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Performance Evaluation Parameter For Banking and Retailing: Unit 3
Performance Evaluation Parameter For Banking and Retailing: Unit 3
Performance Evaluation
Parameter for Banking and
Retailing
As the case of any institution, the evaluation of the performance of banks and
retail sector has to be undertaken in relation to theirs and objectives.
For a Bank the two key scarce resources generally are Capital and Liquidity.
A) Customer Base:
Client relationship, getting back to basics, customer centric culture etc., are some of the
buzzwords in the present day banking universe. Banks today are going out of their way to get
closer to the customer and align their product & service offerings to best match the customer
needs.
a) Meaning:
A customer base is a group of customers who could be served by a business. Many people
define this term as only the consumers who already patronize a business, but others include
any consumer with certain purchasing characteristics in this category, even if that customer
has yet to be convinced to enter the store or take advantage of a product. Within the larger
group is a smaller subset of the customer base that is made up of loyal shoppers, also called
repeat customers.
3.1 Performance Evaluation Parameters for Banks:
b) Drivers of Change from ‘Product-Centric’ to Customer-Centric:
The major drivers for this change include the following:
3.1 Performance Evaluation Parameters for Banks:
b) Drivers of Change from ‘Product-Centric’ to Customer-Centric:
1) Key Customer Segments :
Today key customer segments HNI and UHNI increasingly value trusted lasting relationships
over newer and complex product offerings; this has been proven by research as well.
For banks to keep the focus on core' operations mean that they need to realign and reengineer
their key business processes in such a way that they can synergize their efforts toward
customer intimacy.
3.1 Performance Evaluation Parameters for Banks:
B) Non-Performing Asset (NPAs):
Non-performing asset (NPA) is one of the major concerns for banks in India. NPAs reflect the
performance of banks. A high level of NPAs suggests high probability of a large number of credit
defaults that affect the profitability and net-worth of banks and also erodes the value of the
asset.
a) Meaning:
Assets which generate periodical income are called as performing assets. Assets which do not
generate periodical income are called as non-performing assets. NPAs are further classified
into sub-standard, doubtful and loss assets based on the criteria stipulated by RBI.
3) Doubtful Assets:
All those assets which are considered as non-performing Doubtful Loss
for period of more than 12 months are called as Doubtful Assets Assets
assets.
4) Loss Assets:
A loss asset is one where loss has been identified by the bank or internal or external
auditors or the RBI inspection but the amount has not been written off wholly.
3.1 Performance Evaluation Parameters for Banks:
d) Impact of NPAs on Banking Operations:
The NPAs have deleterious impact on the return on assets in the following ways:
1) The interest income of banks will fall and it is to be accounted only on receipt basis.
2) Banks profitability is affected adversely because of the providing of doubtful debts and
consequent to writing it off as bad debts.
3) Return on investments (ROI) is reduced.
4) The capital adequacy ratio is disturbed as NPAs enter into its calculation.
5) The cost of capital will go up.
6) Asset and liability mismatch will widen.
7) It limits recycling of the funds
e) Reporting of NPAs:
Every year on 31st March, Banks must report on NPAs after completion of audit.
Whenever NPAs are reported to RBI, the amount held in interest suspense account, should be
shown as a deduction from gross NPAs as well as gross advances while arriving at the net
NPAs.
Banks who does not maintain Interest Suspense account for parking interest due
on non- performing advance accounts, May furnishes the amount of interest
receivable on NPAs as a foot note to the report.
3.1 Performance Evaluation Parameters for Banks:
C) Deposits:
Stable funding is vital for banks and the financial system.
This warrants analysis of the significance of a reliable, low-cost way for banks to refinance
their operations deposits.
Deposits play an important role for both consumers and financial services providers.
The chief providers of deposits households hold roughly 30% of their financial wealth in this
form.
As a funding instrument deposits have the advantage of being stable and hardly exposed to
the ups and downs of the capital markets.
Deposits are the most common, and almost always the cheapest, source of loan able funds
for banks.
3.1 Performance Evaluation Parameters for Banks:
a) Significance of Deposits for Banks:
For a commercial bank, deposits are the oldest, most stable and, by volume, most significant
source of funding.
From the bank’s perspective, there are basically three distinct criteria by which deposits can
be differentiated:
Stable Funding
Source
Short-Term
Funds
Significance of
Deposits for
Banks
Helps to Assess
Liquidity
Deposits
Bank's
Origin of the
The Geographic
3.1 Performance Evaluation Parameters for Banks:
a) Significance of Deposits for Banks:
1) Stable Funding Source:
The group of investors who are the source of the deposits these include not only other banks,
financial institutions and the government, but in the narrower sense mainly the private sector,
that is households and businesses.
2) Short-Term Funds:
Generally, deposits tend to be short-term funds that could quickly be withdrawn from an
account again. As a rule, however, in practice they prove to be the most stable form of bank
funding apart from equity capital.
HousehIncome
olds Interest
Rates
Costs and
Availability
Risk-
Reward
Profile
Compe
tition
Demog
Trust in the
Banking
raphy
Sector
3.1 Performance Evaluation Parameters for Banks:
b) Determinants of Deposit Growth:
1) Income:
One assumption would be that as incomes rise, deposits with banks do so as well.
2) Inflation/Interest Rates:
As inflation accelerates, deposits become less attractive, depending on the interest rate. In
this case, the assumption would be that as deposit interest rates rise, deposits would
increase in principle as well.
4) Demography:
The life-cycle hypothesis assumes that deposits increase in the course of a person’s
lifetime, only to decrease as the person reaches old age. So with a population generally
ageing, one would have to expect an overall decline in deposits.
3.1 Performance Evaluation Parameters for Banks:
b) Determinants of Deposit Growth:
5) Trust in the Banking Sector and its Stability:
The assumption would be that given pronounced trust in the banking sector the volume of
deposits would tend to increase. Credible guarantee systems (deposit guarantees, bank
bail-out funds) could be helpful in this case.
6) Competition:
Strong competition in the banking sector could necessitate higher interest rates being
offered to attract deposits. From the banks’ point of view, this could reduce the
attractiveness of deposits as a funding instrument.
8) Households:
It is the greater risk aversion among non-banks. Over the past ten years, households
boosted their investments in insurance policies, deposits and cash.
3.1 Performance Evaluation Parameters for Banks:
c) Alternatives to the Current Funding Structure :
Given difficult funding conditions in the capital market, new regulatory requirements and the
heightened awareness of the need for more stable funding, banks are basically left with the
choice of two complementary alternatives:
Besides interbank loans, bonds and deposits (debt capital), equity capital is also one potential
alternative funding instrument. In principle, equity capital can be increased by issuing new
shares and retaining profits. Both possibilities are subject to restrictions.
3.1 Performance Evaluation Parameters for Banks:
d) Measures to Check Falling in Bank Deposits:
1) Higher Interest Rates :
Banks will offer incentives to depositors in the form of higher interest rates and other
attractive conditions in order to retain depositors on their books.
2) To calculate ROI of an investment center, it is important to define the revenue, expense and
investment allocated to the center.
3) When a firm functions within the goals of the organization in mind, and attains a certain level
of return on the total book value of the investment, then the managers of the investment
centers can be made responsible for ROI as computed in the divisional income statement
and the balance sheet.
4) Return on investment can be used to measure the value of an entire company or of a specific
investment that a company might make.
3.1 Performance Evaluation Parameters for Banks:
E) Financial Inclusion:
India has, for a long time, recognized the social and economic imperatives for broader
financial inclusion and has made an enormous contribution to economic development by
finding innovative ways to empower the poor.
a) Meaning:
Financial inclusion is the process of ensuring access to appropriate financial products and
services needed by vulnerable groups such as weaker sections and low-income groups at
an affordable cost in a fair and transparent manner by mainstream institutional players.
Financial inclusion has become one of the most critical aspects in the context of inclusive
growth and development.
b) Definition:
1) According to CFI:
It is 'the process of ensuring access to financial services and timely and adequate
credit where needed by vulnerable groups such as weaker sections and low income
groups at an affordable cost’.
3.1 Performance Evaluation Parameters for Banks:
c) Importance of Financial Inclusion:
Use of Technology
Adoption of EBT
GCC
4) Use of Technology:
Recognizing that technology has the potential to address the issues of outreach and
credit delivery in rural and remote areas in a viable manner, banks have been
advised to make effective use of information and communications technology (ICT),
to provide doorstep banking services.
3.1 Performance Evaluation Parameters for Banks:
d) Measure taken to Promote Financial Inclusion:
5) Adoption of EBT:
Banks have been advised to implement EBT by leveraging ICT-based banking through BCs to
transfer social benefits electronically to the bank account of the beneficiary and deliver
government benefits to the doorstep of the beneficiary.
6) GCC:
With a view to helping the poor and the disadvantaged with access to easy credit, banks
have been asked to consider introduction of a general purpose credit card facility up to
`25,000 at their rural and semi-urban branches.
Banking
Quality
Spreads
Basic Concept
Spread Between a
Rate and a Public
Long Term Credit
Bond Rate
Curve Spreads:
Banking Yield
3.1 Performance Evaluation Parameters for Banks:
b) Basic Concept in Spread:
1) Intermediation Margin Spreads:
These are spreads between the prime rate or credit average rates and the call money rate,
which is considered here as the marginal cost of finance for banks. An increase in
intermediation margin may stimulate the supply of credit by banks.
4) Spread Between a Long Term Credit Rate and a Public Bond Rate :
Their purpose was to promote an IS-LM model where banking credit and public bonds are
imperfect substitutes. According to their model this spread, that we name here the Bernanke-
Blinder spread, can carry information on the cycle.
3.1 Performance Evaluation Parameters for Banks:
c) Spread as Parameter of Performance Evaluation:
Spread is the gap between interest rate a bank charges on loans and rate pays on deposits.
The amount of total interest earned divided by the total interest paid to depositors as
mentioned in the income statement. This ratio is useful for Banks and DFIs.
Net Interest Margin Ratio= Total Interest Income-Total Interest Expense x 100
Total Asset
This ratio indicates the earning capacity through core banking business by utilizing all
assets. Banks normally borrow from savers and lend to investors. It is the ratio between the
difference of interest income and interest expense to total assets. It is also useful for Banks
and DFIs.
3.1 Performance Evaluation Parameters for Banks:
d) Spreads Linked with Future Growth:
Large amount
Customers of Banking Spread
Dependant on Banking Variations
Credits Despite
1) Large amount Customers of Dependant on Banking Credits Despite :
First, a vast majority of non-financial agents are still dependant on banking credits despite of
the deregulation financial markets. The behaviour of banks, regarding not only interest rates,
but also spreads, is an important channel of transmission of monetary policy.
A) Types of analyses:
1) ABC Analysis:
ABC analysis rank orders merchandise by some performance measure to determine which items
should never be out of stock, which items should occasionally be allowed to be out of stock
and which items should be deleted from the stock selection.
a) Concept:
ABC analysis is a type of analysis of material dividing in three groups called A-group items, B-
Group items and C-group items For the purpose of exercising control over materials.
Manufacturing concerns find it useful to divide materials into three categories.
Group A Group B
3.2 Performance Evaluation Parameters for Retail
b) Classification of items into A, B and C Categories:
1) Group A:
10% of total number of items carries 70% of value- "A" group of items. Similarly, a large
number bottom items (over 70 per cent of the total number of items) account for only
about 10 percent of the consumption value.
2) Group B
20% of total number of items account for only about 20% consumption value - "B" group
items.
3) Group C:
70% of total number of items accounts for only about 10% of consumption value - "C"-
group items.
3.2 Performance Evaluation Parameters for Retail
c) Performance Measure of ABC Analysis:
An ABC analysis can be done at any level of merchandise classification from SKU to department.
ABC analysis utilizes the 80:20 principles, which implies that 80% of the sales come from 20% of
the products.
Contribution Margin = Net sales - Cost of goods sold- Other variable expenses
b) Calculation Formula:
The most common calculation formula is:
3) Operating Costs :
The third is operating costs. Most of the operating costs of inventory burdened businesses are
due to carrying inventory. These are called inventory carrying costs.
3.2 Performance Evaluation Parameters for Retail
c) Importance of GMROI:
1) Effective Planning Tool:
GMROI recognizes the limitations of looking at sales, profit margins, and inventory turns
individually and captures them in one inclusive measurement.
Assist Buyers
3.2 Performance Evaluation Parameters for Retail
5) Economic Order Quantity (EOQ):
Another method of managing inventory investments is to predetermine the stock levels at which
merchandise should be reordered. This is known as the reorder point. Various factors like the
lead-time required, the safety stock and the speed at which the products sell have to be taken
into consideration.
a) Formula:
The EOQ is calculated by using the following formula:
EOQ = 2DS/ IC,
Where,
D = annual demand,
S = costs to place the order,
1 = percentage of annual carrying cost to unit cost and C = unit cost of an item.
3.2 Performance Evaluation Parameters for Retail
6) Direct Product Profit (DPP):
Many a times the retailer may also use the concept of Direct Product Profit (DPP) to measure the
performance of a product. DPP focuses on the contribution profit of individual retail items in
individual stores.
By expressing DPP against a common unit of measure (floor space), retailers can compare the
performance of products of different physical proportions. Since retail space is usually limited,
DPP can be used for:
1) Item selection (high DPP items should generally be added, low ones reviewed with an eye
toward pruning).
2) Store/Shelf location (high DPP items should be given prime location), and
3) Promotion (total DPP can be improved by increasing the sales of high DPP products).