The Increasing Economy Growth Of India Economics Essay

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

India is the considered one of fastest growing economies in the world. In its global economic paper in 2003, the Goldman Sachs coined the word BRICs (Brazil, Russia, India & China) and stated that in next 50 years BRICs economies could become a much larger force in the world economy.

Specifically about India, the report predicted that India shows the potential of the fastest growth over next 30 and 50 years. The growth expected would be higher than 5% over the next 30 years and close to 5% till 2050. Also, its US Dollar per capita would rise 35 times in 2050 [1] . This report is one of the many reports and books written about India on rise.

The economy is growing at a growth experienced seen never before. The average growth rate has been around 7% from 2000-2009, with the highest recoded growth at 9.2% in year 2007. The diagram below will show year-wise GDP growth rate from 2000 to 2009.

(Source: CIA Factbook)

But India's economic story has two phases namely Pre-1991 & Post-1991 phase. The year 1991 is a landmark year in India's economy as it was, in this year that India ran out of its foreign exchange (FX) reserve & was left only with FX of 11 days of imports. Pre 1991 period was considered as "licence Raj" [2] where government regulated virtually all businesses. All the business required government permission and permits which were almost impossible to get. There was tremendous red-tapism and the result was a sluggish growth rate of just 3% which was popularly known as the "Hindu growth rate". In 1990-91, although the direct trigger of crisis in India was increase of crude oil prices and Gulf war but the indirect factors were macro imbalances in the form of unmanageable current account and fiscal deficits. The external debt servicing as a proportion of current receipts increased from 10.2 percent in 1980-81 to 35.3 percent of current receipts in 1990-91. The result was a disaster: curbing of imports, pledging of gold reserves with Bank of England and Bank of Japan, devaluation of Indian Rupee. And with this event the Licence Raj came to an end.

India adopted the liberalisation policies which included major reforms in areas of: Fiscal Stabilisation, Trade and Exchange rate policy, Taxation, Public Sector and last but not the least the financial sector.

It is known that efficient financial sector is a sine qua non for the economic growth of a country. The financial sector is said to be efficient if it can allocate the resources optimally. Banks have a very important role to play as they are the most important financial intermediaries in a developing economy like India. The reform in the Indian real sector aimed at creating a new set of incentive for reallocation of resources for their efficient use. But those could be successful only if there was a parallel process of financial sector reform to bolster the overall reform process. The financial sector reforms aimed at mobilising savings and allocating them efficiently. It also aimed at removing many impediments for free flow of capital within the economy. The virtual monopoly of the public sector banks came to an end and the competition was created among banks. The Non Banking Financial Companies (NBFC) which were allowed to operate, also further created efficient allocation of capital. Even the foreign banks, which were not welcomed earlier, were given licences and were given a level-playing field to operate and compete with the Indian public sector and private sector banks. The most positive aspect of liberalization in financial sector was its introduction of competition.

It has also been seen theoretically and empirically, that the degree of competition in the financial sector can matter for the access of firms and households to financial services and external financing and in turn affecting overall economic growth [Claessens and Laeven, 2004]. Competition increases the efficiency which in turn has a direct influence on the profitability, increased amount of funds being intermediated i.e. increase in the volumes, better prices for customers, improved level of service for the customers and greater safety and soundness due to improved capital buffers that absorb the risk [Berger, A at el, 1993]. But, the deregulation, liberalization and consolidation in the financial services industry have increasingly prompted concerns about greater market power enjoyed by banks and the subsequent impact upon the financial stability [Mishkin, 1999; Group of Ten, 2001; De Nicolo et al, 2004].

Thus, the significant changes post liberalisation in India, also had a significant impact on the Indian banking industry. There has been a re-allocation of resources with public sector, private sector and foreign banks competing with each other for the customer base and market share. Therefore, the significant changes in the Indian Banking industry raise very important policy concerns that banks in the highly concentrated markets gain market power. The higher market power results in banks being able to charge higher than competitive prices thereby offsetting any benefit associated with the competition. Another very important consideration is that a higher concentration ratio among the banking industry limits the effectiveness of monetary and credit policy, increases the probability of the systemic risk and reduction in lending to small and Medium Corporation. In emerging economies like India, monetary policies are a major tool with the central banks to steer the economies. Hence such concentration in the industry would stall the steps taken by the monetary authorities.

This dissertation is trying to assess the competitiveness and the market structure of the Indian banking industry which would give idea of how concentrated the Indian banking industry during the years 2002-2008. The dual aim of this dissertation is to measure the concentration through the applied methods used to measure the concentration ratio namely k-bank concentration ratio (CRk) and Herfindahl- Hirschman Index (HHI). The second aim is measure the market structure of the industry through both the structured and non-structured methods. In structured methods, the competitive conditions would be measured by the most frequently used Structure-Conduct-Performance (SCP) method. In the non-structured methods, Panzar-Rosse (PR) H-statistics method would be used.

The dissertation is organised as follows: Section 2 would include the background of the Indian banking industry since 1991. Section 3 presents the literature review for all the different measures of competition and market structure used in the dissertation. Section 4 would describe the methodology in details and speak about the data used to generate the results. Section 5 describes the interpretation and detailed analysis of the result. Section 6 would summarize the study by giving the concluding remarks.

Section - II

Indian Banking Industry - An overview since 1991

The liberalization of economy also brought changes in the banking industry. Pre-1991, the banking system was under government control. The government controlled the credit rules and restricted the use of funds. It also determined the price of funds i.e. Interest on savings and loans on behalf of the banks. The high statutory requirement of cash reserve ratio (CRR) [3] and statutory liquidity ratio (SLR) [4] made banks unproductive and unprofitable as they had to park more than 40% of their funds in government securities.

The government appointed a Committee on the financial system which was chaired by Mr. M. Narsimhan. The committee came out with several recommendations. The most important recommendation which the committee came out was to increase the competition among the Indian banking industry by opening up the banking sector to the private as well as the foreign players. The recommendations also covered the areas of interest rate deregulation, directed credit rules and statutory pre-emptions. The basic objective of the banking sector reform was to line up with the overall goals of the 1991 economic reforms of opening the economy, giving a greater role to markets in setting prices and allocating resources, and increasing the role of private sector [ Arun and Turner (2002); Bhide, Prasad and Ghosh (2001); Shirai (2002)]

The reforms have taken place in the following areas:

First and foremost were the statutory pre-emptions, in which there was a drastic reduction in the financial repression in India through reduction in the CRR and the SLR requirements, which was one of the major cause low profitability and high interest rate spreads in the Indian banking system [Shirai (2002b)].

CRR was brought to around 5% in 2003 from its peak of 15% in 1991. The SLR was brought down to 25% in 1997 from its peak of 38.5% in 1992.

The reduction of the CRR and SLR resulted in increased flexibility for banks in determining both the volume and terms of lending loan [Kamesam (2002), Reddy (2002)]

Next reform was in the area of interest rate liberalisation. Before reform the interest rate structure was very complex with both savings and lending rates being controlled by the RBI. The deregulation of interest rate was a major component of the banking sector reform that aimed at promoting financial savings and growth of the organised financial system [Reserve Bank of India, 2004]. As of 2004, the RBI was only controlling the interest rates for savings account and NRI deposit rate. For all the other deposits above 15 days, the banks were free to charge and set their own interest rates.

Priority sector lending too came in the reform list. The committee recommended that the percentage advances to Priority Sector should be reduced from 40% to 10%. However this recommendation has not been implemented till date. But instead the definition of the Priority sector has been expanded, thereby reducing the overall burden of the banks.

There were reforms made in area of entry barriers. There was hardly any competition before 1991. The public sector banks dominated the market and all the private banks/ foreign banks had a miniscule market share. Since 1994, 7 private sector banks entered the Indian banking industry. More than 20 foreign banks started their operation in India since 1994. By March 2004, the new private sector banks and foreign banks had a combined share of 20% of total assets.

Deregulating the entry requirements and setting up new private/ foreign banks has benefited the Indian banking system from the improved technology, specialized skills, better risk management practices and greater portfolio diversification [Reserve Bank of India, 2004]

Reforms also aimed at public sector banks where one of the recommendations of the committee was to liquidate the PSBs. But the government decided against that recommendation. But in 1994, State Bank of India became the first PSB to raise equity in the capital markets. Further 11 PSB's were partially privatised by government diluting its share upto 49%.

But inspite of partial privatization, the government is committed to keep their public character by maintaining strong administrative control [Arun and Turner (2002); Ahluwalia (2002)].

Last but not the least, there was reforms in prudential norms. The committee also recommended strengthening of the prudential norms and the supervisory framework. Since then there has been a continuous effort on the part of RBI in bringing transparency and accountability in the banking sector. Several rules regarding the capital adequacy ratio, provisioning of the NPAs, accounting norms etch were changed and brought at par with the global standard.

Indian Banking Industry - 2000 onwards

Similar to the Indian economy which grew at a high rate after 2000, even the Indian banking industry saw very high growth. Significant growth has been seen in the total assets, deposits, advances and even number of branches. The entry of private / foreign players has made the market very competitive and brought new risk management techniques.

The Scheduled Commercial Banks (SCB) [5] have shown an impressive growth from FY04 to the mid of FY09. The banking sector credit recorded credit growth of 33.3% in FY05 which was highest in the last 2½ decades and credit growth excess of 30% for three consecutive years from FY04 to FY07, was the best in the banking industry till date. As there was a high growth in the real sectors of economy, the banks could experience high growth in their fee-based income. There was a significant improvement in the recovery of NPAs, lowest ever increase in the NPAs combined with a sharp increase in gross advances for SCBs which translated in the best asset quality ratios for banking industry in two decades [ Report on Indian Banking Sector, 2009]


The total deposits grew at 19.6% CAGR from FY03 to FY08. The increase in the deposits helped the banks to make more advances. The diagram shows the deposits from FY02 to FY08.

(Source: Reserve Bank of India)

The deposits which stood at nearly INR 10 Trillion grew to nearly INR 35 Trillion in just 7 years.

(Source: Reserve Bank of India)

In terms of group-wise share, the public sector banks not only continued to be the leaders, their share also increased, while the other banks groups witnessed a decline. The diagram above clearly shows that the total bank deposits of SBI and associates and other public sector banks combined is more than half of the aggregate bank deposits. The tall skyscrapers in the diagram show that still the public sector banks dominate the Indian banking industry in generation of the deposits from general public. One of the important factors for such domination of PSBs is their penetration in the Indian rural areas where private / foreign banks have hardly any presence. In September 2009, nationalized banks accounted for 50.5% of the aggregate deposits while SBI and its associates accounted for 23.8%. The share of other scheduled commercial banks, foreign banks and regional rural banks were 17.8%, 5.6% and 3% respectively [ RBI Quarterly Statistics on Deposits and Credit of SCB: September 2009].

The current account and savings account (CASA) deposits are an important source of raising deposits at a lower for the banks. Recently, however the growth rate of CASA deposits decelerated and their total share in the total deposits also declined, posing a challenge to the banking sector.

Advances (Loans)

The advances grew at 27.4% CAGR from FY02 to FY08. The reason for such an increase in the advances was the increase in the deposit base of banks. The diagram shows the increase of advances from FY02 to FY08

(Source: Reserve Bank of India)

The RBI breaks down advances in following categories: PSL, credit to industry, retail credit and credit to the Medium and Small enterprise advances.

The advances increased from INR 6.2 trillion in FY02 to INR 24 trillion FY08. The diagram below shows the group-wise increase in the advances from FY02 to FY08

(Source: Reserve Bank of India)

Again, it's clear from the chart that even in advances SBI and associates and public sector banks lead the markets. The private/ foreign banks are nowhere in their competition. But ICICI Bank, which is India's larges private sector bank, seen whopping level of increase in its advances especially the retail loans like mortgage loans, personal loans, auto loans and credit card receivables since FY06.

Total Assets

The total assets of Indian banking industry stood at INR 46 Trillion by FY08. In FY02, the TA was INR 12 trillion. This shows that the total assets have grown with pace of 20.7% CAGR FY02 to FY08.

(Source: Reserve Bank of India)

State Bank of India and its associates and public sector banks hold the maximum banking assets followed by private banks and foreign banks respectively. Surprisingly, the second largest asset belonged to ICICI Bank which is a private bank.

Non Performing Asset (NPA) [6] 

Non Performing Assets is a very important indicator about the health of the banking industry. A banking industry with a high NPA levels is considered to be very vulnerable and weak. One of the important policy decision taken during the banking reforms was to bring down the NPAs. Due to directed lending practices and poor risk management skills, Indian banks had accumulated alarming level of NPAs.

Between 1993 and 1999, the Government of India injected INR 120 billion in the nationalized banks to clean their balance-sheet. The total re-capitalization amounted to 2% of the GDP.

In FY98, the net performing assets were 7.63% of the total loans. In FY02, the figure was 7.37% which came down 0.79% in FY08. The reduction in the NPA % is unbelievably -72% CAGR.

(Source: Reserve Bank of India)

(Source: Reserve Bank of India)

The NPA of foreign banks in India was among the highest in the entire group followed by the private sector banks in FY02 but it has drastically been reduced and brought down to the industry average in FY08. The NPA of the SBI and its associates and other PSBs was lower compared to the private/ foreign banks due to the fact of re-capitalisation by the Government of India. As the latest, recapitalisation was done in 1999 by GOI, the NPA of SBI and its associates and other PSBs were exceptionally high.


The penetration of banks can be determined by the number of branches a bank has. The more branches a bank has, better market penetration it has got. In India, usually the best penetration is that of SBI and its associates and PSBs as they have large number of branches in the rural sectors. One of the prime reasons for having branches in the rural sector is that the public sector banks are expected to cater to rural areas even if those branches are not "profitable". It's more of a social obligation than a financial decision for PSBs. For private/ foreign banks, although they have to open few branches in the rural areas, but they have pick and choose among the profitable regions.

(Source: Reserve Bank of India)

The diagram above shows that the growth of bank branches has been decent and adding around 1500 branches every year from FY02 to FY08.

As the private / foreign banks are competing fiercely with their public sector counterparts, penetration in the pristine rural market has been the prime focus of the strategy of their strategy. There is a untapped potential in Indian rural market which is yet to be explored. Tapping of these rural pockets would be a jackpot.

Challenges Ahead

As the Indian banking industry is changing rapidly, it also faces lot of challenges. These challenges can be summed up as below:

Competition from new private and foreign players

Comprehensive Risk Management

Capital efficiency

Compliance with the International Accounting Standards

Implementation and adaptation to new technology

NPA management

Enhancing the customer service by maintaining profitability

The Indian banking industry has a long way to go to meet these challenges but the time has shown that it has not only met the challenges but also learnt lessons. The competition has just begun!!

Section III

Literature Review

As per the neoclassical theory, the spectrum of market structure can be defined by the number of firms and size of those firm in the market [Goddard, Molyneux & Wilson (2001)]. Also, the competition in the financial sectors is very critical and important for number of reasons. The competition matters for the efficiency of the production of financial services, quality of financial products, and degree of innovation [Claessens & Laeven (2003)]. The link between competition and stability is very well recognized in theoretical as well as the empirical researches [Vives (2001)]. The researchers also started finding relationships between competition and banking system performance and stability but still it's too early to derive any conclusion based on that research. For example, Classen and Laeven (2004) find no supportive empirical evidence for the much anticipated inverse relationship between concentration and competition.

In a contrary view, Allen and Gale (2000, 2004) exemplify that financial crisis are more likely to occur in less concentrated banking systems. Boyd and de Nicolo (forthcoming) illustrate in a theoretical model that powerful institutions ability to charge higher interest encourages risk taking behaviour such that increased concentration eventually give rises to greater vulnerabilities. This is due to the absence of powerful providers of financial products that can reap benefits from high profits that serve as cushion against asset deterioration.

The general expectation is that increased level of competition in the financial sector would lead to lower costs and enhanced efficiency, but the recent research in these area illustrate that this relationship between competition and banking system performance is much more complex than anticipated. Yet competition and market structure plays a decisive role in the behaviour of the firms within the industry, although this statement is yet to be tested and has not proved to be completely correct, but more importantly it has neither completely proven incorrect. Hence there have been a lot of attempts by the researcher/ academicians to measure the competitiveness and the market structure in order to know the industry dynamics.

Coming to the measures of competition and market structure, Bikker and Haaf (2001)] state that the literature on the measurement of competition may be divided into two mainstreams called the structural and non structural approach. The structural approach to the measurement of competition embraces the Structure-Conduct-Performance paradigm (SCP) and the efficiency hypothesis as well as number of formal approaches with root in Industrial Organisational Theory. The SCP and EH investigates whether the highly concentrated market causes collusive behaviour among the larger banks resulting in superior market performance, and whether it is efficiency of the larger banks that enhances their performance. The structural methods link the competition to concentration. The structural models are further divided into the two major schools of thought: the formal and non formal approaches.

Non structural models namely, the Iwata model (Iwata, 1974), the Bresnahan model, and the Panzar-Rosse model (Panzar and Rosse, 1987) were developed in reaction to the theoretical and empirical deficiencies of the structural models.

Various numerical measures of concentration have been used by empirical researchers for studies in the banking industry. Hall and Tideman (1967) suggested list of six desirable properties for measures of concentration. They are:

A concentration ratio index should be a one-dimensional measure

Concentration in an industry should be independent of the size of the industry

Concentration should increase if the share of any firm is increased at the expense of a smaller firm

If all firms are divided into K parts then the concentration index should be reduced by a proportion 1/K

If all firms are divided into N equal parts then the concentration should be a decreasing function of N;

A concentration measure should be between zero and one.

Concentration measures like k-bank concentration ratio, Herfindahl-Hirschman index (HHI) are extensively used to measure the banking sector performance as a function of market structure [ Barth et al (2004); Beck at el (2006)]. But Bikker (2004) also states that heavily relying on the measures of bank concentration like HHI and k-bank ratio tend to exaggerate the level of competition in small countries and are increasingly unreliable when the number of banks is small.

K-bank concentration ratio

For measuring the concentration of firms, the most frequent used ratio is "k-bank" concentration ratio (Bikker, 2004). The very reason this ratio is so frequently and widely used is because of its simplicity and limited data requirement for its calculation. k-bank ratio is dominantly used in the applied work on banking literature [Bikker and Haff (2002); Bikker (2004); Schaeck et al(2006)].

The concentration ratios can be 3-bank concentration ratio, 5-bank concentration ratio or 5% concentration ratio (k5%). The researchers have used different kind of ratios in their researches. The 3-bank concentration ratio measures the concentration of the top 3 biggest bank in the industry. The 5-bank concentration ratio measures the concentration of the top 5 banks within the industry. The k5% concentration measure is defined as the 5th percentile of the largest banks divided by the total assets in the banking system [Alegria and Schaeck]

Although Alegria and Schaeck in their paper state that use of 3 or 5 bank concentration ratio gives rise to problem when the k3 values are compared to samples of different sizes and that the use of k5% overcomes the issue substantially, the researchers have frequently used the 3- or 5-bank concentration ratio.

Herfindahl Hirschman Index

It is another benchmark measure for measuring the bank concentration and gives more weight to larger banks. Contrary to k3 and k5%, the HHI extends to all the banks in the system thus has representation from all the market participants and not just the larger ones as in the case of k-bank. Thus by taking all the market participants it avoids the arbitrary cut-offs. Bikker (2004) has highlighted its extensive use for the research purpose. The salient feature of HHI is that it not only plays important role in empirical researches, it is practically very vital for central banks for gauging the concentration of domestic banking system. In United States, HHI plays a significant role in the enforcement process of antitrust laws in banking. An application for the merger of two banks will be approved without further investigation if the basic guidelines for the evaluation of the concentration in deposit markets are satisfied. Cetorelli (1999) has stated that HHI plays a statutory role in the US for the approval of bank mergers, where the post-merger market HHI must not exceed 0.18 and that the change in the index should be less than 0.02.

Al-Muharrami, Mathhews and Khabari (2006) have used HHI in order to find out the concentration in GCC countries namely Qatar, Oman, Bahrain, Kuwait, Saudi Arabia and UAE.

Although so widely used in research, Rhoades (1995) shows that market share inequality and the number of firms in the market have an effect on bank's profitability and that is independent of HHI despite the fact that HHI takes both these factors in consideration. Moreover, Berger and Hannan's (1989), Hannan (1997) extends Rhoades (1995) that HHI fails to take into account market share inequality and number of firms. Davies (1979) analyses the sensitivity of the HHI to its two constituent parts i.e. the number of banks in the market and the inequality in the market shares among the different banks and finds that the index becomes less sensitive to changes when the number of banks becomes larger.

Panzer and Rosse H-statistics

There are two widely used techniques following a non-structural approach to empirically measures the degree of competitive behaviour in the market, termed contestability, are those developed by Breshnan (1982) and Lau (1982) and Panzar and Rosse (1987).

This approach of measuring the contestability was expanded by Panzer and Rosse (1982, 1987). It is a non-structural approach. It is abbreviated as PR hence forth and uses the firm (or bank)-level data. It investigates the extent to which a change in a factor input price is reflected in revenues earned by a specific bank. Under perfect competition, an increase in input price raises both the marginal cost and total revenue by same amount as the rise in cost. Under monopoly, an increase in input price will increase the marginal cost but reduce the output and hence reduce the total revenue [ Cleassens and Laeven].

The PR model also provides with the H-statistics, which is a measure between 0 and 1 for the degree of competitiveness of the industry. The value of this statistic determines whether the industry has a perfect competition, monopolistic competition or monopoly. The advantage of PR model is that it uses the bank-level data and allows for bank-specific differences in production function. It also allows one to study differences between the types of banks like large vs. small, foreign vs. domestic etc.

De Bant and Davis (2000) shows that the PR approach require a number of working assumptions. First, the banks should be treated as a single product firms instead of the multiple product firms. The input of the bank is labour, physical capital and financial capital and is believed to be producing intermediation services. Second, higher input prices must not be correlated with higher quality services that would generate higher profits as such an assumption would vitiate the H-statistics. The final assumption is that banks are in long-run equilibrium.

The use of PR has been increasing in the banking related studies. Shaffer (1982) in his work on New York banks, observed monopolistic competition. Nathan and Neave (1989) found perfect competition in the Canadian banks for 1982 but monopolistic competition for 1983-84. In their study Llyod-Williams et al (1991) and Molyneux et al (1996) revealed perfect collusion for Japan. Molyneux et al (1994) also tested the PR statistic on a sample of French, German, Italian, Spanish and British banks from 1986-1989 in order to assess the competitive condition of European countries. The results he obtained was that all countries were having monopolistic competition and hence the hypothesis of monopoly was rejected.

The use of PR method is summarized in the below table


Period of study



Shaffer (1982)


New York

Monopolistic Competition

Nathan and Neave (1989)



1982: Perfect competition; 1983-84 monopolistic competition

Llyod-William et al (1991)




Molyneux et al (1994)


France, Germany, Italy, Spain, UK

Monopoly: Italy; Monopolistic Competition: France, Germany, UK and spain

Vesala (1995)



Monopolistic competition for all but two years

Molyneux et al (1996)




Coccorese (1998)



Monopolistic competition

Rime (1999)



Monopolistic competition

Hondroyiannis et al (1999)



Monopolistic competition

Bikker and Groeneveld (2000)


15 EU countries

Monopolistic competition

De Bandt and Davis (2000)


France, Germany, Italy

Large banks: monopolistic competition in all countries; small banks: monopolistic competition in italy, monopoly in France and Germany

Bikker and Haaf (2002)


23 OECD countries

Monopolistic competition

Gelos and Roldos(2002)


Argentina, Brazil, Chile, Czech Republic, Mexico, Hungary, Poland and Turkey

Monopolistic competition

Hempell (2002)



Monopolistic competition

Philippatos and Yildrim (2002)


15 Central and Eastern European countries

Monopolistic competition except the large banks which had Perfect competition

Belaisch (2003)



Monopolistic except the foreign banks

Levy-Yeyati and Micco (2003)


Argentina, Brazil, Chile, Costa Rica, El Salvador and Peru

Monopolistic competition

Coccorese (2004)



Monopolistic Competition

Prasad and Sibal (2006)



Monopolistic Competition

Al-Muharrami et al. (2006)


GCC countries (Oman, Qatar, Bahrain, Kuwait, UAE and Saudi Arabia)

Kuwait, Saudi Arabia and UAE : Perfect competition ; Oman, Qatar and Bahrain: Monopolistic Competition

Gunalp and Celik (2006)



Monopolistic Competition

Parera et al (2006)


South Asian countries

Monopolistic Competition

Yildrim (2007)


Central and Eastern European countries

Monopolistic Competition except Federal Yugoslavia Republic of Macedonia and Slovakia

One of limitation of this approach is that the increasing relationship between H and competition may not hold in certain oligopoly equilibria [De Bant and Davis (2000)].


There are two main competing approaches with regard to market structure and business performance namely the structure-conduct-performance (SCP) paradigm, which emphasis market collusion, and the efficiency hypothesis, which stress the superior operating efficiency of particular firms.

The SCP paradigm is based on the proposition that market concentration fosters collusion among firms in the industry. According to the hypothesis, the degree of concentration of a market exerts a direct influence on the degree of competition among its firms. The more concentrated the market, the less the degree of competition. This hypothesis would be supported if the impact of the market concentration was found to be significantly positive, regardless of the efficiency of the firm. Thus, more firms in more concentrated markets will earn higher profits (for collusive or monopolistic reasons) than firms operating in less concentrated ones, irrespective of their efficiency [Llyod-Williams and Molyneux(1992)]. In another words, SCP paradigm investigates whether a highly concentrated market causes collusive behaviour among larger banks resulting into superior market performance [ Bikker and Haff (2002)].

The SCP looks closely at the basic supply and demand conditions. The services of banks is a function of providing liquidity, information and asset transformation (of risk, terms and size) which the banks does by simultaneously taking deposits and granting loans. Banks are also a multi-product firms being active on deposit market, the loan market and the securities market.

The structure of banks can be determined by:


Product differentiation

Barriers to entry.

The conduct is determined by the policies aimed at coercing the rivals and policies towards set the price. The variables of the conduct can be branch network, the density of automated teller machines, the reputation for solvency, and the quality of staff or of the premises (Neven 1990)

The performance of any firm can be measured in terms of their productive (cost and profit).

There have been numerous empirical studies using SCP for measuring the collusion in the banking industry. In their paper on the Spanish Banking, Lloyd-William and Molyneux (1994) stated the effect of the government and regulatory pressure on the banks which prompted them to merge and their subsequent effects upon the market structure and conduct in Spain. In 1995, Molyneux and Forbes deployed the SCP paradigm to the 18 countries and concluded that "degree of concentration" had an effect on the level of competition within the industry [Katib, N (2004)].

The recent studies have opted for to use profits as the measure of performance rather than prices since it alleviates the problem of wage control and also as banking is a multi-product in nature it at times includes "cross-subsidisation" amongst goods and services offered [Molyneux and Forbes (1995)]

Abbreviation used

GDP : Gross Domestic Product

NPA : Non Performing Assets

CRR : Cash Reserve Ratio

SLR : Statutory Liquidity Ratio

INR : Indian Rupee

SBI : State Bank of India

PSB : Public Sector Banks

CAGR : Compounded Annual Growth Rate

PSL : Priority Sector Lending

SCB : Scheduled Commercial Banks

HHI : Herfindahl Hirschman Index

SCP : Structure Conduct Performance

PR : Panzer Rosse

CRk : Concentration Ratio for k-banks