How do Banks Earn profit / Incur Loss?

How do Banks Earn profit / Incur Loss?

We have been encountering this question from many of our students. We are here with a detailed answer. This whole post has been written under the guidance of our retired banking officers.

Banks have purposely 2 work to do. 

• Deposits: Banks are the medium of save for all the people. People deposit funds in different type of accounts and get different interests over the same. Where the minimum saving bank rate is capped at 4%, fixed deposit rates depend from bank to bank.
  The funds which bank take for minimum 4% interest or No interest money in Current accounts together make up the CASA of the bank. CASA ratio is regarded very important for a bank’s profitability.
• Advances: Banks are the engines of growth of any economy. Banks take deposit from depositors in forms of Saving bank account, current accounts and Fixed deposits and later lend that money to public on a higher rate of interest for various purposes. These purposes can be many including housing loans, agri loans, priority sector loans, MSE loans etc.

The difference between the NET Interest On Advances – Net Interest on Deposits = Net Interest Margin.

What are the other cost of A Bank:

Banks have many other costs involved in their functioning. They are divided in basically 2 parts.

Fixed Expenditure: They include expenses of

• Salary to Staff
• Office Rent
• Other Charges

Variable Expenses: These expenses change from time to time. They include

• Electricity bills
• Telephone Bills
• Other Bills
• Staff TA and Halting Bills
• Other Charges.

The addition of both the fixed charges, and variable charges add to the Expenditure incurred by the bank.

Addition of Fixed and Variable Expenditure is later added to the Interest Payable on deposit and then deducted from the income earned from Loan Accounts. The difference turns out to be the Gross Profit/ Operating Profit of the Bank

From this Gross profit provisioning for all Non Preforming Assets and government Taxes is deducted.

After deduction what comes out is known as Net Profit/Loss.

We hope the above explanation was helpful. If you have any other query, you can 
use the comment box to ask it.