Technical Efficiency of Banking Industry in India: A Longitudinal Analysis.

AuthorKhosla, Rajiv


The efficiency in general and technical efficiency in particular of an economic enterprise has come to be widely perceived as the crux of its performance in a modern market-driven economy. Rather, it is generally observed to be one of the most critical determinants of the economies' survival, growth and sustenance. It is also equally true for the survival, growth and sustenance of the Indian economy as well as of its sectors that the post-reform period has witnessed a great surge of interest in this area of Indian banking. Numerous studies such as by Kumbhakar and Sarkar (2003), Ram Mohan and Ray (2004), Shanmugam and Das (2004)" Das et al. (2005), Sahoo et al. (2007),Sahoo and Acharya (2007), Saini (2009), Tabak and Tecles (2010), Sanyal and Shankar (2011), Das and Kumbhakar (2012), Casu et al. (2013), Fujii et al. (2014) and Arora et al. (2018) have been undertaken to explore the extent of efficiency and its various correlates. It is unquestionably true that these studies are important in their own right in terms of offering a variety of perspectives and conclusions regarding the performance of Indian banking industry due to their rich empirical content, sound theoretical backing and methodological sophistication. As such, they make an important contribution to improving our understanding of various issues that they sought to explore. Regardless of this, however, these studies seem to suffer from various conceptual and measurement inadequacies. Moreover, since these studies cover different reference periods and have varying assumptions, they are not strictly comparable as well. There, thus, exist important research gaps in the existing body of literature on the theme under consideration. This, in turn, calls for unearthing if the observed technical inefficiency in the case of banking industry in India is on account of managerial underperformance or due to the choice of inappropriate scale or both. Needless to emphasize that addressing such issues through appropriate policy-mix assumes tremendous significance in the prevailing environment, particularly when survival, growth and sustenance not only of the banking sector per se, but also of the world's currently fastest growing Indian economy as a whole are at stake in view of close inter-connectedness between the two. It is against this backdrop that the present study seeks to approach the issue of technical efficiency of the banking industry in India in terms of the temporal behavioral pattern of efficiencies attendant to it for locating plausible explanations in respect of the same. More precisely, it makes an effort to estimate of Technical, Pure Technical and Scale efficiencies of the banking industry in India for the period 1995-2016.

The present study differs from the earlier ones on the theme under consideration in the following ways. First, it is extensive in coverage in that it encompasses in its fold information pertaining to 51 sample banks of different ownership categories. Second, it develops for itself a methodological framework that suits its analytical needs. Third, the choice of the reference period of the study (i.e. 19952016) is primarily dictated by the availability of relevant and reliable data in consonance with consistency tests.

Data, Input-Output Variables & Estimation Procedure

In order to meet its analytical needs, the present study draws upon data culled from RBI website ( More precisely, our study is based on secondary data borrowed from the 'Statistical Tables Relating to Banks in India', which is brought out annually by the country's apex financial institution i.e., the Reserve Bank of India. These data pertain to the period falling in-between 1995 and 2016.

Input & Output Variables

In the matter of selection of inputs and outputs for measuring bank level efficiency of the banking sector in India, the present study has chosen the intermediation approach rather than its alternative. i.e, the production approach. While the first of these two approaches is widely viewed to be more appropriate for analyzing branch level efficiency, the latter on the other hand, does so at the overall level of a bank. Our choice in doing so is guided exclusively by the suitability criterion that envisions the fact that while the bank management generally seeks to reduce total costs and not just non-interest expenses at the level of the bank; at the branch level, on the other hand, there exists conspicuous absence of control of branches over the bank-funding and investment decisions due to the occurrence of a large number of customer service processing.

For computing the various efficiency scores in respect of categories of banks, our study uses 3 inputs, namely, (i) Physical capital (measured as the value of fixed assets), (ii) labor (measured as the number of employees), and (iii) loanable funds (measured as the sum of deposits and borrowings). As against this, the 3 selected output variables employed in the study are: (i) Advances, (ii) Investments, and (iii) Non-interest income.

It is not impertinent to mention that all the input (excepting labor which, as stated above, is measured in terms of number of employees) and output variables used in the present study are measured in terms of Rupees in lakhs (note that 10 lakhs=1million). All the current price figures have been deflated to the base price of 2004. Further, in order to get per branch figures and remove bank size specific heterogeneity, all the input-output variables have been divided by the number of branches. Thus, all the efficiency scores in respect of the various banks included in the present study represent per branch levels.

Estimation Procedure

Thanks to the growing recognition that all banks cannot be perceived to be equally efficient or successful in meeting their objectives, the literature on banking sector efficiency estimation in India through the increasing use of frontier efficiency techniques has tended to swell over the past couple of years. This notwithstanding for a while, what needs to be noted, in particular, in respect of these efficiency estimation techniques is that they seek to measure the performance of each bank in the industry in relation to the efficient frontier of the most efficient banks in the industry. Accordingly, a bank is labelled as fully efficient if it lies on the efficiency frontier, and inefficient if it deviates from it. The extent of inefficiency in this case is measured by the distance between the efficiency frontier of the most efficient bank and the actual location of the bank below it. The distance between the two bears a positive relationship with the level of inefficiency. That these techniques are superior to conventional ratio analysis as techniques of measurement of banking sector efficiency and have dislodged the latter is a widely documented fact and barely needs any fresh affirmation.

The present study employs the Data Envelopment Analysis (DEA), which is a non-parametric technique and is often viewed as the most potent approach for measuring relative efficiency across banks due to its in-built advantages over its rival techniques. In more specific terms, our study evolves for itself a two-stage Data Envelopment Analysis (DEA) methodology in the estimation of the efficiency scores of various categories of banks in India. In the first phase overall technical efficiency (OTE), pure technical efficiency (PTE) and scale efficiency (SE) scores for the three ownership categories of banks under consideration have been estimated by utilizing two famous DEA models, namely the CCR (Chames, Cooper & Rhodes) and BCC (Banker...

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