In any country, economic development is determined, to a great extent, by the patterns and levels of resource mobilization and allocation. Resources are mobilized through savings, which, at the macro level, pave the way for the allocation of resources for consumption and investment. Financial institutions facilitate mobilization of resources by receiving savings from those individuals and institutions that do not have immediate use of the funds at their disposal. These savings are then made available for both consumption and investment to other individuals and institutions. These financial institutions attempt to match demand and supply of funds (Beck 2001, cited in Joseph, et al, 2012). Resources are mobilised from net savers and then reallocated to net spenders. Although there are many types of financial institutions, commercial banks play an especially important role in both mobilization and allocation of resources. Banks are the most important financial institutions in a country that act as a conduit for the transfer of financial resources from net savers to net borrowers (Lalitha, 2013). Banks transfer money from those who spend less than they earn, to those who spend more than what they earn. Banks are therefore a financial intermediary between net savers and net spenders. Generally, banks mobilize funds by accepting deposits from net savers. Funds are allocated to net spenders by disbursing funds after accepting their loan applications. It should be appreciated that net spenders do not necessarily apply for loans in order to increase their consumption levels. Most of the time, loans are applied for investment purposes. Indeed, as argued by Greuning and Bratanovic (2003) cited in Joseph, et al. (2012), commercial banks play a critical role to emerging economies where most borrowers have no access to capital markets. With no access to capital markets, the remaining source of finances necessary for production is the banks. Banks lend their own debt to borrowers who need money for investment and consumption.
The business of banking is different from other general commodity businesses. Yadav (2011) observes that a number of studies found that banking sector does not work as general commodity production because it has many facets; as an industry itself, as an input and also as a servicing providing sector. Bagchi and Benerajee (2005) cited in Yadav (2011) also contend that advocacy of banks mergers as general policy by using the argument of economies of scale, really conceal the hidden goal of exclusion of small borrowers and marginal farmers from the credit policies of the banking sector. In fact, merging of banks did not give viable results at international level. Banking as a sector therefore need to be looked at differently and the strategies (for example, mergers) that seem to work favourably in other sectors may not be plausible in this sector.
It has been pointed out that banks mobilize funds by accepting deposits from net savers. Generally, there are two types of deposits that banks offer to mobilize funds from net savers. These are time deposits and demand deposits. Time deposits are repayable after a certain fixed period of time. They cannot be withdrawn by cheque, draft or by other means before the expiry of the fixed period for repayment. On the other hand, demand deposits are the deposits which may be withdrawn by the depositor at any time without previous notice. They can be withdrawn by cheque or draft. Demand deposits include savings and currents account deposits. It is these deposited amounts that a bank makes them available to borrowers. Although cash from depositors is issued to borrowers as loans, the bank must be careful to ensure that depositors always get their withdraw requests respected without fail. This is normally achieved by ensuring that the bank maintains the required cash reserve ratio (CRR) at all times. CRR is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves with the central bank. CRR is set according to the guidelines of the central bank of a country
In practice, banks operate accounts that are variants of these two types, with features of both time deposits and demand deposits. Some include:
Fixed Deposits: a type of time deposits that can be withdrawn only after expiry of a certain period, say one year, two years or so. The banker allows a rate of interest depending upon the amount and period of time. Normally, higher rates are allowed for longer periods of time. This interest is an income to the depositor and acts as a motivation to net savers to deposit their savings into fixed deposit accounts. The deposited funds are therefore available to the bank for issuance of loans to applicants.
Saving accounts: These are normally held by individuals and non-profit institutions. The rate of interest paid on savings deposits is lower than that of time deposits. The savings account holder gets the advantage of small income in the form of interests. Occasionally there will be some restrictions on withdrawals from saving accounts in terms of limit on the amount that can be withdrawn and requirements for an advance notice in case of withdrawals of large amounts. Funds on saving accounts are also available for borrowing by loan applicants, although to a restricted extent.
Current Deposit Account: These are maintained by the people and business organizations that need to have liquid balances. Current account offers high liquidity to the depositors. Normally, no interest is paid on current deposits and there are no restrictions on withdrawals from a current account. In addition, depositors pay for service charges to the bank for safeguarding their funds. Generally, these funds deposited in current accounts are not available for borrowing by loan applicants.
It needs to be appreciated that depositors put their money into banks not exclusively for interest income motivation. As has been pointed out, some deposit accounts do not earn any interest to the depositor but, to the contrary, is charged for service by the bank. And yet depositors maintain their money in these non-interest earning accounts. This is because of another important incentive for net savers to have their money deposited in banks. It is about security concerns. Invariably, there are risks associated with handling or holding cash by individuals and therefore keeping that money in banks shifts most of these risks from the individuals to the banks. By accepting deposits, the banks therefore offer an opportunity for depositors to have their excess cash kept in safe custody. It can therefore be concluded that the principal reasons for keeping money in banks include the opportunity for the depositors to earn income in the form of interest, and to shift the risk of handling cash from the depositors to the banks.
The process of financial intermediation supports increasing capital accumulation through the institutionalization of savings and investment and, as such, fosters economic growth in a country (Lalitha, 2013). There can be no development without investment. In most situations, an investor will not possess all the funds required for an available investment opportunity. Sometimes, the investor may only have the necessary skills and know-how to implement a profitable project but without any funds. This means that borrowing is the only realistic source of the funds required to implement the project. Banks provide these funds since they are able to mobilise funds from depositors and make them available to investors through borrowing. In this respect, investors obtain funds to finance the productive activities required for development of the country.
Banks earn their income by charging interest on borrowed funds. This is the primary source of income for any bank or financial institution. Reed and Gill (1989) cited in Joseph, et al. (2012) pointed out that traditionally, 85 percent of commercial banks’ income is contributed by interest on loans. Loans therefore represent the majority of a bank’s assets since income is derived from assets. This means that banks are in the business of lending. Lending is not an easy business. Lending creates a big problem which is called non performing loans (Upal, 2009) cited in (Joseph, et al., 2012). This is bank’s main business risk. This risk is associated with the lending activity, which is the bank’s principal activity. This risk is the possibility that some borrowers will not fulfil their obligations in accordance with the loan agreements. This is the whole concept about non-performing assets (NPAs) whereby loans advanced are not repaid together with the applicable interest as stipulated in the respective loan agreements. Since NPAs result from default in repayment of loans, occasionally they are referred to as non performing loans (NPLs). It is felt that non-performing assets (NPA) is a better description of the concept since, from the perspective of the banks, the issued loans are assets and therefore shown on the asset side of the bank’s balance sheets. They are loans only from the perspective of the borrowers who have to show them on the liability side of their balance sheets. In addition, it is only assets that can generate income that is why NPAs are defined as accounts that cease to generate income to the bank. These accounts must represent assets since they are expected to earn income for the bank. On the other hand, loans are liabilities and should be expected to constitute a reason for incurring expenses rather than generating income. Interest on borrowed funds is an expense from the perspective of the borrowers. Hence they consider the borrowed funds as liabilities.
For citing this article use:
- Meela, D. J. (2016). A comparative study of NPAs in commercial banks case study of selected banks in Tanzania and India.
- Joseph, M. T., Edson, G., Manuere, F., Clifford, M. & Michael, K. (2012). Nonperforming loans in commercial banks: A case of CBZ Bank Limited in Zimbabwe. Interdisciplinary Journal of Contemporary Research in Business, 4, 7, 467-488.
- Lalitha, N. (2013). Non-performing assets: Status & impact: A comparative study of public & private sector banks with special reference to SBI, Canara, HDFC and Karur Vysya Banks. Unpublished PhD Thesis, Andhra University
- Yadav, M. S. (2011). Impact of non-performing assets on profitability and productivity of public sector banks in India. AFBE Journal, 4, 1, 232-241