INDIAN INSTITUTE OF MANAGEMENT
AHMEDABAD INDIA
Efficiency of Indian Banking Industry in the Post-Reform Era
Amit Kumar Dwivedi
D. Kumara Charyulu
W.P. No. 2011-03-01
March 2011
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INDIAN INSTITUTE OF MANAGEMENT
AHMEDABAD-380 015
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Efficiency of Indian Banking Industry in the Post-Reform Era
Amit Kumar Dwivedi
1
D. Kumara Charyulu
2
Abstract
One of the major objectives of Indian banking sector reforms was to encourage
operational self-sufficiency, flexibility and competition in the system and to
increase the banking standards in India to the international best practices. The
second phase of reforms began in 1997 with aim to reorganization measures,
human capital development, technological up-gradation, structural development
which helped them for achieving universal benchmarks in terms of prudential
norms and pre-eminent practices. This paper seeks to determine the impact of
various market and regulatory initiatives on efficiency improvements of Indian
banks. Efficiency of firm is measured in terms of its relative performance that is,
efficiency of a firm relative to the efficiencies of firms in a sample. Data
Envelopment Analysis (DEA) has used to identify banks that are on the output
frontier given the various inputs at their disposal. The present study is confined
only to the Constant-Return-to-Scale (CRS) assumption of decision making units
(DMUs). Variable returns to scale (VRS) assumption for estimating the efficiency
was not attempted. It was found from the results that national banks, new private
banks and foreign banks have showed high efficiency over a period time than
remaining banks.
Keywords: Efficiency measurement, banking industry and DEA.
1
Academic Associate, Indian Institute of Management, Ahmedabad, India
E-mail: dwivedipgdm@gmail.com
2
Former Post-Doctoral Fellow, Indian Institute of Management, Ahmedabad, India
Email: kumaracharya@gmail.com
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I. Introduction
Indian banking industry, the backbone of the country’s economy, has always
played a key role in prevention the economic catastrophe from reaching terrible
volume in the country. It has achieved enormous appreciation for its strength,
particularly in the wake of the worldwide economic disasters, which pressed its
worldwide counterparts to the edge of fall down. If we compare the business of top
three banks in total assets and in terms of return on assets, the Indian banking
system is among the healthier performers in the world. This sector is
tremendously competitive and recorded as growing in the right trend (Ram
Mohan, 2008). Indian banking industry has increased its total assets more than
five times between March 2000 and March 2010, i.e., US$250 billion to more than
US$1.3 trillion. This industry recorded CAGR growth of 18 percent as compared to
country’s average GDP growth of 7.2 percent during the same period. The
commercial banking assets to GDP ratio has increased to nearly 100 percent
while the ratio of bank’s business to GDP has recorded nearly twofold, from 68
percent to 135 percent. The overall development has been lucrative with
enhancement in banking industry efficiency and productivity. It should be
underlined here is financial turmoil which hit the western economies in 2008 and
the distress effect widened to the majority of the other countries but Indian
banking system survived with the distress and showed the stable performance.
Indian banks have remained flexible even throughout the height of the sub-prime
catastrophe and the subsequent financial turmoil.
The Indian banking industry is measured as a flourishing and the secure in the
banking world. The country’s economy growth rate by over 9 percent since last
several years and that has made it regarded as the next economic power in the
world. Our banking industry is a mixture of public, private and foreign ownerships.
The major dominance of commercial banks can be easily found in Indian banking,
although the co-operative and regional rural banks have little business segment.
The Indian banking sector has two kinds of scheduled banks i.e. scheduled
commercial banks and scheduled co-operative banks. Under the first category of
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scheduled banks, four types of entities have found based on their establishments
and legal obligations. They are:
i) Public banks (28)
3
,
ii) Private Banks (25),
iii) Foreign Banks working in India (29) and
iv) Regional Rural Banks (91)
The second category of scheduled cooperative banks consists of:
i) Scheduled Urban Co-operative banks (55) and
ii) Scheduled State Co-operative Banks (16)
Under public & private sector, banks are more clearly defined according to
nationalization and privatization. The banks under public banks are Nationalized
Banks (20) and State Banks of India (with its associates, the number is come to
8). Under Private Bank category, banks are divided into two types i.e., Old private
banks (17) and New-private banks (8).
II. Reforms and Banking system
In the post liberalization-era, Reserve Bank of India (RBI) has initiated quite a few
measures to ensure safety and consistency of the banking system in the country
and at the same point in time to support banks to play an effective role in
accelerating the economic growth process. One of the major objectives of Indian
banking sector reforms was to encourage operational self-sufficiency, flexibility
and competition in the system and to increase the banking standards in India to
the international best practices
4
. Although the Indian banks have contributed
much in the Indian economy, certain weaknesses, i.e. turn down in efficiency and
erosion in profitability had developed in the system, observance in view these
conditions, the Committee on Financial System
5
(CFS) was lay down.
3
The number in brackets are No. of the Banks exists in that type.
4
Dr. Y.V. Reddy (2002), “Monetary and Financial Sector Reforms in India: A Practitioner’s
Perspective”, The Indian Economy Conference, Program on Comparative Economic Development
(PCED) at Cornell University, USA.
5
Narsimham Committee-I
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Reserve Bank of India has implemented banking sector reforms in two phases.
The first reform focused on introduction of several prudential norms, major
changes in the policy framework, and formation of competitive atmosphere. The
second phase of reforms began in 1997 with aim to reorganization measures,
human capital development, technological up-gradation, structural development
which helped them for achieving universal benchmarks in terms of prudential
norms and pre-eminent practices. The Financial sector reforms were undertaken
in 1992 based on the recommendations of the CFS. Later, The Narsimham
Committee has provided the proposal for reforming the financial sector. The
committee also argued that ‘economic reforms in the real sector of economy will,
however, fail to realize their full potential without a parallel reform of the financial
sector. It focused on several issues like, releasing of more funds to banks,
deregulation in interest rates, capital adequacy, income recognition, disclosures
and transparency norms etc. However, financial sector reforms focused on
improving the competitive efficiency of the banking system. The financial reform
process has commenced since 1991 which was made the banking sector healthy,
sound, well- capitalized and become competitive.
This paper seeks to determine the impact of various market and regulatory
initiatives on efficiency improvements of Indian banks. The reform process has
shifted the focus of public sector dominated banking system from social banking
to a more efficient and profit oriented industry. While the reform process has
resulted in the private sector replacing the government as the source of resources
for public sector banks (PSBs), the infusion of private equity capital has led to
shareholders challenges to bureaucratic decision making. PSBs also face
increasing competition not only from private and foreign banks but also from
growing non-banking financial intermediaries like mutual funds and other capital
market entities. The competitive pressures to improve efficiency in the banking
sector has resulted in a switch from traditional paper based banking to electronic
banking, use information technology and shift of emphasis from brick and mortar
banking to use of ATMs.
