Privatization, Performance, and Efficiency: A Study of Indian Banks

Abstract

Enhancing efficiency and performance of public sector banks (PSBs) is a key objective of economic reforms in many countries including India. It is believed that private ownership helps improve efficiency and performance. Accordingly, the Indian government started diluting its equity in PSBs from early 1990s in a phased manner. Has the partial privatization of Indian banks really helped improve their efficiency and performance? International evidence on impact of privatization is mixed. Though the issue is important in the Indian context, no study to the author's knowledge has addressed it so far. The present study, thus, fills an important gap. The data required for the study were obtained from Performance Highlights of Banks, a publication of the Indian Banks' Association. The author could readily obtain publications for five years — 1998-2002; his analysis is, thus, restricted to these five years. The financial performance of the banks was measured using the standard financial performance measures such as return on assets. The efficiency of banks was measured using accounting ratios, e.g., deposits per employee. Two main approaches are generally used to evaluate the impact of privatization on firm performance: ‘Synchronic’ approach in which the performance of state-owned firms is compared with the firms that were privatized or with the firms that were already in private ownership. ‘Historical’ approach, in which ex-ante and ex-post privatization performance of the same enterprise is compared. Given that the data are available for only five years, the author uses the synchronic approach. Since the dataset is not large enough to allow the use of more robust multivariate statistical procedures, he confines himself to the use of the difference of means test. This study reveals the following: Financial performance of partially privatized banks (measured by return on assets) and their efficiency (measured by three different ratios) were significantly higher than that of the fully public banks. In the matter of quality of advances (measured by the ratio of non-performing assets to net advances), significant difference was not found in these two groups. Of course, there is no quick fix for this problem. Partially privatized banks also seem to be catching up fast with fully private banks as no significant difference was found in financial performance and efficiency between them. On comparing the strategies of privatization in India with the other countries, India was found to adopt the strategy of initial public offerings like Poland. This strategy failed in Poland but seems to have succeeded in India. Gradual privatization and well-developed financial markets seem to have contributed to Indian success.