Producing Financial Services: An Efficiency Analysis of Indian Commercial Banks

Summary

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The present study attempts to examine the changes in the productive efficiency of Indian commercial banks after the financial sector reforms initiated in 1992. Using stochastic frontier technique we estimate bank specific deposit, advance and investment efficiencies for the period 1985-2004. Our results show that deregulation has significant impacts on all three types of efficiency measures. While deposit and investment efficiencies have improved, advance efficiency has declined marginally. Public sector banks as a group ranks first in all the three efficiency measures showing that, as opposed to the general perception, these banks are doing better than their private counterparts. Private Banks however have shown marked improvement during the post-liberalisation period in terms of all three types of efficiency measures.

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Producing Financial Services: An Efficiency Analysis of Indian Commercial Banks

INTRODUCTION

It has been around one and a half decade since financial sector reforms were initiated in India. As banks are the major segment of the financial sector in India, reform measures are primarily aimed at improving the performance of the banking sector. The importance of banking system in India is noted by the fact that aggregate deposits stood at 55 percent of GDP and bank credit to government and commercial sector stood at 26 percent and 33 percent of GDP respectively in 2004-05. An efficient banking system has significant positive externalities, as it increases the efficiency of economic transaction in general. Therefore, one of the important objectives of financial sector reforms was to improve the efficiency of banking system (RBI, 2002). In this backdrop it is essential to study the efficiency levels of Indian commercial banks to understand the impact of financial sector reforms on its performance.

The impact of deregulation on efficiency of different banking sectors has been found to be mixed across the globe. While in countries like Australia (Sturn and Williams, 2004) Spain (Vivas A L, 1997), Turkey (Isik and Hassan, 2003) and Norway (Berg et al., 1992) financial liberalisation has positively affected the efficiency and productivity of commercial banks; for Italy (Boscia, 1999) US (Bauer et al., 1993) and others banking efficiency was relatively unchanged after deregulation. Surprisingly, in Korea, productivity of the banking sector has declined after deregulation (Mahadevan, 2004). A survey of 130 studies by Berger and Humphrey (2000) of financial ins...

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