Contingent Liabilities

Yet another significant component of the bank’s balance sheet is the contingentliability. Many banks, particularly the largest banking institutions generateincome 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 form ofacceptances, endorsements in the form of 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 andother items like arrears of cumulative dividends, bills rediscounted,

underwriting commitments, estimated amount of contracts remaining to beexecuted on capital account and not provided for, etc.


DEPARTMENTAL JOURNALS 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

department.

Other Memoranda Books

Besides, the books mentioned above, various departments of the bank maintain anumber 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 cashier’s cash book, paying cashier’s 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 cardsand 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 from customers 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 thecheques 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.




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LOANS AND OVERDRAFT DEPARTMENT

a. Registers for shares and other securities held on behalf of each customer.

b. Summary books of securities giving details of Government securities, sharesof 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 bank.

e. Overdraft sanction register.

f. Drawing power book.

g. Delivery order book

h. Storage book.

DEPOSITS DEPARTMENT 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

ESTABLISHMENT DEPARTMENT a. Salary and allied registers, such as attendance register, leave register, overtime

register.

b. Register of fixed assets.

c. Stationery register.

d. Old records register.

GENERAL

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 thecommon books maintained are as follows:

For average balances in loans and advances

Deposits

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 arisingfrom secured 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 borrower’s 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 hisdeposits have been put by his bank. The banks issue participation certificates

against the working capital advances granted to the industrial concerns.



Overview of Banking

64

These advances are earmarked in favor of the holder of certificates. Theseinstruments were discontinued as they distort the credit deployment of banks.

The banks which purchased the certificates were required to show the amountunder ‘Advances to banks’ and were required to report the funds in weekly returnunder 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 Certificateswhich had been phased out should be reintroduced in modified form. This

instrument would be revived after the Indian Banks Association evolves asatisfactory 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 ofwithdrawals 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

accounts:

a. NRO Account (Non-Resident Ordinary)

b. NRE Account (Non-Resident External)

c. FCNR Account (Foreign Currency Non-Resident)

d. QA 22 Account


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 sustenanceof the financial intermediaries.

SUMMARY

Banks, acting as vital links between the economic policies of the government

and the various economic factors have become the most important financial

intermediaries.

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.




65

The assets side of a bank’s 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

Books.

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.



Overview of Banking

66

Annexure

“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 system of the

economy.

Presently banks are subjected to Annual Financial Inspections (AFI) by RBI with

the main accent on the assessment of the bank’s financial position and senior

officials of the RBI’s 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).




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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.

sources and uses-icmr

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