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Deregulation and Efficiency of Indian Banks pp 167–200Cite as

Relevance of Non-traditional Activities on the Efficiency of Indian Banks

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Abstract

This chapter investigates the relevance of the inclusion of non-traditional activities in the specification of banks’ output on the efficiency of Indian banks. The empirical results indicate that the exclusion of non-traditional activities not only understates the cost, technical and allocative efficiencies of individual banks, but also affects the ranking of ownership groups in the industry. In particular, when a proxy for non-traditional activities is accounted for in the output specification, the foreign banks appear to be more efficient than public and private sector banks. Overall, the results reinforce the prevailing view in the extant literature that the exclusion of non-traditional activities causes misspecification of banks’ output, and may distort the efficiency estimates.

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Notes

  1. 1.

    The traditional banking business has been to make long-term loans and fund them by issuing short-dated deposits, a process which is commonly referred to as ‘borrowing short and lending long’ (Edwards and Mishkin 1995).

  2. 2.

    Off-balance sheet activities involve trading financial instruments and generating income from fees and loans sales, activities that affect bank profit but do not appear on the bank balance sheet (Mishkin 2004). Therefore, we have used the terms off-balance sheet activities and non-traditional activities interchangeably in this chapter.

  3. 3.

    Note that Table A.2 is given in the Appendix.

  4. 4.

    In practice, the researchers identify three behavioural goals to be pursued by the banks, i.e. cost minimisation, revenue maximisation and profit maximisation.

  5. 5.

    Even though the true technology could be different from constant returns-to-scale (CRS), but we adopt the CRS specification of technology on account of the following reasons. First, given the small sample size like ours, one may get a distribution with many observations having efficiency score equal to 1 using variable returns-to-scale (VRS) specification. This implies that one may not get better discrimination of sampled units under VRS specification of technology in case of small sample size. Second, regarding the use of VRS specification of technology, Noulas (1997) stated that the assumption of CRS allows the comparison between small and large banks. In a sample where a few large banks are present, the use of VRS framework raises the possibility that these large banks will appear as being efficient for the simple reason that there are no truly efficient banks. Avkiran (1999) also mentions that under VRS each unit is compared only against other units of similar size, instead of against all units. Pasiouras et al. (2007) point out that the assumption of VRS is more suitable for large samples. The prominent studies that made use of CRS assumptions for measuring cost and technical efficiencies in banking system include Aly et al. (1990), Ariss et al. (2007), Hassan and Sanchez (2007), Pasiouras et al. (2007) and Rezvanian et al. (2008) among others.

  6. 6.

    The ‘grand frontier’ envelops the pooled input–output data of all banks in all years.

  7. 7.

    Like Ray and Das (2010), we treat equity as quasi-fixed input because compared to other inputs, the level of equity is much more difficult to alter, especially in the short run.

  8. 8.

    Cost inefficiency (%) = (1 − cost efficiency score) × 100.

  9. 9.

    For making optimal use of labour force, these banks evolved policies aimed at ‘rightsizing’ and ‘redeployment’ of the surplus staff either by way of retraining them and giving them appropriate alternate employment or by introducing a ‘voluntary retirement scheme (VRS)’ with appropriate incentives. Consequently, the labour cost per unit of earning assets fell from 2.44 % in 1992–1993 to 0.95 % in 2007–2008.

  10. 10.

    This is evident from the fact that in PSBs group, the quantum of net NPAs as percentage of net advances declined from 10.7 % in 1994–1995 to 1.0 % in 2007–2008.

  11. 11.

    The intermediation cost is defined by operating costs as a percentage of total assets. It is believed that larger the cost–asset ratio, the lower is the level of efficiency. The cost–asset ratio for PSBs (PBs) group has declined from 2.64 % (2.71 %) in 1992–1993 to 1.77 % (2.06 %) in 2006–2007. However, the cost–asset ratio of FBs group has remained as high in 2006–2007 as it was in 1992–1993.

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Authors and Affiliations

  1. Faculty of Economics, South Asian University, New Delhi, India

    Sunil Kumar

  2. Department of Humanities and Social Sciences, Indian Institute of Technology Roorkee, Roorkee, Uttaranchal, India

    Rachita Gulati

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  1. Sunil Kumar
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Kumar, S., Gulati, R. (2014). Relevance of Non-traditional Activities on the Efficiency of Indian Banks. In: Deregulation and Efficiency of Indian Banks. India Studies in Business and Economics. Springer, New Delhi. https://doi.org/10.1007/978-81-322-1545-5_5

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