Academic journal article International Journal of Business

An Empirical Analysis of Cost Efficiencies in the Indian Banking Industry

Academic journal article International Journal of Business

An Empirical Analysis of Cost Efficiencies in the Indian Banking Industry

Article excerpt

ABSTRACT

This study analyzes the cost efficiencies of 35 Indian commercial banks over the period 2007 to 2013. We use translog cost function to evaluate economies of scale in the Indian banking sector. Translog cost function is estimated for total cost, operating cost, non-operating cost, interest expenses, and employee cost. We estimate cost efficiencies with respect to output and output is defined in three different ways-total assets, total deposits, and total loans of Indian banks. Estimates of cost elasticity show that Indian commercial banks are reaping economies of scale with respect to total assets, total deposits, and total loans, because with every rupee increase in assets or deposits or loans, cost is rising less than proportionately. We also find that ownership structure of a bank (public sector or private sector) plays a role in determining cost efficiencies in the Indian banking industry.

JEL Classifications: G21, C23

Keywords: economies of scale; translog cost function; Indian banks

(ProQuest: ... denotes formulae omitted.)

I. INTRODUCTION

The banking industry in India has come a long way from the nationalization of its banks in 1969 to the liberalization of the financial system since 1991. During the reform process that started in 1991, the banking sector was opened up with the objective of improving the efficiency of the banking system in India through increased competition from private and foreign banks. With this view, the government initiated the process of removing interest rate controls. The government also introduced capital adequacy requirements and other safety norms to ensure a sound banking system. The objective is to strengthen banking supervision and increase competition through licensing of private banks and foreign banks. The ultimate goal is to integrate Indian banks into the global financial system.

Although the amount of assets and deposits managed by the Indian banking industry has increased several folds, empirical research on economies of scale and cost efficiencies in the Indian banking industry is still limited. The issue of economies of scale and cost efficiencies in the banking industry is important for several reasons.

Firstly, the Indian economy is the second fastest growing economy in the world after China. Since these nations represent an engine of growth for the world economy, a large amount of capital is flowing to the stock markets of these nations. Banks, as financial intermediaries, are playing a crucial role by bringing enhanced liquidity and promoting market efficiency by facilitating smooth transfer of funds between borrowers and lenders that will promote capital mobility among nations. A sound and efficient banking system is essential for a smooth integration of Indian financial markets with the rest of the world, because banks play a crucial role in facilitating transfer of funds between borrowers and lenders. Therefore, the size of the banking system is bound to grow further.

Secondly, previous studies show that a country's financial sector influences future economic growth. The banking sector is the most important part of the financial markets. If the Indian banking sector is sound and efficient, it will have a positive impact on India's growth.

Thirdly, we examine the cost efficiencies of Indian commercial banks during the period 2007 to 2013. This time period covers "before-crisis" and "after-crisis" time. Findings from this study will highlight the cost behavior of the Indian banking sector during and after the global financial crisis.

This study will also help the banking industry as well as regulatory agencies such as the Reserve Bank of India (RBI) get a better understanding of the impact of growth of a bank on a bank's expenses and its benefits to bank shareholders in the form of higher returns and increased shareholder wealth.

We distinguish our study from previous studies in two ways. Firstly, this study provides a more comprehensive view of the cost efficiencies in the Indian banking sector. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.