11.1 Introduction

Banks are basically commercial entities and maximising profit is the main objective in the banking business. Profit for banks arises from broadly two sources. The major source is interest income from loans and investments over interest cost on deposits and borrowings, popularly referred to as net interest income (NII). We have observed earlier in this book that deposits constitute the bulk of the liabilities of a bank and loans and investments overwhelmingly dominate a bank's assets. Therefore, NII constitutes the main source of a bank's profit. A bank has to choose a judicious mix of deposits and loans as also appropriately price such products to maximise its NII. The second source of profit for banks is earnings in the form of fees, commissions and charges, and so on.

However, banks cannot ignore the risks involved in various banking products. Generally, higher risk is associated with higher returns. Prudent banking entails containment of overall risks within reasonable limits; otherwise excessive risks may wipe out the entire profit. In exceptional situations, excessive risk may even cause complete collapse of a bank. In view of these aspects, optimising risk-adjusted returns without compromising solvency and liquidity aspects is the ultimate goal in the banking business.

It is important to note that profitability can be maximised through improving banking efficiency and productivity. In banking, productivity is popularly measured in terms of per employee business and profit. This closely resembles the concept of labour productivity used in microeconomics. Higher business per employee reflects higher productivity.