Magazine article Journal of Services Research

Producing Financial Services: An Efficiency Analysis of Indian Commercial Banks

Magazine article Journal of Services Research

Producing Financial Services: An Efficiency Analysis of Indian Commercial Banks

Article excerpt


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 institutions in 21 countries shows that impact of deregulation on the efficiency of banks is mixed.

Most of the studies which look at the efficiency of Indian commercial banks concentrate on cost, profit, income or revenue efficiencies (Das, 1997; Shanmugam and Lakshmanasamy, 2001; Kumar and Verma, 2003; Mohan and Ray, 2004; Das et al, 2005; Kumbhakara and Sarkar, 2003; De, 2004; and Sensarma, 2005). Amongst them, few studies use data related to either only pre-reform period or only post-reform period. Furthermore, many of them use data for a single time period which makes it difficult to compare the efficiency levels in a dynamic setup. While few studies concentrate on the efficiency of only public sector banks, others look at the relationship between ownership and efficiency. Most of the studies use Data Envelopment Analysis (DEA) method as a technique of analysis. While these studies are no doubt relevant, it is important to note that there are only a limited number of studies that examine productive efficiency of the commercial banks in India.

Productive efficiency of a commercial bank gives a measure of the performance of a bank in producing financial services relative to the best performing bank. While Bhattacharya et al, (1997) use DEA to measure the productive efficiency of Indian commercial banks for the period 1986-1991, Keshari and Paul (1994) use Stochastic Frontier Analysis (SFA) to measure the same for the period 1990-91. As these studies were conducted before the financial sector reforms were introduced, there is a need to revisit the productive efficiency issue. This assumes all the more importance because in the post nationalization period of Indian banking sector (i.e., since 1969), deposit mobilisation and credit disbursements received considerable attention.

Given this background the paper is organized as follows; in the next section we discuss briefly about the Indian banking system and various reforms introduced after 1992. Third section contains discussion about the methodology used for measuring technical efficiency; and various approaches of output measurement in the banking sector are presented. Details about the data used for the study are presented in section four; and the estimated results are presented in the penultimate section. The concluding section sums up the findings.


After independence, the major development in the Indian banking sector was nationalisation of commercial banks in 1969. …

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