Efficiency analysis of Indian banks

Abstract

1. INTRODUCTION Efficiency of a bank has been one of the most important issues in emerging economies around the world and more so in India with the next step of financial deregulation only a couple of years ahead. Most of the emerging economies have faced one banking crises or the other. So, many policy discussions would be centering on questions like: Should the foreign banks allowed to enter the market, should the small banks be allowed to exist with the industry showing signs of consolidation in the wake of globalization. Apart from these discussions, the major issues would be the relative comparison of banks based on its size, ownership type and its year of commencement of business. Therefore it is imperative to understand a bank’s performance relative to the market over a certain period of time. Data Envelopment Analysis (DEA) has become increasingly popular in measuring efficiency in different national banking industries for it allows comparison of relative efficiency of individual banks and also peer group performance. The most traditional method to benchmark efficiency in the banking sector is the ratio analysis of different financial parameters (like ROA or ROI). However, these ratios give a one dimensional, incomplete picture of the process and fail to account for the interaction and tradeoff between the various parameters. Apart from the traditional analysis of financial statements of banks, a most common way to tackle the issue is to use an econometric approach to measure various aspects of bank efficiency in a multi-bank environment. DEA has been widely used to measure efficiency performance of different financial institutions like banks, insurance and mutual funds. Particularly in the banking sector, it has been applied to benchmark the performance of different banks or to study the efficiency estimates of different branches of a particular bank. The post-liberalization era in Indian banking has witnessed a host of financial reforms leading to stiff competition among banking units. In recent times, the question of relative comparison of banks by size, type of ownership or date of appearance has been a pertinent issue to reckon with. Performance evaluation becomes more significant to give a true and fair picture of the financial health of an organization. There are various parametric and non-parametric approaches to measure performance. Performance ratios are widely used in all sectors of business.