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In this work we will be seeing the research proposal for the topic study on ownership structure and performance efficiency of banks in India and the methodology used to analyse the performance efficiency of banks. First of all we will see the background of the case study, and then we will see the main aims and objectives of the case study. Then in the later section we see about the method of collection of data and the methodology used followed by the structure plan of the case study.


In banking industry the pre-nationalisation period was mainly focusing on the business house and industry needs only. The banking society totally neglected farmers and the indigenous entrepreneurs as the government machinery was to bring financial resources in the arcades of the socialistic pattern. Banking sector cannot do anything much to reach all types of society even though was a regulatory authorities to monitor exclusively like RBI. Due to the improper and inadequate of regulations and power under the government, private ownership of the banks was came into action and they conduct banking in a way so it reaches all the sections of the society. The decision was made by Mrs. Indira Gandhi, the Prime Minister of India in 1969 to nationalise 14 private sector banks in the country.

After the nationalisation of the banks there were lots of changes in the Indian banking system in the positive direction as there were regulations in place to achieve the goals of nationalisation. As there were positive effects in the first phase of nationalisation, in the 1980 it was decided to make 6 more private banks to nationalise in the country. The nationalisation has ensured that the banking sector has penetrated into all the sections of the society and even it has increased the competition and ensuring profit which was not or never a goal of it. As a result of this the performance of the banks was not good in terms of profit making. This was the time where the leaders of Indian finance started to introduce the financial sector reforms. The pavement for the new generation banks in the Indian banking sector was due to the first report given by the Narasimham Committee on the financial sector reforms which did not any permission during 1969 to 1991. This helped to induce the completion in the Indian Baking Industry and this also helped to increase the performance and efficiency of the overall banking in India.

Aims and Objectives of the Study:

The main aim and objective of the base study is to calculate and explain the productive efficiency of the Indian commercial banks from 1990 to 2007. The study will contain the comparison of commercial banks and nationalised banks before the liberalisation policies that is before 1991 and after the period of that implemented and till the year 2007. Variation in performance and efficiency of the commercial banks in the country is also measured for the above mentioned years. There have been similar studies to calculate and estimate the performance of the banks in the countries like US and others but there is not much study conducted for the performance of the banks in the developing countries. There are only few. There has been studies conducted by Tyagarajan (1975), Rangarajan and Mampilly (1972) and Subrahmanyam (1993) regarding the various problems related to the Indian banks but there is no study conducted which examined the efficiency of banks. In the study, the performance of the Indian banks during mid and late 1990's that is before the financial sector reforms and after that period. The selection of that period is to suggest that how Indian banking sector should become stronger and also make it competitive not only in the country but internationally. The study also says the performance of the Indian banks with the relation to the ownership structure of the bank.

Data and Methodology:

The data for the study is collected from Reserve Bank of India's (online) database. The sample taken is from the period 1990 to 2007 from the data. We has choose 1990 as the initial year because we are using data on year by year change in our variables and the 1990 will provide base for 1991 as in 1991 was the start for the process of deregulation and it has been considered as nil or zero. The year 2007 was considered the final year as there was only data is available till this year. In general financial ratios are used to calculate the performance of the banks. For measuring the performance of the bank frontier analysis method is used now a day. This was argued by Sathye (2002). According to this method the better performing banks are separated from the poor performing banks. This separation is done by non parametric or parametric frontier analysis. There are lots of parametric approaches like free disposal hull, thick frontier and the distribution free approaches. The non parametric approaches include Data envelopment analysis (DEA) (Molyneux et al, 1996). Sathye (2002) used this method in his case study to analysis the efficiency of banks in developing economy: The case of India. According to him in 2003 the technical efficiency is the ability to alter multiple resources into multiple financial services. Here using the DEA methodology is used to calculate the efficiency using the variable returns to scale input.

We consider two input and two output variables with 2 different models A and B. These variables are to measure the management success in cost controlling and generating revenues. Interest expenses and non interest expenses are considered as input variables under model A. Then as the output variables we consider the net interest income and noninterest income in model B. The analysis for the model b will run with staff number and deposits as the inputs and for the outputs we see net loans and non interest income. But the deposits and the staff number can be replaced with the interest expense and non interest expenses respectively for having a direct approach in model B. For the net interest income, the net loans become the proxy. The choice of the input and output variables are very sensitive in the DEA technique, this is one of the strengths of DEA so this helps the bank to understand what variables should be monitored to improve the efficiency of the banks. Avkiran (1999) has done a similar study for the Australian banks with two model analysis. The main advantage of DEA is that the variable can be selected according to the needs of the management.

By using the above methodology we analyse the performance of different banks like private sector, public sector and foreign banks from the year 1990 to 2007.

Structure Plan of the Study:

The study will involve seven chapters that are the first chapter deals with the introduction to the case study and we also give the aim and objective of the study. In the second chapter will give the literature review of the corporate governance and ownership structure. This is a theoretical one. Then in the third chapter we will have theoretical evidences for the Indian banking scenario. Further in chapter four we see the about the Indian banking sector's recent trends and also gives the progress in the Indian banking. The fifth chapter will have the data and methodology used and the description of the variables in this chapter. In the sixth chapter we will have the empirical results of the study. In the final chapter that is in the seventh chapter we will provide the conclusion with the key findings and summary of the study. We will also see the limitations of this study.


Like discussed above we for calculating the performance efficiency of Indian banks we are going to DEA and the data's are all collected from Reserve Bank of India through internet.


The history of the ownership structure is first dealt in this work. We also see the performance efficiency of the banking system with the different ownership structure . this is dealt in an international perspective. With the available literature an detailed discussion about the nationalisation, performance and efficiency of the banking industry is given in respect with different ownership control. Firstly the history of the corporate governance is given. Also the ownership structure in the historical prespective is discussed. Then this is followed by the shareholding and corporate governance. The later section give the different views regarding the government ownership of the bank with some literature discussed. The final section gives the detailed discussion of the literatures regarding the performance of the bank with under different ownerships which is the essence of this work.


The main subject of thought from the 1930s has been ownership and control but according to Berle and Means (1932), the thought of separating ownership from control had taken its origin in the United States by the late 1920s. Agency problem occurred when to separation of ownership and control took place wherein the firm operated not in the favour of shareholders but in the interest of management (Jensen and Meckling, 1976; Fama and Jenson, 1983). In the optimistic development view of Gerschenkron (1962) the government in the financial markets mainly focused on the economic growth of the country. In his study, he argue that private commercial banks were in the front line of channelling savings in many of the industrialised countries in the late 1900's. In Russia during the 1890's the private banks failed to succeed in attracting required funds to finance a major industrialisation because of the scarcity of capital and underdeveloped economic institutions for those private banks. Therefore to kick start the financial and economic development the government had to step in through its banks which otherwise wouldn't have been possible through the privately owned bank. According to Lewis(1950) argument that government ownership of the banks as a part of “commanding heights” approach where the government will develop industries which are strategic through control on the finance approach and also through direct ownership. But Myrdal (1968) sympathetically prefers government ownership of banks in India and other Asian countries. The nationalisation of commercial banks in Africa, Asia and latin America during the 1960s and 1970s was lead due to the saying by Lenin in 1970 that, “Without big banks, socialism would be impossible; the big banks are the state apparatus which need to bring about socialism and which we ready-made from capitalism...” , this was said before a few days of the octobar revolution were widely adopted around the world (Garvy 1977). The government took the control of the bank in order to give jobs, subsidies and much benefits to the supporters who will in turn reciprocate in the form of votes, bribes and favours. This is the political view which is against the development view. (Kornai, 1979 and Shleifer and Vishny, 1994). The attraction of political control over the banks is dominant in underdeveloped countries, since the prvate banks need not be competed by the government as a source of fund and this is well supported by the evidence that is the documentation of lack of efficiency in government enterprises, the political side benefits out of it and on the other there are benefits of privatisation (Megginson et al.,(1994) Barberis et al.,(1996) Lopez-de-Silanes et al.,(1997) Frydman et al.,(1999) and La Porta et al.,( 1999). The higher leverage of control over the selection of projects being financed due to the ownership of the banks by the gvernment and at the same time the hadling over the implementation of the projects to the private sector Thus considering previous statements it would be right to say that the ownership of banks by the government promotes not only developmental but also political strategies. As argued by Caprio and Levine (2002), In the developing countries the corporate governance of the banks is always been a neglected area by most of the researchers. The subject has even been discussed only in recent literature even by developed countries (Macey and O'Hara, 2001) and to a great surprise it has also captured a great deal of attention (Oman, 2001; Goswami, 2001; Lin, 2001; Malherbe and Segal, 2001).

Firstly according to Arun and turner(2004), the banks are the most important device of economic growth(King and levine 1993a, 1993b, Levine 1997) and also takes a very dominant position in the financial systems of the developing countries, corporate governance of banks is most important aspect. Secondly according to them , the financial markets in these countries are underdeveloped , banks plays a vital role to the majority of the firms as the primary and the important source of finance in these countries. Thirdly the main depositors for the econoic savings in thse countries are the banks. Fourthly the managers of the banks have obtained greater freedom in running their bank owing to deregulation this is due to consequent to the librtalisation in the banking system in the developing economies.

Corporate Governance and Share Holding:

In a nut shell, corporate governance is a mechanism through which shareholders are assured that the managers will act in the better interest of them, but on the contrary as argued by Henderson (1986); and as far back as Adam Smith, it has been understood that managers do not always act in the interests of shareholders. By the development of mordern firms charecterised by a number of atomised shareholders in the Anglo Saxon economies has ultimately lead to the seperation of control and ownership.this has lead to the agency problems where the mangement dose not opertate in the interest of the shareholders but in their own interest. ( Jenson and Meckling, 1976; Fama and Jensen, 1983). This actually leads to managerial avoidance or otherwise the empire building and at last expropriation. Shleifer and Vishny, 1997; Vives, 2000 and Oman, 2001 provided the border view of coporate finance by which the subject is viewed as the method by which the suppliers of finance control managers in order to ensure that the get enought returns on their investments and also their capital cannot be tansfered. Macey and O'Hara (2001), argue that to take the border view is better since the interset of the depositors and the shareholders are prtected by the corporate governanace machinery of the banks.

In many countries especially in the developing countires, government ownership of banks are common phenomenon. (La Porta et al., 2002). This may be attributed to the severe informational problems attached to the developing financial systems aiding the developmental process of the economy (Arun and Turner, 2002). According to their arugment that with the govenment owned bank, the conflict between the government and the pricipal agent always depends on how much the govermnment is capable and it is proven that the capable government with political stability will have less conflict with the principal agent as the guarantees for everything in the deal is given by the government.

Rationale for Government Ownership of Banks:

According to Arun and Turner (2002), even though there are several rationalizations regarding ownership of the banks, the most improtant explantion for the government ownership of the banks are asymmetric information view, developmental view and political views.

Asymmetric Information View:

Banks institutions are the main source of finance for entreprenuers and firms in the developing country economies, this is due to the informational costs of using finance directly. But these banking institutions have to face moral hazards and adverse selection in giving loads, which in turn prompt the banks to have a fixed position in their credits (Stiglitz and Weiss, 1981; Stiglitz,1989). This leads to a situation that the access to credit is denied for the indegenous entrepreneurs[1] and they are not able to provide the adequate collateral (Khatkhate,1996). Adding to this severe credit shortage is expreienced by the indigenous entrepreneurs due to administering these loans to them which are relatively high. Even though the above mentioned problems do not necessiarily say that the governments should own the banks, but the persuasion of lending to these indigenous entrepreneurs can be more effective in the banks are owned by governments. By doing so the lender of last resort for the neglected sections of society will be the government. According to Arun and Turner (2002), the information problems is also between depositors rather than restricting it to the bank and borrowers alone. In the developing countires, the severity has been increased by the existance of directed credit schemes which compels the banks under high risk to lend for the social beneficial schemes, etc. Due to the inherent risks involved in this type of lending,the depositers are prompted to ask for high risk premia and at certain times their deposits with the bank is also refused by them.enen though the deposit insurance and monitoring of the banks are provided by the govrnment. Due to lack of credible insurance and inadequate monitoring technology there is a chance of err in both these areas(Arun and Turner,2002 ).On the contrary the depositiors will have guarantee for the bank solvency these inspiring them to deposit their money in the banks if the banks is owned by the government and this also enhances the proper functioning of the banks. Hence the beter predictor for the level of government ownership is suggested by this asummetric view.

Development View:

Recent literature has highlighted much on the close relation between economic growth and financial systems (King and Levine 1993; Levine 1997). Gerschenkron (1966) aruged that the government ownership of the banks helps to bring an economy out of economic bacwardness and this is improtant in the intial stages of the development to ensure the overcome of the inadequacy in the financial system. As public sector banks are not concerned about the maximisation of the profit, they can lend in the long term basis for the indigenous entrepreneuers and in the rural areas and underdeveloped areas, they can open new branches which will add to the social benefits. As argued by Ketkar and Ketkar (1992), there will be more savings mobilised by incresing the branches and also help in acessingbank facilities in the underdeveloped regions by the small business men. Finally the dominance of government banks can potentially influence the private banking entities to act in a socially desirable manner to develop a country (Park 1991).

Political View:

The argument of Shleifer and Vishny (1994) and La Porta et al.,(2002) is that if the government takes the ownership of the banks it will extend the benefits to the political supporters. Alternative view suggest that after decolonisation the foreign control was to be removed, the banks became nationalised and this can be interpreted as a deviation of La porta et al., that the anticolonial supporters will benefit if the government acquire ownership of the banks. La porta et al., (2002) aruges that in the democratic countries the government ownership of the banks is low and this can be interpreted as the stablitiy of the democtactic government is less to redistribute wealth among their political supporters and less interest is shown to the owning banks.

Literature regarding the Performance of the Bank:

Megginson, (2005 ) by examining the epmpirical literature that he public sector banks are less effecient then the private sector banks. He also says that the private sector banks gain less when compared to the other private industries. His argument continues saying tha the privatisation will maximise the development only if runs independently i.e. free from government influence.

Beck et al., (2005) from his exammination of banking industry in Nigeria from 1990 to 2001, he finds that the performance of the bank is good whn the government fully gave up the control over the banks and when the government showed less interest in the control over the banks.

A study of the Brazillian banks was conducted by Nakane and Weintraub(2005) from 1900 to 2002. This study showed that after privatisation the performance of the bank increased.

However the study of operating and stock price performance of 18 privatised banks and its competitors in developing economies by Otchere (2005) has found that in a long run the operating performance has slightly increased where as the performance has decreased.

Verbrugge et al., (1999) when investigating the privatised banks which are using government offerings as a sell off mechansim, it was found that there was serious threats raised for establishing market- oriented governance and decision making in the banks as the the government ownership of the banks continued.

Shleifer and Vishny (1994) arguement it was seen that government ownership according to the modern political theories, the allocation resources through its banks are highly for getting bribes and votes. Because of this the economic efficiency and budget constraints become more poor.

Gerschenkron (1966) argues in favour of government ownership as it always helps the countries which are economically week and help them to improve their economie.

The study conducted by Boubakri et al. (2005a) regarding the ownership structure and investor protetion which involved 209 firms in 25 developing countires and 14 industrialsed nations. The study says that the the ownership percentage was increased for the foregin investors and local institutions when compared to the proportion percentage owned by the individuals.

Boubakri et al., (2005b) studied the performance of 81 banks in 22 differrent developing economies after privatisation. In which he found that the profitability increased from country to country even though it increased. It was also found that the credit risk was more for local industries even with the incresed banking efficiency

Beck et al., (2005) conducted a study on the privatisation of Brazilian banks in which it was found that the state government were causing problems in the banks which are running efficiently.

In Argentina , a study was conducted by Berger et al., (2005) regarding the performance of the banks in the 1900's. In which it was revealed that the government banks was strongly outperformed by the private banks and also the individual banks performance was also increased due to privatisation.

The study by Boehmer et al., (2005) involving 101 countries from the year 1982 to 2000, in which it was found that the privatisation in the developing countries are affected by the poltical factors in that country whereas the privatisation in all the countries are affected by their economic factors.

The privatisation in Mexico from 1991 to 2003 was studied by Haber(2005), in which he argues that there was no improvement in the Mexicon banking industry either by privatisation or by the reforms.

But Claessens et al.,(2000) in their studies found that the foregin banks was less profitable when compared to the local bank in the developing countires but the foregin banks in the developed country is more profitable.

According to the observation done by Hasan et al.,(1996) that the domestic banks are more effective then the foreign banks and this was concurred by Yildirim et al.,(2002) in his study of the transition economies of Central and Eastern Europe. But Vennet (1996) revealed that in the developed country except US the foreign banks and domestic banks are equally efficient. On the other hand Barajas et al., (2000) showed that in Latin America that the domestic banks were less productive then the foreign banks. However there exists a slight difference in the performance of the domestic and foreign banks according to the report by Crystal et al.,( 2001)

To help the economic development , the government banks can have finance projects that could help it where private banks wont be willing to do so. But in the argument of La Porta et al., (2002) it is seen that the the economic growth is lowered due to politicains as they misuse the government owned banks to acheive their political goals. The empirical evidence provided by Barth et al.,( 1999) show that the financial development of the country is not enhanced by the government ownership of banks. Even the study by Beck and Levine (2002) has failed to give any proof of development of the economy under government ownership. The study by Caprio and Peria (2000) showed that the banking crisis was highly associated with the negative impact of the government ownership in the development. According to the arguement the negative effect will be continuing as in most countries the banks are owned by the government.


In this review many arguments have been dealt regarding the nationalisation and privatisation of the banks. The literatures suggests that penetration of banking domain to all types of society with different finance projects that is really helpful in developing the economy for which the private banks are not willing to finance. This is one of the own benefits of nationalisation. The banking industry had no improvement in tis efficiency as it was not a goal of nationalisation. The countries where the financial development is low has government ownership and this has empirical ecidence to prove it and there are studies which failed to prove that it has given raise to the economy of the country. On the other hand the from the studies of the performance of the banks suggests that atleast in the developed economy the competition is increased and it had made the efficiency improve due to privatisation.




Having seen the literature review of the banking scenario all over the world which clearly shows some evidences of the effects due to privatisation is positive and in the developed economies the efficiency have been increased due to privatisation. In this chapter we are going to see the study about the banking scenario in India. The second section of this chapter deals with ownership and the corporate governance in India with some theoretical evidence and the last part deals with the conclusion.


According to Reserve Bank of India (RBI) in 2007 the aggregate deposit and the bank credit was about 63.2% and 46.8% in GDP respectively. The existence of all banks like public, private and the foreign banks is a striking feature in Indian Banking Industry. The economic growths of countries which are under developed have been contributed by banks which are owned by the Government to a certain extent according to Gerschenkron (1966). Then later there was a research conducted by La Porta et al., (2002) which showed that the economic growth was brought down by the government ownership rather than helping to improve the economic growth. Further the cause or rather one of the causes for the East Asian Crisis was due to the banks owned by the government. This suggestion was given by Barth et al., (1998). But Arun and Turner (2002) argued that the crises did not give a conclusion either for public or private sector banks, this is due to that most of the banks in the East Asian economies countries like Korea, Indonesia, Philippines, Thailand and Malaysia have been given to private sector in 1970s. The case of India was completely unlike the East Asian countries as the stable public sector is still dominating the banking system and the government ownership has information asymmetric to the crises and the need for the development. Initially the private banks and the foreign banks was been controlled by Reserve Bank of India which was the central bank in India whereas the public sector banks was dominating the banking industry in India. There was possible deregulation in operation, interest rate and even licensing after the recommendations given in the Narasimham Committee in 1992; this was due to the fall in the efficiency and profitability as predicted. There is only few studies has been conducted for measuring the performance efficiency in the developing countries like India but there are lots of studies conducted to measure the performance of banks in developed economies like United States. The efficiency of banks in India has not been done even though there was studies and research have been conducted by Tyagarajan (1975), Rangarajan and Mampilly(1975) and Subrahmanyam (1993). The study conducted by Milind(2003) about the effciency of banks under different ownership reveled that the private and foreign ownered banks are less efficient then the banks owned by the government. The efficiency of the commercial banks and the public sector banks was adversly affected by the one factor that is the establishment cost as the percentage of total expenses. The study by Milind(2002) proved that the ratio of the total expenses was found to be the highest for the public sector banks in the year 1997 to 1998 which was about 20.13% where as for the public and foreign banks was 9.87% and 7.66% respectively. But The voluntary redundancy scheme which was introduced for the staffs by the public sector banks so as to realising the burden of high establishment expenses, this scheme was also to a greater extend that the effciency can be improved increased and also reduce the cost. In the public sector the aggressive reduction of non- preforming reduction and the staff is attributed acrroding to the result of Milind(2003) and this was a well declared objective by the government of India as to obtain the gains in the efficiency.

Its been found that financial development is slow and also the productivity growth is also very low in the banks owned by public , this was found using a study of a panel consist of 92 countries by La Porta et al.(2002) and there was also found that lower growth in per capita income also. Then in the study conducted by Hasan and Marton(2003_in hungary on the various transition economies and it was found that there was effects of banks owned by private was favourable. Due to liberalisation polices the banking industry can be opened up to have much more efficiency in the public sector banks. The study after the year 1991 thats is after liberalisation on the performance of Indian banks by Bhaumik et al.,(2004) showed that due to the heavy competion in the market the public and private owned banks were able to be bridged for the gap in the performance as the ownership was less important then the heavy competition in the market. There was more studies conducted on the performance of banks in India and Sensarma had found a similar finding that the in terms of cost efficency the public sector banks were performing better and continuosly good everytime. After the banks being deregulaized, the ownership of the banks was not so important as it was before in the studies conducted on cost measures but due to deregulation in the banking industry there was more heavy competition in the market and this helped to improve the efficiency in the public sector banks. But when seeing the performance and the cost efficiency of the Foreign banks was very low which was mainly by the practices followed by them which was really costly. In further studies it was found that the new generation private sector banks was more cost efficient, this can be of not having any previous losses in braches and having more staffs, etc. So finally in many studies it was found that deregulation had got the result what it have targetted as there was better performance in public sector banks then the foreign banks. But these studies does not say that the private sector banks are less effiecient then that public sector banks as the public sector banks have practices which are less cost effective. In the studies for the Indian Banking system by BIkram de(2203) and Sarkar, Sarkar and Bhaumik(1998) as they all followed the same method argued that the returns of asset(ROA) was not been affected by ownership of the banks. Sarkar et al.(1998) in their study said that the ownership of the bank had a robustic on the effects of operating cost ratio and net interest margin. The net interest margin was high for the public sector banks follwed by old public which was in turn followed by the new private banks and even the operating cost ratio was the same for all sector banks. Eventhough the public sector banks able to attain the high interest margins with the low cost funds but they were not able to match the private secor banks which had the low operating cost ratio. From we can say that the public sector banks are gaining as their high cost have properly have been for wider range and big net work whereas the public sector banks are losing at the other hand. However when the newly entered private banks are analysised after removing the public sector banks from the analysis it was found that the new private banks are having a good Return on Assets then the public sector banks even though at a significance level of 10%. In a study by Bikram de(2003) , they concluded that now a days the ownership is not as much important then competition in the banking industry. From all the results , it has been found that in a developing economy the public sector banks are less superior to the private sector banks. In the other study by using the empirical frame work of Sarkar et al,.(1998) which was conducted by Bhaumik and Dimova(2004) in which the banks have been sepetated into public,foreign,private and denova firms. In this study it was found that after the government adopting the onset of the liberalisation policies after 1992 suggested that the public sector banks are poorly performing then the domestic and foreign sector banks. In a matter of time the differeance between the private sector banks and public sector banks performance has been narrowed don as the public sector banks they became more competitive as the market forced to be more competitive and also it was performing better then the private and foreign sector banks. Similarly the public secotr banks was performing more efficiently then its counterparts that is foreign and private banks, which was found in the studies conducted by Das and Ghosh(2006) which coinsides with the views of Sensarma(2005), Ram Mohan (2002), Das et al., and Mohan and Ray(2004).


With the relevant literature's it's found that the performance of different banks under different ownership structure has been taken frequently in the global scenario. In the developing countries it was found that the private sector banks are more efficient then the public sector banks and this has been empirically proved. On the other hand in the other studies it was revealed that the private firms are getting more performance gain then the private sector banks. Also there are lots of thoughts that the desired results can be obtained by privatisation only if they operate independently but under the government. There are lots of studies conducted on the ownership of banks and in every study it was found that private banks perform better in productivity and efficiency but there are also conclusions that on a long run the private banks are not steadily performing in the developing economies. It is clearly notable that the competition in the market is increased due to privatisation; this also improved the performance of all individual banks. On the other hand there was studies conducted in Mexico which concluded that the banking performance has been improved neither due to reforms nor privatisation or not even the opening of new banks with has foreign investment. There were many aims to attain certain social commitments so nationalisation was undertaken and profitability was not the main aim or goal for undertaking the nationalisation. In the many studies which were conducted after onset of liberalisation policies been adopted around the world which revealed that the competition has been improved in all developed, developing and also the undeveloped countries. But in the studies conducted for different ownership of banks in India which is one of the developing countries it was found that the public sector banks even though they are less cost efficiency they were higher in mean efficiency. In the studies conducted on Indian banking sectors it was found that the performance of the public sector banks are less efficient then the private sector banks and foreign banks but the difference between them is been narrowed down year by year after the adoption of liberalisation policies by the government which induced the public sector banks to perform well and it will even perform better in future then the private sector banks. In conclusion we could say that the competition in the world market is more important than the ownership of the banks in the present scenario. But what we have to keep a watch about is that will the government will still maintain the social needs or whether they will improve further to attain more profit in the industry.




Due the population of India it became quite natural that the needs of the people are high even though they are economically not a big giant. The banking system of any country is directly related to the economy of the country and the needs of the people. In this chapter we are going to be see the history of the banking industry in the world and also banking industries growth and prospective in India which happened during the period of before and after the British invasion. But we can't forget the study of the banking industry of the world as it has gone various reforms and there were dramatic changes in the banking industry in India after independence.


When we see the history it was found that there was a banking system in existence in the temples of Babylon of more than two millenniums. The temples of Ephesus and Delphi were found to be the most powerful banking institutions in the great Greek banking system. Since then there was an increase in the banking system but it took a step back during the fifth century as the fall of Roman Empire occurred. Then there was a period where disintegration of banking occurred due to unnatural and immoral charging of interest after the Aristotle implementing the idea. Due to the charging of the interest rates in few countries, then few Muslim nations also observed with the respect to the sentiments and the commands have stopped this charging of interest for the loans. On the other hand the establishment of banks in places like Venice and Geneva due the theory of supply and demand. Even though the international banking network was developed by Knights Templar who is the order of warrior monks who really had interest in the business in Europe and Middle East but the Italian were believed to be the ones who started the international banking and to they had evidence in the form of commercial revolutions from Italy. Under the dominance of countries like Italy, Flemish, Germany and Dutch from the year 1350 to 1600, the international banking had the biggest leap. After finding the sea route to India in 1948 by Vasco da Gama which was used to trade with India by this activity the dominance of the Italians reduced. The banking from all the countries was taken over by the British after the defeat of the mercantile French by the year 1815 and the Britain became most powerful. Later in the early 1900s the Americans also provided some contribution in to the banking system this happened due to the force over Britain and this was happened after the Second World War as to surviving the impacts of the war. Until the international debt crisis the US institutions were dominating the international banking market in the years 1960s and 1970 and they were spreading over the world markets. This lead the Japanese banks to dominate as the US banks have to shrink in numbers due to international debt crisis. There was continuous change from the year 1990s in the banking industry like introduction of new products, regulations, innovations and more over there was lots of competition to increase the level of efficiency in the banking industry.

The banking in India was the main pillar of Indian society and also with any civilisation or country. The borrowing and lending practices existed from the period of Vedic (2000bc to 600bc) in Manusmriti and inscriptions of Gautama3 quotes and also in the quotes of Brihaspati1 and Budhayana1 (Monga 2001) and they were governing the policy of the interest rates and policy of loans. In the Arthasatra1(Mabbett 1964) there was referance of the banking was found which was really interesting. Even though the modern banking system was unknown in those days money lending was the main activity of the banking.


The network of the Indian banks were able to fulfil their commercial needs in important towns after only the British took over India and begin to institute them, this was opined by Monga in 2001. It has been seen that the growth of the European controlled banks structure which was combining with other business in the eighteenth and in the beginning of the nineteenth century. The modern banking was started in India in the eighteenth due to the formation of General Bank of India in the year1786 and later on by the establishment of Bank of Rajasthan but now both the banks are extinct. The State bank of India is the old and the surviving bank till now as it was established in the year 1806 as Bank of Bengal. In 1850s the foreign banks like Credit Lyonnais was established in Calcutta which was the important trade port in those days due to the British Empire.


For handling the cotton business in India with England there was many banks started after the year 1840. But at the period of American civil war the trade of cotton to England was been stopped by the Americans. The trades of cotton was also been done by the banks which was opened to finance the industries. But this was shut down due to the downfall of the prices for cottons which lead to heavy loss during the American civil war. The banking industry in India found a major change during the first war of independence in 1857. There was a flow capital from Britain to India in order to give loans for a minimum guarantee loans since the year 1960s which ultimately lead the root for the banking and also led to the growth of banking industry. Then for a few decades there was failure in the banks of India under the rule of Europeans until the beginning of the twentieth century.


After the first war of independence the economy of India has been stable for more than five decades which improved the development in social, infrastructural and industrial facilities at the beginning of the twentieth century. Indian banks were few in number and most of them were operated by communities. The Bank of Bombay, the Bank of Madras and the Bank of Bengal which were the presidential banks of India was started under the East India company of Britain were combined to gather to form the Imperial Bank of India. Due to this there was a memorandum submitted by the John Maynard Keynes who was one of the member of the Chamberlain Commission, he submitted this memorandum in 1914 in which he mentioned about the creation of Reserve Bank (Deshmukh 1948). The other banks were not able to compete with the presidency banks as they were not capable and they lacked experience and also maturity. There were lots of banks opened in India the its citizens due to the growing economy and they are successfully being operated till now namely Bank of India, Indian Bank, Corporation Bank, etc. During the war time the Indian banking industry was tough and it took many away especially during the First World War (1914-1918) and the Second World War (1939-1945).


The functions of the central banks was run by Imperial banks which was formed with three presidency banks but after the first world war the demand for the financial resources in India had increased and this lead to passing of the act on the general lines of the memorandum submitted by Keynes' that is the Imperial Bank Act in 1920. But in the later years according to the central banking theory there should be a bank which carries out all the commercial functions in the country and also be a central bank in that country. So in the year 1926 there was a strong recommendation by the Hilton- Young commission that there should be a separate institution for the above needs and it should be named as Reserve Bank of India. But due to many political and legislative reasons the Reserve Bank bill of 1927 was dropped after the acrimonious and kaleidoscopic discussions. Then again this was bought in the round table conference in 1933 about the establishment of Reserve Bank of India. This conference led to the paving of the Reserve Bank of India (RBI) act in 1934 and in the year 1935 the RBI was established under the first Governor of the bank which was Sir Osborne Smith.


The banking system in India after British took over India was really good and it followed the path carved in England, (Monga 2001), according to him after the independence in India in 1947 the banking system took a different root as there was transformation in the society which was fundamental and he also argued that the feudalism and deep rooted capitalism was considered by the politicians cannot be ignored. There were even thoughts of having healthier suppleness and vitality as it was a mixed economy and it had its own social structure which was one of its special kinds. In the later years there was many events caused in the history of banking industry due to some basic causes. The other duties that the bank under took was like to destroy poverty in the country and also the inequalities. As said by Monga (2001) the banks was assigned to have social betterment and it has to remove the poverty that is economic backwardness was the main aims of the banking industry. There was a complainant that was argued that the banks are favouring only the large business people and the others were not treated in the same manner in the society.


Kaur (2001) has opined that during the pre-nationalisation period the banks were only concentrating on the large borrowers and corporate borrowers who were in the metropolitan cities [2] or port cities [3]. This was an unfair behaviour of the banking industry and they never considered or even looked at the farm sector or any small scale industries in the village, this can be said that the banking never helped in the improvement of the villages which was the heart of any society.


The government had the rules and regulation was in place and the level of control was with them. Due to the unorganised nature and the primitive of the banking industry in India was deteriorating and this was the most pressing issue faced after the end of the Second World War. Lots of Banks were not following any scrupulous procedures for accepting the deposits and lending these deposits as loans due to the inflationary problems created by the war. Such banks were not even traceable even by the controlling authority and this authority called as the Registrar of Companies. Due to the expansion of these banks expansion was uncontrollable this lead to failure of many banks during the period 1939 to 1949, it was like around 588 banks which failed(Rao, 1960 page 38,50 years of central banking). The Reserve Bank of India permission was not required for the floating a new bank and there was commercial banks which was governed by the Company Law which was also applicable to non-banking companies. The power was not superior for the Reserve Bank of India in the Indian banking system even though it was established in the year 1935. Then after the nationalisation in the year 1949 which occurred with the passing of the Banking companies Act in the year 1949 which was then the RBI had full control on the banking system in India. During this time even the Imperial Bank of India was also nationalised which is currently known as the State Bank of India.

The Reserve Bank of India becomes more powerful after passing the Banking Companies act in 1949. The RBI can inspect any banks at any time without any notification, this was the most effective power gained by RBI. When RBI visiting the banking companies, they inspect whether the bank is entitled for a license, who are its mergers, whether the banking facilities are unto the standards and is the bank updating from time to time. On the other hand when the RBI is licensing a provision it examines loads of stuff like whether the bank is capable of repaying its depositors in full, verify the account books and check the method of operation of the bank is satisfied by RBI itself. The regulations which was promoted was to safe guard the depositors money and this help the banking industry in India to be streamlined.


The banking industry was mainly concentrating on the large business houses and all the big industries before nationalisation could occur. This occurred due the failure of the government to help the people in the society equally and the banking sector completely neglected the farmers. The facility of the banks was reached by everyone in the society even though RBI was in existence which was there to monitor the banks performance. This was mainly due to poor regulations and also the power under the government machinery were not capable enough induce the private banks to help the society. Then Mrs. Indira Gandhi who was the prime minister at that time for India had nationalised 14 banks that existed.

Mrs. Indira Gandhi in her speech in the parliament when the Banking Companies (Acquisition and Transfer of Undertakings) bill act in 1969 said that by nationalisation of banks there are millions of people who will be happy and their needs will be fulfilled and also it would improve the economy by promoting and improving the agriculture and also the small scale industries will be benefited by this and new industries and developments will improve in the underdeveloped areas of the country. This nationalisation is been justified (Eresi and Hossain 2001). The main objectives for making the banks nationalised according to Erwsi and Hossain(2001) was:

• To help the economic development by giving the necessary finance.

• For having a healthy growth in the organisation and functional reorientation in the banking industry.

• To improve the profession activities in the bank.

• To understand customers and check their credit worthiness. This was mainly for the small borrowers and this required focusing on the areas which was neglected before by introducing new strategy.

• This also done to improve and help the economic development.

In the study given by Sharma and Vashishtha (2007) the cause for the nationalisation of the banks was:

• In the rural and semi-urban places branches widened that is the banks network increased.

• To help the neglected sector and improve the agriculture and also help the small scale industries by the re-orientation the flow of credits.

• By doing bank deposits there will be a greater mobilisation on savings.


The financial system of India evolved only in the latter half of the twenth century even though the establishment of RBI took place in 1935. The RBI was less in regulatory power until the nationalisation occurred in 1949 and became the effective regulators for the banking industry in India. In the period before independence the financial system in countries was undergoing many crisis and failures as the banking was underdeveloped. There was development of many holes in the banking system due to the absence of proper legislation and there was no separate acts introduced to control and to create the regulations in the organisation (Sharma and Vashishtha 2007). The bankers conducted business by adopting the traditional practices which was completely outside the banking business which was organised. Seeing these practices in the indifference in the banking in the late 1930s the RBI suggested all the banks to follow a professional way of work and suggested them to give up the traditional practices of trading and commission banking business and asked them to follow a proper and a better accounting system and also a better audit system. But due to the absence of the regulatory control induced bankers to refuse the suggestion and they conducted the business in a directionless and disorganised way. Due to this situation the RBI was nationalised in 1949 and it became the regulatory power of the Indian banking system and this was the first evolution of the financial system in India. After this nationalisation of RBI there were many developments in the adequate legislative framework so as for the consolidation of the banking system and also for the assisting in the reorganisation of the banking system. To help the agricultural industries and small scale industries the co operative credit structure of the banks was strengthened and there was even certain institutional framework was put in place just before the nationalisation period. At the period of independence and nationalisation there was many financial institutions took its birth like Life Insurance Corporation of India (LIC), United Trust of India (UTI), Industrial Credit and Investment Corporation of India (ICICI) and Industrial Development Bank of India (IDBI). In all these points we see that in the two decades after independence that there was a phased reorganisation in the banking system.


At the very early stage of commercial banking in India the regulator framework was not oraganised rather it was scattered and due to this the presidencial banks was regulated and they were administred well by the Royal Charter with the help of the Indian Government and the East Indian Company at that time that is in 1800's. As there was no banking Company law in the early 1850's, the banking companies was not properly operated and this lead to many crisis like the banking crisis in 1913 and the Indian banking system was weekened by not having enough liquid assets and the the bank failed due to the connected lending practices was unravelled. Then it was the Central Banking Enquiry committe(CBEC)(1929-1931) who recommened the way for the legislation for the banks in India to be regulated after analysising the issues of the bank failures.(Leeladhar. 2007)


There was the need of the development of pari pasu in the banking industry as the economy growth was becoming more refined and even classy. The development of this pari pasu was to support and stimulate such economy growth according to Mohan (2005). He also argued that the reforms occurred in India was really unique then the other developing countries and it had many flourishes and it had been measured and watched which was not observed in many other emerging countries.

Mohan also argued that the India was an example of “financial repression” in the financial sector until the 1990s even though there was strong implementation of the nationalisation in 1969 and 1980. There was increase in the savings and deposits in the rural branches in the country due the nationalisation and social ‘control' which lead to this increase. We can also mention the credit flows increase in the area which was neglected once like the agriculture and small scale industries. In this period there was no bank failures recorded but there was a big concern for the true viability of the bank as the opaque accounting norms and the limited disclosure of activities are considered to be the true health of the financial intermediaries. According to Mohan (2005) due to the financial sector reforms in the early 1900s, the main objectives were:

i. Under both domestic and external ownership the maintenance of financial stability must be ensured.

ii. The financial institutions should be offered operational and functional autonomy.

iii. The financial industry should be crafted into well-organized, dynamic and profitable industries.

iv. The financial system should be organised in such a way to increase the competition in the international market.

v. The foreign sector should be opened in a regulated and more organised manner.

vi. The financial repression which was existing earlier should be dealt with.

vii. There would be much help in the well-0raganised industry with the perfect allocation of resources by facilitating the price discovery of the market determination of interest rate.


In August 1991 there was a committee created to understand and examine the organisation structure and the functioning of the financial system under Mr. M Narasimham who was the chairman of the Reserve Bank of India at that period. This committee was set up by the government of India. There was few recommendations given by them on 17th December 1991 in the parliament, they are:

• The phasing out of the directed credit programs can be done by changing the priority sector.

• The prudential asset classification norms should be adopted and this norms is also called as asset classification norms.

• By doing full disclosures there would be transparency in the balance sheet.

• Allow foreign banks in India to open offices.

• By March 1996 the capital adequacy should be at least increased by 8%.

• The banks should be opening new branches in most places where there is high potential and they should be rationalisation of Indian banks operating overseas. This can be done by giving branch licensing.

• To recover from the bad debts the banks should set up the recovery tribunals.

• The banks and the financial institutions should be watched by the Reserve Bank of India strongly and this can be done by using off-site surveillance and by also doing on-site supervision.

• As to match the emerging market conditions the interest rates should have deregulation which in turn will increase the competition in the market as well as the efficiency of the banking systems will increase.

• The Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) should be reduced progressively. This in turn helps banks to increase the credit portfolio and also will increase their profits.

• The banking system should be restructured so as to reduce the international banks to three or four in number, national banks reduced to eight to ten.

These recommendations were to increase the competition in the market and also with the foreign banks in the field of increasing the integration, privatisation, liberalisation and also the globalisation. Even though there was lots of recommendations in the committee there was only few of them accepted like the capital adequacy norms, asset classification norms adoption, SLR/CLR reduction and interest rate deregulation was accepted by the government.


The organisational structure and the financial system functioning was mainly focused of the first committee were as the second committee which was set up by the central government focussed on the different perspectives of the bank and widened its operations. This committee is also called as the “Committee on Banking Sector Reforms”. The committee focused on certain major areas like:

• The bank operation of the week banks should be restricted to certain area and certain activities. This is known as narrow banking.

• The capital adequacy ratio by the year 2000 it should be increased from 8% to 9 % and by the year 2002 it should be further increased to 10%.

• The board of the banks should be given power so as to appoint the Managing Director or the chairman. This can be done by giving the banks the functional autonomy.

• All the customers need should be attended by all the financial institutions without any difference between them.

• The committee also thought about the mergers as the strong banks should be merged as to bring the force multiplier.

• The market subscription should be increased as to reduce the government holding by 33%.

• The three types of banks were considered in the tree tier banking.

o The small scale industry and the agriculture should be served by the local banks in that regional area and they should also take care of the local trade.

o The international disposition should be there with two or three big banks in India.

o The large corporate sector and the other large organisations should be catered with eight to ten national banks which are huge.

• The asset classification should be classified as the NPA if they are more scrupulous and it can be done only when in the period of 90 days the principal and the interest rates have not been serviced. Even there was 1% general provision on the standard assets was added.

• There was amendment of laws, supervisory powers and functions, and the segregation of the regulations of the RBI has renovated the complete banking system and the competition has been increased and kept in place due to adaptation to the new technology.


The Government of India conservative about the ideas of both the committee's reports and they were even conservative about accepting the suggestions and implementing these suggestions. The following area was the major areas covered in the banking sector according to Mohan (2005) due to the implementation of the reforms:

I. There was measure for ensuring the competition. This is done by granting the public sector banks the operational autonomy, also increase the capital from the equity market for the banks up to 49%. The entry of the private banks and the foreign banks had the relaxed and transparent norms and the banks were permitted to have the Foreign Direct Investment (FDI) in the financial sectors and the banks can have portfolio of products which are diversified and even diversified business activities.

II. There were enough prudential measures. The provisioning and the exposure were implemented in the best international practice and norms. Even the requirement of risk weighted capital adequacy, accounting, asset classification and even the income recognition are also implemented under these practices and norms. The different types of the risk are identified and the risk management was strengthened by have a well measured strategy.


Sollapur(2001) in his study the generation and the mobilisation of the savings and even the social desirable transfer of those who invested and the purpose of production are been affected as the financial institutions are diversified and diversification of the mechanisms and this helps the development by accelerating the system. Co operative banks, commercial banks, regional rural banks are all in the Indian Banking system. There was a shift in the life style and the banking business according to Shollapur. The outlook of the banking business and the clientele concern are on an increasing scale in the banking sector. The banking industry in the 21st century will not only increase in size but also in their production due to competition which ensures further gain. There should be exploration of the intelligent avenues and the future challenges which are going to occur should be looked forward. In the ongoing millennium there are certain areas should be concentrated by the Indian banking system, these areas are effectiveness of the management of the quality assets, human resource development, the banks internal organisation should be redesigned, mergers and consolidations should be encouraged, technology should be used properly, innovative products should be introduced, customer service should be improved, there should be greater operational freedom, direct lending rigidities should be removed, reengineering and cost pruning, and the banking resources should be used well and used for promoting.


The Indian Banking sectors truth has been seen in this chapter. The growth of the economy in India was helped by the banking sector; this was proved by seeing the deposit/GDP ratio which attained up to 60% in the year 2004-2005 and the reach of 48% by the commercial sector from the bank credit IN 2004-2005.

After the introduction of Banking Regulation Act in 1949 were considered to be the turning point of the Indian banking sector. In the year 1969 there was 14 banks which were to be nationalised by the GOI and in 1980 there was 6 banks which was nationalised, this was considered to be the first change in the banking sector. This lead to the domination of the public sector banks which had in 1990-1991 nearly accounted for about 90% of the total deposits. On the other hand, the operation of the private banks and the foreign banks were not allowed after 1969.

The GOI was motivated to have the financial sector reforms due to the tumultuous situations encountered by the Indian banking sector such as higher inflation rate, IMF loans increasing burden, low reserves, Non performing assets(NPA), deficit in the current accounts, etc. CFS was established by the GOI as to provide baseline for the reforms and to give recommendations. This CFS is also known as Narasimham Committee (1991). The foreign banks should open its offices and branches all over India was the major recommendation of this committee which will ensure competition in the banking industry in India and also increase the efficiency of the banks.

In conclusion the banking industry in India have had many changes in the past sixty years which was positive and which was after independence and there was more change after the nationalisation of banks in 1969. After the implementation of the financial sector reforms in the early 1990s had made the banking industry more stable and it made the banks to be more competitive.




The empirical literature's theory and review's background are been outlined in this chapter which deals with the operational efficiencies in the banking studies arena which is mainly focused on the economies of scope and scale and also X-efficiency. The second section deals with the literature views of the banks in the framework of te firms theory and the studies of the banking sector efficiency's significance of all the parties who are participating in the financial system of the country. In the third section the various types of inputs and outputs of the banks production process are been discussed. The next sections deals with the data collection, methodology and also the characteristics of the one-way ANNOVA is been discussed. The different variables used in this study is also been discussed.


The operational efficiency have been focused more and it became more important among the managers, shareholders, regulators and the researches of the financial institution and even among the policy makers. The banking systems performance was been impacted due to many policies which are implemented in the financial system. Hence there would be many policies created in the banking system by the policy makers and regulators as the efficiency of the banks are been understood. An example of this is that the studies conducted in 1994 by Berger and Humphrey was really helpful to review that to what extent the deregulation have helped to improve the banks efficiency by removing restrictions as to improve the performance, by increasing the competition in the market as competitive market prices are created and the trimming of down waste of the resources as to generate social gains.

The studies conducted to understand the profitability of the banks and the operational efficiency due to market forces are considered to be important by the regulators for the performance as well as the market structure( Berger,1995; Molyneux et al. 1996). There are two ways the banking sector can improve its efficiency , they are the first one testing the marketing power hypothesis by creating products and services which makes high profit for the banking sector but this is unfavourable to the customers and second way is by is the efficient structure hypothesis that is by creating products which are favourable for the customers and also increase the market shares and profits by competitive prices. This also makes way for regulatory reforms in the banking industry.

The performance efficiency of the banks is lined with the capital level which are strong which was found out by many studies conducted. The studies conducted by Mester 1996, Berger and Humphrey, 1992 and by Hermalin and Wallace, 1994 in all these studies it was argued that by improving the solvency base can improve the profits and even generate higher profits and the banks efficiency is inversely related to the loan losses of the bank.

The banks ranking is based on their performance efficiency and this ranking accuracy is increased by the efficiency studies which helps us to find the best and the worst practice by the banks. It was argued by Berger and Humphery, 1997 that the policies set by the policy makers are to improve the performance of the worst and also encourages the good practice.

The out put side that is the marketing strategies and the pricing strategies helps to improve the profit efficiency and the input side that helps to improve the cost efficiency by adopting the latest information technology, good practices which are managerial and also ensuring proper capital. This two sides have to be seen as to improve the efficiency and the managers should find the reason and should bne determinant to do that. This shows the important part of the managers leading to efficiency studies.

After mention the managers part in the effieciency and the importance of these studeis, and now to mention the Shareholders part as they are the ones who appoint the managers and give them the control to run the instituttion properly and effectively. Mangers work effectively and make a efficient profit , this can only happen with the interest of the shareholders.

We can say that the studies which aree conducted on the efficiency of banks are helpfull for getting a improved results . these results are can be in great interest of the shareholders, managers, policy makers and also academic researchers. The resource usage by the banks, the power of the market, safety of the system, and profitablitiy of the banks in the country.


Acoording to the traditional theory it is said that banks convert the input resources into output resources as a finacial firm. Even though this was there the bank handling is very hard under this theory as these theories have no consensus of the banks prodution. In the study by Sealey and Lindley,1977,p1251 it was found that by judging the firms decisions on the economy the output an the input of the firm can be seperated and sorted. There are lot of problems to really consider what is the output or input for the bank production even though there is nop consensus as to consider the deposits in the bank to be input or output.

The inputs and outputs are given in the banks blaance sheet. The inputs from the liablity side and the output is from the assets side. The argument of Berger and Humphret,1990,p.247 is that, “[v]irtually all observers would agree that bank liabilities have some charecteristics of inputs, ecause they provide the raw material of investable funds, and that bank assets have some characteristics of outputs as they are ultimate use of funds that generate the bulk of revenue that bank earns.” But there is no proper agreement that the bank balance sheets categorization of the inputs and outputs in the assets and liabilities can be used to explain the process of the bank even though there is a potential insight of the inpouts and outs of the bank in the banks balance sheet.

Deposits one of the item n the balance sheet is the crucial value to seperate the inputs and outputs of the bank. This is considered to be a important issue as to decide it as a input or as an output. The time deposits are considered to be the inputs and the demand deposits are considered to be th outputs in the studies conducted by HUges and Mester(1993) and Bauer et al.,(1993) in the view of interest paid. But here was other studies conducted as whether to treat deposits as inputs or outputs were attempted by Hughes and Mester, 1993,and Favero and Papi, 1995. These test main idea was that using some inputs is increasing and the expense of the other inputs has to decrease. In these studies it was found that the other inputs is inversly propostional to the deposits as for the given outputs, which shows that the deposit is better considered as a input rather considered to be output.

Humphrey, 1985; Berger and Humphrey, 1990, in their literatures regarding banking was clearly said about the two approaches of defining the inouts and outputs of the banks . the two approaches are the production approach and the internediation approach. In these approaches it is clearly said how the deposit is treated.

In the banking production process it is clearly noted that the inputs used are the labour and physical capital, this is the concept agreed by both the internediation and production aprroaches. But in these two approaches the main differance is considered to the way the inputs and outputs are treated and the how the deposits are viewed to measure. In the argument of Sealy and Lindley, 1977 that the deposit is treated as the input in the intermediation process as the deposits are consider to produce earning assets such as loans and this leads to the decision making if the banking firm. On the other hand in the study conducted by Bauer et all, 1993; Berger et al,. 1997; Resti, 1997 , the deposits are considered to be the output in the production approach as it is been using the resources of the banks like the labour and the capital as to provide a value added output for the customers like security services, book keeping and the shape of clearing.

In the intermediation approach the operating and the interest cost are used as the measurements of outputs and inputs where as in the production apporach the physical quantities are used as the output, they are the total deposit accounts, loan lent, current accounts and the cost for operation is considered and measured.

As these two approachs are used in the banking industry for calcualtating the efficiency of the banks performance, in real only the one process is practices that is intermediation approach. This approach is adoped in the studoies conducted by Berger and Mester, 1997; Altunbas et al. 2000; Allen and Rai, 1996.

According to the microeconomic theory of intermediation , it was firstly suggested in the studies conducted berger et al., 1987; Ferrier and Lovell, 1990, thats the deposited funds by the depositers are intermediated with the cost which is minimum to the lenders.

Secondly, the intermediation apporach is the best way to calculate the bank efficiency said by Karparakis et al., 1994, if the banks which are large are included in the study as sample as these banks from their non-deposit sources they fund their assets.

Thirdly , when we see the production approach when calculating the banks efficiency it is hard to get datas on the details of the accounts as they are all private and owned by one person. In the studies conducted by Berger and Humphery, 1997, in that it was argued that the financial institutions efficiency and its branches efficiency is calculated using the production approach as these institutions have the deatails of the customer records and they process as a whole. But the decisions like the investment and funding does not involve the manager of these branches much.

Form the above we can say that the production of the banks is mainly focused on the approach of defining the inputs and outputs of the bank in the microeconomic aspect. Debate still presites for the mesure ment of the outputs and inputs of the banks and also defining them. From the literature that are available it is found that the intermediation approach is the best wayh to clculate the efficiecny of the banks .


Reserve Bank of India is the regulators of the Indian banking sector. The data for the study is taken from the website of the RBI ( . The data is collected as per the availability in the website. But the certain banks are not considered for the studies are there are no data available.


While calculating the efficiency of the banks the banks financial ratios are used in common. But in the study by Yeh 1996, it was argued that the as these ratios are independent and dependents mainly on the arbitrary bench mark ratios, so the analyst will have difficulties calculating the efficiency of the banks. Sherman and Gold (1985) added arguments to this view that the long term performance of the banks are not been captured by these ratios. For measuring the banks performance the method is used frontier analysis was said by Sathye(2002). According to this method the poor performing banks are separated from the banks that are performing better. Non parametric frontier analysis and the parametric frontier analysis is used to separate these banks. The stochastic frontier analysis, distribution free approaches, thick frontier and the free disposal hull are the various parametric approaches and the Data Envelopment Analysis (DEA) (Molyneux et al, 1996) is one of the approaches of non parametric approach. DEA approach is used by many people in calculating the performance of the banks. It was also used by Sathye(2002) in his study for calculating the efficiency of the banks in the developing countries: the case of India. In the studies by Seiford and Thrall (1990) it was found that the other methods procedure is completely different and is not as much robust as the DEA mathematical programming procedure. There was lots of empirical analysis after the coining of the term DEA by Charnes et al., (1978) and it was almost accurate (Coelli, 1996). The technical efficiency is associated with the performance of the bank studies according to Bhattacharya et al., (1997). The ability for converting into the multiple financial services can be done by technical efficiency from multiple resources according to Sathye 2003. The calculation of the efficiency of the banks are been calculated by the DEA methodology using the variable returns to scale input oriented model. There are two models considered that is model A and model B which has two inputs and two output variables in each as to measure the success of the management in cost controlling and revenues generation. The variables used as the inputs in model A are interest and non interest expenses and the net interest and non interest income are used are the output variables in model A. Deposits and the number of staffs are used as inputs in model B and the output variables are net loans adn non interest are used to analysis model B. But when compared with model A, the model B has less direct approach. The deposits are been substituted with interest expense and the number of staffs can be substituted with the non interest expenses. The net interest income are been replaced by the net loans. Sathye (2003) in his studies has used the above mentioned method. This study with the use of two models are to see the difference in the efficiency if the variables are been changed. Even though there is a debate among the researchers about the variables input and output in both intermediation and the production process, we are going to carry out the intermediation approach where there are only certain variables are used and the banks act like the financial intermediaries. In the analysis method DEA, the variable selection should be absolute as this method is sensitive to the variables selected and so it gives banks better idea for selecting the variables as to have a better efficiency. There was a study about the Australian banks by Avkiran (1999) which is a similar study like this.


DEA was invented to calculate the performance efficiency of the non profitable branches and organisation in the public sector by Charnes et al (1978). This method was first used in the banking sector by Sherman and Gold (1985). Using this method various decision making units (DMUs) can be compared and evaluated in a taken sample. Decision making unit in this study are the banks. Efficiency of Each bank is evaluated and compared with each other's efficiency levels. Using this method the better performers are been noted and the also helps to find the possible peers and this method is more efficient then the other methods. The weaker DMU is been identified and the inefficiency is also identified with the stronger DMUs, this is the important strength of this method. But in the other methods the performance is evaluated by using the statistical averages of the banks.


Charnes et al (1978) who developed the DEA has described the characteristic of this method well. DMU is considered to be the units and it of N numbers, which in turn converts to J number of outputs using I number of inputs. Here J can be greater or smaller or even equal to I. The ratio proposed by Charnes et al that is the weighted outputs to the weighted inputs for a unit , are considered for the other DMUs valuation and this can be equal or less to one another. That is,


∑ u0jy0j

Max e0 = j=1 equation (1)


∑ v0ix0i

i =1

Subject to


∑ u0jynj

j=1 ≤ 1; n = 1... N,


∑ v0ixni

i =1

vi0, uj0 ≥ 0; i=1 ...I; j =1... J.

Where yjn are considered as the positive input of the nth DMU.

xjn are considered to be the positive outputs of the nth DMU.

vi0and uj0 are the weighted variables used to solve the equation 1

The index 0 represents the DMU which is measured as the base DMU. The maximum score assigned t the DMU0 which is the score of the efficiency given by the problem is e0. The DMU0 is considered to be efficient only if the e0 = 1 otherwise it is considered to be in efficient.

The first equation objective is non linear and fractional function so it was difficult to solve this equation , so as to overcome this there was the second equation was formed by transforming the first equation by Charnes et al. The transformed equation is as follows:

Max h0 = ∑J u0jy0j equation (2)


Subject to


∑ v0ix0i =1,



∑ u0jy 0j _ ∑ v0ixni ≤ 0;

j=1 i=1

n=1,......N, v0i ≥ ε, u0j ≥ ε i=1,....,I,

j = 1,....,J

the second equation has the same variable like the first equation. But in the second equation ε is added which is the arbitrarily very small positive number, so as to make all the values of the inputs and the outputs positive and also when calculating the efficiency scores in the DEA for the DMUs there should not be any problem given in the equation due to the values given by the slack variables. Same like the equation 1 that the DMU0 is considered efficient only when h0 = 1 otherwise it is considered to be inefficient.

By using this method the researchers can change their variables and select the proper variable for the study as per the requirement of the management. This is a big advantage of this method. This method also helps management to focus on the areas where it will improve the performance according to the result. There is no need to standardize the units in the variables in this method. The results cannot be found out with precision and confidence if the data's integrity are debased. The DEA is restricted as the performance scores of the base DMU is compared with the other samples in the study. In the process of analysing the efficient values are compared with the values of the organisations which are inefficient, this helps the researchers to understand the inefficiency of the banks and according to that allocate the resources as to improve the performance. For evaluating the banks performance in various countries and in various studies DEA is used. It has been used by researchers like Sathye (2001), Yue (1992); Miller and Noulas (1996); Resti (1997); Berg et al. (1993); Mester (1996); Favero and Papi (1995); and Wheelock and Wilson (1995)

In this study we are going to analyse the banking performance of the different types of banks like the pulic, private and the foreign banking sector for different year. The main years that we are concentrating are 1969, 80, 91 and 2006.


The variables that are used as the banks inputs and the outputs which are used in the study are explained below.


When the borrower gets the money from the lender, he gives some price for the depositor for the use of the lenders money and this is called the Interest expenses. In the banking industry this is considered to be the charge for the depositors whose investments and deposits are maintained by the bank. This can be otherwise called as the payment of the interest to all the depositors of the bank.


The operating expenses are considered to be the non interest expenses which include like the salaries to the employees, benefits for them, occupancy, etc. Majority of this is the salaries and the benefits given to the employee which was considered to be 50% of the total noninterest expenses. The other operating expenses are considered to be standard and fixed.


All the organisations have balance sheets and they are divided into two categories, they are the assets and liabilities. In the banking field the liabilities are consider to have the deposits of the customers and the asset compress of the different types of loans and the securities. The difference between the money got from the asset and the cost spent for the services for the liabilities is considered to be the net interest income (NII). These two types of cash payments are the non interest payments. We

Also say that difference between the interest that are paid to the bank on the given loans and the bank paying customers interest for the deposits that they have made is NII.


The banks have some income which has no interest on them; these services are like planning for the finance, services through computer, brokerage, and others. Even the fiduciary services are also considered to be the non interest income. These services are like the transfer of stocks in the corporate side, safekeeping of the securities, and others. These are incomes which are off balance sheet items like the swapping of the interest rate contracts.


These are nothing but the money put in the bank by the customers as deposits in their current account and this can be put in and withdrawn anytime by the account holder. There are banks which have this service as free and there are banks which charge interest for this service.


This is nothing but the number of total employees of the bank working at the particular given time.


This is the total loans lend to the customers for different purposes like housing. Personal loan, etc. And which has to be paid with the interest at the given date.

[1] Small scale industrial artisans, small farmers and small scale processing enterprises.

[2] Financing the industrial sectors

[3] Financing the export industry