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Efficiency Of The Indian Banking System Economics Essay


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Indian Market has become nightmare of earning; it is one most emerging market in the world. Banking system in India has started in 18th century. From then it has under gone numerous changes. The establishment of Reserve Bank of India (RBI) is considered one the great achievement in the Indian Banking system. The RBI was established in 1935 during the British rule, in order to run the central banking system in India. Before RBI, there was no concept of centralisation of banking system. The Imperial bank of Indian by responsible for doing these functions. The banking system of India at that time was vulnerable to many things, which may have created the many risk exposure the clients at that time.

After some drastic changes in the banking system, the first ever Public Sector Bank came into existence in Indian on July 01, 1955, in the name of State bank of India (SBI).The main function of this bank was to provide lending facilities for entrepreneurs. These pave new way for the business man to raise capital with less risk. Each and every lending institution in the country at that were closely associated with the promotion and control of one or more banking companies (RBI report, June 30, 2009). Most of deposits were deployed in the organised sectors, while as the farmers, transporters, small entrepreneurs and all other self-employed and professionals were more dependent on the others for financial support who were taking advantage of them and were exploited by heavy interest rates. This type of lending was the most serious barrier for the development of country as a whole .To overcome this issue the Indian Government started a Scheme of Social Control in February 1966 whose main was to assess the demand for bank credit from various sectors in order to determine the priorities for grant of loans and advances so as to ensure optimum and efficient utilisation of resources.

Most Important phase of Indian Banking and Key characteristics of Market

India is one of the emerging country in the world. No can deny that IT industry in India is dominating throughout the globe. Due to the development of India in every sector, this brings some changes in the spending moods of people in India. Each and every sector of India is improving day by day. Besides these key characteristics, Indian cultural differences are also an attractive factor for targeting customers. The Banking system in India has undergone four major different phases, which I am going to explain below.

Foundation phase

This is initial phase of banking system in India, how banking system started changing from the distributed system towards centralisation, this phase can be considered as the back bone of taken place from 1950 and 1960’s till the nationalisation of banks in 1969. The main focus during this phase was lay down on, how to improve the banking system in the country. This phase is regarded as the crucial phase in the history of Indian system. Some necessary steps were taken for the development of necessary legislative framework for facilitating re- organisation and consolidation of the banking system, for improving the Indian economy. The major development was transformation of Imperial Bank of India into State bank of India in 1955 and one more important thing was the nationalisation of 14 major private banks during 1969.

Expansion phase

This phase had begun in the mid-60s but had gained momentum after nationalisation of banks and continued till 1984. Many efforts were made to make banking facilities available to every person. Banking sector was increasing at the very fast rate throughout the whole country. Mostly credit flows were guided towards priority sectors. However this weakened the lines of supervision and affected the quality of assets of banks and pressurised their profitability and brought competitive efficiency of the system.

Consolidation phase

Consolidation phase was started in 1985 when a series of policy initiatives were taken by RBI which saw marked slowdown in the branch expansion. Attention was paid to profitability of banks. Measures were also taken to reduce the structural constraints that obstructed the growth money market.

Reforms phase

The macro-economic crisis faced by the country in 1991 paved the way for extensive financial sector reforms which brought deregulation of interest rates, more competition technological changes, prudential guidelines on assets classification and income recognition, capital adequacy, autonomy packages.


Review of the empirical literature on bank competition and efficiency within the Indian market

The efficiency of the banking sector can be divided into Scale of Efficiency, scope of efficiency, pure technical efficiency and allocative efficiency (Chen, 2001). When the banks operates in the range of constant returns to scale then bank is said to have scale of efficiency and have scope of efficiency, when it operates in different diversified locations. Maximising output from a given level of input is called technical efficiency and when a bank chooses

X-efficiency is considered as one of the most important origin of cost problems in banking as per Berger, which is the difference in the Managerial ability to control cost for a given level of production. Both technical and allocative efficiency are included in X-efficiency. The X-efficiency can be calculated in four different ways which I am going to explain as under.

Data Envelopment Analysis (DEA)

Stochastic Frontier Approach (SFA)

Thick Frontier Approach (TFA)

Distribution free Approach (DFA)

Studies on Banking Sector Efficiency in India

The number of has been carried out to measure the performance of banking sector in India in number of contexts. However, few studies have been done on the cost efficiency of Indian Banking system. One of the famous Indian scholars Bhattacharya, he did a lot of research to measure the efficiency of banks and was also followed by some other scholars as well. Bhattacharya et al (1997), in his study he examined the productivity efficiency of 70 Indian commercial banks during 1989 to 1991.He used data environmental Analysis (DEA) and concluded that the public sector banks have been performing well and was followed by the foreign and the private banks. Similarly in 2003,Sathye also did the same research by using DEA method to estimate efficiency, and found that Private banks are less efficient than public and foreign banks. Although, in the recent survey carried out by the Das and Ghose by using the non-parametric DEA to estimate the efficiency of the Indian Commercial banks in the post reform period, 1992-2002.

Using non-parametric DEA to estimate the cost and profit efficiency of the Indian banking sector in the post reform period, Ray and Das (2009) found the public sector banks are more efficient than private banks. The DEA and SFA are two techniques which help in estimating the position of a firm relative to an efficient frontier (Johansson, 2005). Santosh uses SFA method to evaluate the cost efficiency of the Indian Banking sector. The stochastic Frontier Approach (SFA) is also referred as Econometric Frontier Approach.

Santosh in his research use data from the banking statistics in Indian, The Reserve Bank of Indian (RBI) which is the supreme and reliable source of banks in the Indian data base. He has analysis to estimate the efficiency of public, private and foreign banks in the period reform the period and the efficiency of the public, private and foreign in the post reform period. All the variables used in the study have been deflated with the GDP deflator and converted to constant price (1993-34). However, he has determined the cost efficiency of the public sector is less than foreign and private banks, during both pre and post reform period. He has also analysed 27 public sector banks were he found the same result. To examine the efficiency level of the Indian banks by ownership, 27 PSB’s, 17 PB’s and 16 foreign bank have been taken into account. The banks those have been included were operating continuously since 1996 and banks those discontinued have not been considered.

The mean efficiency score of the Indian Public sector have been explained in the following table (Table 1). The result shows the mean efficiency value of the public sector banks during the post reform period show decline marginally.

Table 1: Descriptive Statistics of efficiency scores. PSB’s (pre 1980-87) and (post 1992-07) reform period.

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