Academic journal article IUP Journal of Applied Economics

Data Envelopment Analysis Models to Measure Risk Efficiency: Indian Commercial Banks

Academic journal article IUP Journal of Applied Economics

Data Envelopment Analysis Models to Measure Risk Efficiency: Indian Commercial Banks

Article excerpt

In this study, a four-stage Data Envelopment Analysis (DEA) model has been proposed to examine the productive efficiency of commercial banks. Risk that leads to an undesirable output, and which is viewed as originating due to exogenous and endogenous factors, has been explicitly introduced. It is hypothesized that neither of them can be controlled by the decision-making unit under efficiency evaluation. Thus, this non-discretionary DEA variable is both internal and external. The four-stage DEA is performed to measure risk efficiency and multiplicatively decompose it into exogenous and endogenous risk efficiency. The DEA models formulated are implemented to investigate input productive efficiency of 81 commercial banks covering public, private and foreign sectors. In the presence of risk, foreign sector banks are well ahead of public and private sector banks in attaining risk efficiency. Structural risk efficiency attributed to exogenous and endogenous factors appears to be the same for public and private sector banks.

(ProQuest: ... denotes formulae omitted.)

Introduction

The planning era of India commenced from the year 1950. At that time, it was recognized that the banking sector is the key instrument for the rapid economic development of India. The Imperial Bank of India was nationalized in the year 1955, renamed as the State Bank of India, and is now the largest of all public, private and foreign sector banks. In the year 1959, the State Bank of India Act was passed, and by enclosing seven states as its associated banks, the domain of SBI was expanded. SBI and its associates were assigned the task of serving India toward economic development by meeting the credit needs of the economy. All other banks were privately owned till 1969. During 1947-1960, the commercial bank credit was channeled more to meet the requirement of urban-based customers, industry and trade than agriculture and small-scale industries. To fulfill the social objectives like the welfare and wellbeing of all sections of people and for uniform distribution of bank credit under Nationalization Act, 14 of the largest private banks were nationalized in the first phase. In the second phase, another six private banks were nationalized in the year 1980. The private and public sector banks coexisted in a highly regulated environment where their activities were closely monitored and controlled through regulated entry and strict branch licensing.

During 1969-1990, 3000 branches were opened in rural areas where commercial banks did not exist (Kumar and Gulati, 2009). All the regulatory measures led to a phenomenal growth of the Indian banking sector, in particular the public sector banks. In 1990, 90% of commercial bank business was accounted for by the public sector banks. However, excessive focus on social objectives rendered many banks inefficient, unprofitable and undercapitalized (Sensarma, 2005).

In 1991, Indian commercial banks were found facing financial repression. The policies, laws, regulations and informal controls which prevented the proper functioning of the banking sector led to financial repression, for which government intervention was mainly responsible. The government could interfere in a number of ways to cause financial repression by pursuing intervention policies involving statutory preemptions, interest regulation and directing credit to the priority sectors (Joshi and Little, 1997).

In India, in 1992, 40% of the total credit had to go to priority sectors such as agriculture, small-scale industries, small transport operators or the export sector. These funds were channeled at regulated interest rates which fell below the market rates of interest. During the 1960s and 1970s, the Cash Reserve Ratio (CRR) was about 5%, and in 1991, it reached the level of 15%. 3% and 15% were legal minimal and maximum levels of CRR respectively. In February 1992, Statutory Liquidity Ratio (SLR) was 38.5%, while the upper limit existed at 40%. …

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