242
CHAPTER - 6
IMPACT OF NON-PERFORMING ASSETS ON PROFITABILITY OF
SAMPLED BANKS
CHAPTER INDEX
No. Content of the Chapter Page No.
6.1 Introduction 243
6.2 Research Model 243
6.3 Hypotheses of the Study 244
6.4 Database for Calculation 244
6.5 Analysis and Interpretation 252
243
CHAPTER - 6
IMPACT OF NON-PERFORMING ASSETS ON PROFITABILITY OF
SAMPLED BANKS
6.1 Introduction:
The bank plays an important role in the economy of a country by performing
it’s the most important function known as credit creation. The bank creates credit in
various forms such as loans and advances, cash credit; bank over draft etc. in this
manner the bank creates money supply into the market. The banks give these loans
and advances, cash credit, bank over draft to the individuals, firms, companies,
government, etc. in this sense the bank plays role of a lender of money and all these
parties play the role of borrower. Unfortunately the credit provided by the bank
doesn’t come back to the bank. This creates bad debts, which is known as Non-
Performing Assets (NPA) in the terminology of bank.
For the last a few years the NPA of banks is increasing tremendously. Several
steps have been undertaken by the RBI and the government of India to curb the
increasing NPA of Indian banks, but these steps have not been proved to be
successful. Majority of banks are suffering from the problem of NPA and it has
attracted intense debate and attention across banking industries in the corporate
finance. The reports and review of literature reveals that increasing NPA worsens the
efficiency of the bank and in turn the profitability decreases. Now a day the increasing
NPA has become the burning issue in banking sector. This problem is more critical in
nationalized banks. Under this section of the research, the researcher has made efforts
to check impact of NPAs on profitability of the banks.
6.2 Research Model:
Regression analysis was carried out to test the impact of NPA on profitability.
Here NPA is the independent variable and profitability is the dependent variable. Here
profitability is measured with the help of five ratios viz. Interest Spread as % to Total
Assets, Net Profit Margin, Return on Net Worth, Net Profit to Total Fund, and Net
Profit to Total Assets. Non-Performing Assets is measured through Gross NPAs to
Advances Ratio and Net NPAs to Advances Ratio. The formulated hypotheses are to
be tested at 2-tailed @ 5% level of significance.
244
6.3 Hypotheses of the Study:
To justify this section of present research study, following null-hypotheses
were formulated by the researcher:
1. There is significant impact of Gross NPAs to Advances Ratio on Interest
Spread as % to Total Assets.
2. There is significant impact of Gross NPAs to Advances Ratio on Net Interest
Margin.
3. There is significant impact of Gross NPAs to Advances Ratio on Return on
Net Worth.
4. There is significant impact of Gross NPAs to Advances Ratio on Net Profit to
Total Fund.
5. There is significant impact of Gross NPAs to Advances Ratio on Net Profit to
Total Assets.
6. There is significant impact of Net NPAs to Advances Ratio on Interest Spread
as % to Total Assets.
7. There is significant impact of Net NPAs to Advances Ratio on Net Interest
Margin.
8. There is significant impact of Net NPAs to Advances Ratio on Return on Net
Worth.
9. There is significant impact of Net NPAs to Advances Ratio on Net Profit to
Total Fund.
10. There is significant impact of Net NPAs to Advances Ratio on Net Profit to
Total Assets.
6.4 Database for Calculation:
To measure the impact of NPAs on profitability of the banks, the researcher
has assumed NPAs as the independent variable and profitability as the dependent
variable. To support the calculation, the researcher has compiled the data from various
secondary sources, and presented in tabulated form to facilitate the present research.
The explanation of various ratios and presentation of database to support the research
are presented in table 6.1 to 6.7
245
6.4.1 Gross NPAs to Advances Ratio:
This ratio shows relation between the amounts of Gross NPAs to Advances in
terms of percentage. This ratio shows negative feature of the stability of the banks. If
this ratio is higher, it shows that the financial capacity of the bank is poor and vice-
versa. So the banks should try to control this ratio to the minimum. To measure the
impact of NPAs on profitability, the researcher considers this ratio as one of the
independent variable. Here, the researcher has made the presentation of this ratio for
the sample units for the period of 10 years i.e. 2002-03 to 2011-12. The said ratio is
presented in table 6.1, given below:
Formulae Gross NPAs x 100
Advances
Table – 6.1
A Table Showing Gross NPAs to Advances Ratios in Selected Nationalized Banks
of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 11.79 8.92 10.07 14.58 19.16 12.38
2003-04 11.18 8.14 8.14 13.56 15.77 9.89
2004-05 7.65 5.68 7.36 9.61 10.15 6.19
2005-06 3.99 3.80 5.73 7.16 6.67 4.21
2006-07 2.50 2.47 3.58 4.97 4.07 3.51
2007-08 1.86 1.70 2.65 3.22 2.49 2.78
2008-09 1.28 1.73 2.33 2.70 2.15 1.79
2009-10 1.37 2.90 3.00 2.43 1.81 1.72
2010-11 1.38 2.26 2.50 1.85 1.88 1.81
2011-12 1.55 2.37 2.31 4.93 1.69 2.97
Average 4.46 4.00 4.77 6.50 6.58 4.73
246
6.4.2 Net NPAs to Advances Ratio:
This ratio shows relation between amounts of Net NPAs to Advances in terms
of percentage (%). This is also a negative performance indicator for the financial
stability and soundness of the banks. If this ratio is higher, it shows that the financial
strength of the bank is poor and vice-versa. So the banks should try to control this
ratio to the as minimum as possible. To measure the impact of NPAs on profitability,
the researcher also considers this ratio as one of the independent variable. Here, the
researcher has made the presentation of this ratio for the sample units for the period of
10 years i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.2, given below:
Formulae Net NPAs x 100
Advances
Table- 6.2
A Table Showing Net NPAs to Advances Ratio in Selected Nationalized Banks of
India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 4.81 5.59 4.83 7.02 11.82 3.80
2003-04 4.95 4.50 2.46 5.57 9.40 0.95
2004-05 1.43 2.80 2.15 2.98 5.23 0.20
2005-06 0.86 1.49 2.03 2.59 3.04 0.28
2006-07 0.60 0.95 0.99 1.70 1.99 0.75
2007-08 0.46 0.52 0.87 1.45 0.94 0.63
2008-09 0.31 0.44 0.79 1.24 1.09 0.17
2009-10 0.34 1.31 1.64 0.69 1.21 0.53
2010-11 0.35 0.91 1.32 0.65 1.22 0.84
2011-12 0.54 1.47 0.84 3.09 1.01 1.52
Average 1.47 2.00 1.79 2.70 3.70 0.97
247
6.4.3 Spread as % to Total Assets:
This ratio is prepared to present the profitability of the banks. Spread is also
termed as interest spread or net interest margin or net interest spread. Net interest
spread is expressed as interest yield on earning assets (any assets, such as a loan, that
generates interest income) less interest rates paid on borrowed funds. It also refers to
the difference in lending rates and borrowing rates of financial institutions. It is the
first and foremost measure to evaluate the profitability of the banks and financial
institutions, as the spread is the main source of earning the profit.
This ratio shows relation of spread to the total assets of the banks, to measure
the earning capacity of the company against total assets held by them. For this section
of research, this ratio is considered as one if the dependent ratio. Here, the researcher
has made the presentation of this ratio for the sample units for the period of 10 years
i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.3, given below:
Formulae Interest Spread x 100 = Interest Earned – Interest Paid x 100
Total Assets Total Assets
Table- 6.3
A Table Showing Interest Spread as % to Total Assets in Selected Nationalized
Banks of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 2.75 2.67 2.72 3.32 2.82 3.62
2003-04 3.02 2.59 2.40 3.35 2.67 3.54
2004-05 3.15 2.36 2.68 3.46 2.86 3.17
2005-06 2.84 2.34 2.71 3.19 2.72 3.21
2006-07 2.50 2.43 2.80 2.66 2.72 3.21
2007-08 2.18 2.36 2.55 1.79 2.31 2.78
2008-09 2.26 2.44 2.13 1.51 2.20 2.85
2009-10 2.13 2.09 2.82 1.39 1.91 2.87
2010-11 2.46 2.22 2.58 2.54 2.49 3.12
2011-12 2.31 2.16 2.86 2.25 2.40 2.93
Average 2.56 2.366 2.625 2.546 2.51 3.13
248
6.4.4 Net Profit Margin:
Net profit margin is the percentage of revenue remaining after all operating
expenses; interest, taxes and preference share dividend have been deducted from a
company’s total revenue. By dividing net profit by total revenue, one can see what
percentage of revenue made it all the way to the bottom line, which is good for the
investors. It is considered as one of the profitability ratio in banking industry. The
higher the net profit margin is, the more effective the bank is at converting revenue
into actual profit. The net profit margin is one of the good ways of comparing
different units in the same industry. For this section of research, this ratio is
considered as one if the dependent ratio. Here, the researcher has made the
presentation of this ratio for the sample units for the period of 10 years i.e. 2002-03 to
2011-12. The said ratio is presented in table 6.4, given below:
Formulae Net Profit x 100
Revenue
Table- 6.4
A Table Showing Net Profit Margin in Selected Nationalized Banks of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 10.50 11.27 9.09 5.42 5.16 9.79
2003-04 12.13 13.38 11.42 10.25 9.79 11.45
2004-05 9.77 5.08 6.97 6.21 3.11 13.84
2005-06 10.76 8.63 2.18 4.92 3.85 14.50
2006-07 10.22 10.48 9.36 7.69 8.30 12.53
2007-08 10.38 13.96 8.65 6.31 11.61 12.68
2008-09 12.86 15.89 7.88 4.99 10.95 13.76
2009-10 15.37 8.59 8.16 7.70 11.17 15.64
2010-11 17.17 10.25 5.42 7.66 11.07 14.48
2011-12 15.12 8.53 5.52 2.61 11.04 12.02
Average 12.43 10.61 7.47 6.38 8.61 13.07
249
6.4.5 Return on Net Worth:
Net worth is a concept applicable to individuals and businesses as a key
measure of how much an entity is worth. A consistent increase in net worth indicates
good financial health of the entity. Here the term ‘net-worth’ indicates owners’ fund
i.e. sum of paid up capital and reserves and surplus. This ratio is useful to judge the
profitability of the entity from the shareholders’ point of view. Here, the researcher
has used this ratio as the indicator of profitability, which is one of the dependent
variable in this section of research, i.e. to measure the impact of NPAs on
profitability. Here, the researcher has made the presentation of this ratio for the
sample units for the period of 10 years i.e. 2002-03 to 2011-12. The said ratio is
presented in table 6.5, given below:
Formulae Net Profit x 100
Net Worth
Table- 6.5
A Table Showing Return on Net Worth in Selected Nationalized Banks of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 18.81 28.32 27.55 18.61 12.41 24.97
2003-04 20.32 28.04 23.45 28.73 26.55 26.42
2004-05 12.58 8.36 8.82 13.03 7.43 17.96
2005-06 10.54 15.37 4.08 8.77 9.03 17.01
2006-07 11.86 21.25 14.00 19.88 17.48 16.03
2007-08 12.99 22.76 18.60 15.46 22.96 19.00
2008-09 17.35 25.51 18.16 14.43 21.68 23.52
2009-10 20.24 13.60 18.28 23.03 21.36 24.06
2010-11 20.15 15.58 10.23 21.45 17.68 20.61
2011-12 18.22 13.57 9.97 4.52 18.71 17.55
Average 16.31 19.24 15.31 16.79 17.53 20.71
250
6.4.6 Net Profit to Total Fund Ratio:
This ratio shows relation between net profit and total fund in terms of
percentage. This ratio shows capacity of the enterprise to generate net profit against
the total fund employed. This ratio is one of the indicators of the profitability. . This
ratio shows efficiency of the business entity to utilize its total fund in more profitable
means. This ratio is useful to judge the profitability of the entity from the different
stakeholders’ point of view. A consistent increase in net profit to total fund ratio
indicates good financial health of the entity. Here, the researcher has used this ratio as
the indicator of profitability, which is one of the dependent variable in this section of
research, i.e. to measure the impact of NPAs on profitability. Here, the researcher has
made the presentation of this ratio for the sample units for the period of 10 years i.e.
2002-03 to 2011-12. The said ratio is presented in table 6.6, given below:
Formulae Net Profit x 100
Total Fund
Table- 6.6
A Table Showing Net Profit to Total Fund Ratio in Selected Nationalized Banks
of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 1.05 1.17 0.96 0.56 0.59 1.06
2003-04 1.20 1.25 0.97 1.04 1.13 1.18
2004-05 0.75 0.38 0.40 0.46 0.31 1.24
2005-06 1.01 0.68 0.20 0.36 0.37 1.06
2006-07 0.80 0.89 0.65 0.60 0.70 1.00
2007-08 0.89 1.26 0.75 0.51 1.03 1.14
2008-09 1.09 1.50 0.68 0.43 0.98 1.40
2009-10 1.21 0.70 0.68 0.65 0.97 1.45
2010-11 1.33 0.80 0.24 0.64 0.96 1.32
2011-12 1.24 0.73 0.52 0.24 1.02 1.17
Average 1.06 0.94 0.61 0.55 0.81 1.20
251
6.4.7 Return on Assets:
Return on assets (RoA) is a profitability ratio which indicates the net profit
(net income) generated on total assets. This ratio shows efficiency of the business
entity to utilize its assets in more profitable means. It is computed by dividing net
income by average total assets of the banks. Here the researcher has assumed this
ratio as one of the dependent ratio to measure the impact of NPAs on profitability.
Here, the researcher has made the presentation of this ratio for the sample units for the
period of 10 years i.e. 2002-03 to 2011-12. The said ratio is presented in table 6.7,
given below:
Formulae Net Profit x 100
Average Total Assets
Table- 6.7
A Table Showing Net Profit to Average Total Assets (RoA) Ratio in Selected
Nationalized Banks of India
[In %]
Year BOB BOI BOM CBI DENA PNB
2002-03 1.01 1.12 0.89 0.54 0.57 0.98
2003-04 1.14 1.19 0.95 0.98 1.04 1.08
2004-05 0.71 0.36 0.54 0.52 0.25 1.12
2005-06 0.73 0.62 0.16 0.34 0.27 0.99
2006-07 0.72 0.79 0.70 0.54 0.64 0.95
2007-08 0.80 1.12 0.68 0.44 0.93 1.03
2008-09 0.98 1.33 0.64 0.39 0.87 1.25
2009-10 1.10 0.63 0.62 0.58 0.89 1.32
2010-11 1.18 0.71 0.43 0.60 0.86 1.17
2011-12 1.12 0.70 0.49 0.23 0.92 1.07
Average 0.95 0.86 0.61 0.52 0.72 1.10
252
Table – 6.8
A Table Showing Average Ratios of Selected Nationalized Banks of India
Ratios*
Bank X1 X2 X3 X4 X5 X6 X7
BOB 4.46 1.47 2.56 12.43 16.31 1.06 0.95
BOI 4.00 2.00 2.37 10.61 19.24 0.94 0.86
BOM 4.77 1.79 2.63 7.47 15.31 0.61 0.61
CBI 6.50 2.70 2.55 6.38 16.79 0.55 0.52
Dena 6.58 3.70 2.51 8.61 17.53 0.81 0.72
PNB 4.73 0.97 3.13 13.07 20.71 1.20 1.10
* Explanation of codes used for ratios
X1 = Gross NPAs to Advances Ratio
X2 = Net NPAs to Advances Ratio
X3 = Interest Spread as % to Total Assets Ratio
X4 = Net Profit Margin
X5 = Return on Net Worth
X6 = Net Profit to Total Fund Ratio
X7 = Net Profit to Total Assets Ratio
6.5 Analysis and Interpretation:
Table – 6.9
A Table Showing Descriptive Statistics of Ratios
Ratio Code N Range Minimum Maximum Mean Std.
Deviation
Gross NPAs to
Advances Ratio
X1 6 2.58 4.00 6.58 5.17 1.09
Net NPAs to
Advances Ratio
X2 6 2.73 0.97 3.70 2.11 0.97
Interested Spread as
% to Total Assets
Ratio
X3 6 0.76 2.37 3.13 2.63 0.26
Net Profit Margin X4 6 6.69 6.38 13.07 9.76 2.71
Return on Net Worth X5 6 5.40 15.31 20.71 17.65 2.00
Net Profit to Total
Fund Ratio
X6 6 0.65 0.55 1.20 0.86 0.25
Net Profit to Total
Assets Ratio
X7 6 0.58 0.52 1.10 0.79 0.22
253
The above mentioned table shows descriptive statistics of the different ratios
i.e. variables covered under the study. Here Gross NPAs to Advances Ratio and Net
NPAs to Advances Ratio identified as independent ratio, showing position of position
of Non-Performing Assets in sampled units. Whereas Interest Spread as % to Total
Assets, Net Profit Margin, Return on Net Worth, Net Profit to Total Fund Ratio and
Net Profit to Total Assets Ratio (RoA) are dependent variable of the study, showing
profitability in the sampled units.
The descriptive statistics show that over the period under the study i.e. 2002-
03 to 2011-12, the profitability ratios measured by interest spread as % to total assets,
net profit margin, return on net worth, net profit to total fund ratio and net profit to
total assets ratio averaged 2.63, 9.76, 17.65, 0.86 and 0.79 respectively, with the
standard deviation 0.26, 2.71, 2.00, 0.25 and 0.22. The gross NPA to advances ratio
is 5.17 and average net NPA to advances ratio is 2.11, with the standard deviation
1.09 and 0.97.
Regression Analysis:
Table – 6.10
Predictor of Profitability – Model Summary
Independent
Variable
(Ratio)
Dependent
Variable
(Ratio)
R R2 Adjusted
R2
Standard
Error of
Estimate
X1
(Gross NPA
to Advances
Ratio)
X3 0.099 0.0098 -0.238 0.29
X4 0.643 0.414 0.267 2.322
X5 0.241 0.058 -0.177 2.166
X6 0.552 0.305 0.131 0.237
X7 0.603 0.364 0.204 0.194
X2
(Net NPA to
Advances
Ratio)
X3 0.579 0.335 0.168 0.239
X4 0.659 0.434 0.293 2.281
X5 0.285 0.081 -0.149 2.14
X6 0.574 0.329 0.161 0.233
X7 0.641 0.411 0.264 0.187
254
Table – 6.11
A Table Showing Coefficient for Predictors of Performance
Independent
Variable
(Ratio)
Dependent
Variable
(Ratio)
Unstandardized
Coefficients
Standardized
Coefficients
t-value Sig.
X1
(Gross NPA
to
Advances
Ratio)
B Std. Error Beta
X3 -0.024 0.119 -0.099 -0.119 0.852
X4 -1.596 0.949 -0.643 -1.681 0.168
X5 -0.440 0.885 -0.241 -0.497 0.645
X6 -0.128 0.097 -0.552 -1.325 0.256
X7 -0.120 0.079 -0.603 -1.512 0.205
X2
(Net NPA
to
Advances
Ratio)
X3 -0.156 0.110 -0.579 -1.419 0.229
X4 1.844 1.052 -0.659 -1.752 0.155
X5 -0.586 0.987 -0.285 -0.594 0.584
X6 -0.150 0.107 -0.574 -1.400 0.234
X7 -0.144 0.086 -0.641 -1.671 0.170
The R2
values (table 6.10) of 0.0098, 0.414, 0.058, 0.305 and 0.364
denotes that 00.98%, 41.40%, 5.80%, 30.50% and 36.40% of the observed variability
in interest spread as % to total assets, net profit margin, return on net worth, net profit
to total fund ratio and net profit to total assets ratio is explained by the variability in
the independent variable of gross NPA to total advances ratio. These R2
values
indicate that there may be number of variables which may have impact on
profitability other than the gross NPA to total advances ratio.
The R2 values (table 6.10) of 0.335, 0.434, 0.081, 0.329 and 0.411 denotes that
33.50%, 43.40%, 8.10%, 32.90% and 41.10% of the observed variability in interest
spread as % to total assets, net profit margin, return on net worth, net profit to total
fund ratio and net profit to total assets ratio is explained by variability in the
independent variable net NPA to total advances ratio. These R2
values indicate that
there may be number of variables which may have impact on profitability other than
the net NPA to total advances ratio.
Literature existing on this area of research theoretically proves that the NPA is
the most influencing factor that affecting to profitability in negative manner. From the
statistical analysis given in table 6.11, it is clear that the negative association was
255
found between all the independent and dependent variables under the study.
Here, the researcher may conclude that, the Gross NPAs and Net NPAs are not
only the factors, which is affecting to the profitability of the banks under the sample.
So, the evidences found while measuring the impact of NPAs on profitability clearly
shows that the banks are required to control and monitor the other variables.
The statistical analysis of application of student ‘t’ test for the testing of
hypotheses @ 5% level of significance also reveals that all hypotheses formulated by
researcher is rejected, it means gross NPA and net NPA are not only variables that
affects to profitability of the nationalized banks of India. Hence, to check the impact
of other variables on profitability indicated as a scope of future research.