9.1 Introduction

In the backdrop of our discussion in the previous chapters, it is important to reiterate two key aspects pertaining to the banking business. First, as a financial intermediary, a commercial bank undertakes deposit mobilisation and uses such deposits for lending and investments. Surplus interest income earned on loans and investments over the cost of deposits is the main source of a bank's profit. Needless to mention, to calculate a bank's overall profitability, non-interest income is to be counted and operational costs and taxes need to be adjusted. As a commercial entity, profit maximisation is the prime objective of a bank. Second, we also discussed that lending and investments entail various types of risks. Aggressive lending in search of higher returns inherently involves higher levels of risks. The quantum of risks in the banking business needs to be kept within reasonable limits to ensure banking stability.

Considering these facts, the guiding principle for prudent banking is to strive for optimising risk-adjusted profit. In that direction, the banking business is conducted keeping in mind not only the primary objective of profitability but also considerations of solvency and liquidity.

As regards promoting profitability, banks aim to maximise their NII and non-interest income. The NII is nothing but interest income over interest cost of a bank and accounts for the bulk of banking profitability. Higher NII can be generated by expanding interest income from loans and investments while reducing costs on deposits. Thus, maximising NII requires judicious decision-making in choosing the portfolio of bank deposits, loans and investments and the pricing of products.