Profit Efficiency of Indian Commercial Banks in the Post-liberalisation Period: A Stochastic Frontier Approach

Abstract

This article estimates bank-specific profit efficiency of three broad ownership groups of Indian banks during the period 1995–96 to 2011–12, using the stochastic frontier methodology. Results reveal that during the post-liberalisation period, public sector banks in India are the best performers in terms of estimated profit efficiency. Further, foreign banks operating in India record higher profit efficiency levels compared to domestic private banks. The introduction of prudential regulations, such as capital adequacy ratios, has had a significant positive impact on the profit efficiency of Indian banks, while loan defaults adversely affect their profit efficiency. Market power does not necessarily lead to an increase in profit efficiency, while bank mergers have had a significant positive effect. Contrary to the expectation that the Indian banking system is highly resilient and sufficiently robust to cope with external shocks, the results reveal that the ongoing global financial crisis has had a significant adverse effect on the profit efficiency of Indian banks. JEL classifications: C14, G21, G28