Evaluating efficiency of Indian banks and rethinking their future policy measures

Abstract

This paper empirically estimates and analyzes efficiency index of various public sector, private sector and foreign banks using DEA analysis. The ratios published by RBI for various banks in the years 2008, 2009 and 2010 were used for the purpose of analysis. The analysis was done with the chosen critical inputs and outputs initially for all 79 banks followed by individual sector specific analysis for 2010 data initially followed by time series analysis for 2008, 2009 and 2010 data. In the combined analysis it is found that the foreign banks on an average have the highest efficiency on account of favorable factors such as lower deposits, lower cost of deposits, higher interest and non-interest income. The private sector banks come next in average efficiency scores followed by public sector banks. The public sectors banks have lowest efficiency due to lower credits and investments coupled with lower return on advances, high cost of capital, lower income and lower return on investments. The private sectors banks are marginally better as they are able to put their assets and deposits to better use when compared with public sector banks. In the sector specific run it is seen that the efficiency scores of public sectors are high and more clustered implying that there is no stark difference in their performances. However, for private sector banks and foreign banks the efficiency scores are comparatively more dispersed. When the combined analysis was done with 2008, 2009 and 2010 data it is seen that efficiency index of public and private banks have decreased over the years. It is seen that over the years the Ratio of NPA to net advances increased and Return on investments adjusted to cost of funds decreased for both private and public sector banks. For foreign banks the decrease has only been marginal. In the sector specific run we find that the efficiency index has decreased for both private and public sector but increased for foreign banks although only marginally for all sectors. Finally, this paper suggests policy measures for banks that could bring about increases in the efficiency of inefficient banks.