Dynamics of scale effficiency of Indian banks: A deterministic frontier approach

Abstract

Indian banking sector is characterized with intense competition, amongst the best regulated in the world and rapid growth. Indian banking sector have undergone rapid reforms and liberalization in last two decades, which resulted into advent of new and strong private sector banks, increased technology adoptions, rapid branch expansion, prudential regulations, focus on financial inclusion, market discipline of public sector banks and demanding customers. With Indian Banking system poised to become the world’s 3 rd largest by 2025 and owing to the dynamism in banking sector the paper examines the bank efficiency. Most past studies focused on the impact of some or other regulatory phase, some segments of banking and under constant return scale assumption. Our study is distinct to the extent that we examine the bank efficiency after the Phase III and IV reforms and subprime crisis, across all ownership segments of Scheduled Commercial Banks and under plausible assumption of variable returns of scale given the dynamic banking environment. We employ non-parametric Data Envelopment Analysis using intermediation approach under of variable return of scale. Our study period consist of 2008-2012 post reform and subprime crisis period and covers 26 public, 19 private and 21 foreign banks operating in India. We further examine the variation in efficiency across different ownership groups and small and large bank sizes over the period. Our findings indicate that Public sector banks’ average efficiency scores were better than that of private sector while foreign banks had the lowest efficiency score. Private sector banks had lower heterogeneity in efficiency compared to public sector banks. The smaller banks showed better efficiency compared to larger banks across the ownership groups. We find that the banking reforms have seen improvement in efficiency of public sector banks as compared to private and foreign banks. Thus our findings differ from studies on other emerging markets indicating efficiency improvement of foreign banks as compared to pubic banks. While banks have shown overall efficiency the lower technical efficiency indicate inefficiency in large banks probably due to sub optimal scale and scope efficiency. Our study point outs management of assets, branch rationalization and use of technology to improve the bank efficiency. The study suggests policy focus on reduction of non-performing assets and rationalization of staff and branches to obtain efficiency gain. Regulatory reforms in Indian Banking sector saw improvement in efficiency of public and private banks and efficiency scores differed across various ownership and large and small bank groups.