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Did efficiency of Indian public sector banks converge with banking reforms?

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Abstract

This paper examines the issue of convergence of efficiency levels among Indian public sector banks (PSBs) during the post-reforms period spanning from 1992/1993 to 2005/2006. The empirical results indicate that the majority of PSBs have observed an ascent in technical efficiency during the post-reforms years. Further, the inefficient PSBs have been noted to be catching up with the efficient ones. That is, the banks with low level of efficiency at the beginning of the period are growing more rapidly than the highly efficient banks. In sum, the study confirms a presence of convergence phenomenon in the Indian public sector banking industry.

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Notes

  1. For supporting their observation, the authors cited that “The profitability of banks was extremely low in spite of rapid growth of deposits. The average return on assets in the second half of the 1980s was about 0.15%, an extraordinary low figure by world standards. Return on equity was higher (about 9.5%) but that was simply a reflection of the low capitalization of Indian banks. Capital and reserves averaged about 1.5% of assets, compared to 4–6% in other Asian countries. The true picture was even worse because these figures were not based on applying the correct income recognition and provisioning criteria….The banking system had become extremely fragile as a result of the large overhang of non-performing assets (NPAs). Under proper accounting procedures, the latter result in lower income, high provisions, lower net profits, and erosion of capital and net worth”.

  2. In India, the policy makers that have been entrusted with the task of formulating the policies for the banking sector comprise the Reserve Bank of India (Central Bank), Ministry of Finance, and related Government and financial sector regulatory entities.

  3. This committee is popularly known as Narasimham Committee I, named after its chairman M. Narasimham.

  4. This committee is popularly known as Narasimham Committee II, named after its chairman M. Narasimham.

  5. As on March 31, 2006, PSBs accounted for 72.3% of the total assets, 74.9% of the deposits, and 72.9% of the advances of all the scheduled commercial banks.

  6. The 60 remaining studies applied other four-frontier approaches namely, stochastic frontier analysis (SFA), thick frontier approach (TFA), distribution free approach (DFA), and free disposal hull (FDH).

  7. This committee is popularly known as Verma Committee, named after its chairman M. S. Verma.

  8. Except saving deposit account, non-resident Indian (NRI) deposits, small loans up to Rs. 0.2 million and export credit, the interest rates are fully deregulated.

  9. The combined pre-emptions under CRR and SLR, amounting to 63.5% of net demand and time liabilities in 1991 (of which CRR was 25%) have since been reduced and presently, the combined ratio stands below 35% (of which, the SLR is at its statutory minimum at 25%).

  10. The GOI has injected about 0.1% of GDP annually into weak public sector banks (Hanson 2005; Rangarajan 2007). During the period 1992/1993 to 2001/2002, GOI contributed some Rs. 177 billion, about 1.9% of the 1995/1996 GDP, to nationalized banks (Mohan and Prasad 2005).

  11. In 1993, the State Bank of India (SBI) Act, 1955 was amended to promote partial private shareholding. The SBI became the first PSB to raise equity in the capital markets. The amendment of the Banking Regulation Act in 1994 allowed the PSBs to raise private equity up to 49% of paid up capital. Since then 20 PSBs have diversified their ownership, although the government has remained as the largest shareholder.

  12. India adopted the Basel Accord Capital Standards in April 1992. An 8% capital adequacy ratio was introduced in phases between 1993–1996, according to banks ownership and scope of their operations. Following the recommendations of Narasimham Committee II, the regulatory minimum capital adequacy ratio was later raised to 10% in the phased manner.

  13. The time for classification of assets as non-performing has been tightened over the years, with a view to move towards the international best practice norm of 90 days by end 2004.

  14. From 2000–2001, the PSBs are required to attach the balance sheet of their subsidiaries to their balance sheets.

  15. In 1993, the RBI issued guidelines concerning the establishment of new private sector banks. Nine new private banks have entered the market since then. In addition, over 20 foreign banks have started their operations since 1994.

  16. A high powered Board of Financial Supervision (BFS) has been constituted in 1994. BFS exercised the power of supervision in relation to the banking companies, financial institutions, and non-banking companies, creating an arms–length relationship between regulation and supervision. On-site supervision was introduced in 1995, and annual supervision of capital adequacy, asset quality, management quality, earnings, liquidity, and systems (CAMELS) was introduced in 1997.

  17. DMUs are usually defined as entities responsible for turning input(s) into output(s), such as firms and production units. In the present study, DMUs refer to banks. A DMU must, as the name indicates, have at least some degree of freedom in setting behavioral goals and choosing how to achieve them.

  18. Given the small sample size (27 PSBs in each year) in the present study, CCR model provides better discrimination than any other DEA model, especially BCC model, named after Banker et al. (1984). In the CCR model, it is assumed that constant returns-to-scale prevail in the industry while BCC model is based on the assumption of variable returns-to-scale.

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

  20. Mean technical inefficiency (TIE) = (1-mean TE) × 100.

  21. The ‘profitability’ is measured in terms of return on assets (ROA).

  22. The variable ‘size’ is measured in terms of value of total assets.

  23. The ‘intermediation cost’ is measures as the ratio of operating expenses as a percentage of total assets.

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We would like thank anonymous reviewers and the editor of this journal for providing useful comments and suggestions which have resulted in significant improvements in the quality of the paper. Errors remain unerringly our own.

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    Sunil Kumar & Rachita Gulati

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Kumar, S., Gulati, R. Did efficiency of Indian public sector banks converge with banking reforms?. Int Rev Econ 56, 47–84 (2009). https://doi.org/10.1007/s12232-008-0057-2

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  • DOI: https://doi.org/10.1007/s12232-008-0057-2

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