Determinants of allocative, scale and scope efficiencies of Indian banks

Abstract

This paper analyses the impact of second phase of issuing banking licences, on the determinants of allocative, scope, and cost efficiencies of Indian scheduled commercial banks. The paper follows a two stage estimation process. In the first stage, allocative, scope and cost efficiency scores are estimated following Data Envelopment Analysis. Thereafter, in the second stage, using these scores, determinants of the stated efficiencies are analysed by specifying a regime switching panel regression model. Prior studies, both in the context of Indian and international banks, do not measure and analyse the determinants of scope efficiencies of Banks. The findings reveal that reforms had little impact on the stated measures of efficiency. However, on each of these efficiency parameters, state owned banks perform better than private or even foreign owned banks. Further, the paper finds that profitability, size, ownership and economic growth rate are significant determinants of the stated efficiency measures. As expected, we find that as a result of competition, net interest margins of Indian public and private sector banks have come close to global standards. Reforms have resulted in adoption of global asset classification norms which has resulted in rationalisation of risk across assets. We also find that bigger banks tend to be more efficient although the impact of size on all stated measures of efficiency is diminishing over time. Thus, in order to enhance efficiency, policy measures must encourage banks to reduce their cost to income ratio and enhance their size measured as log of deposits. Accordingly, in order to enhance efficiency, banks need to introduce a number of investment products that are linked to the risk of advances, thus catering to the diversified expectation of depositors. Another way for banks to enhance their efficiency is by offering a wide array of products and services which would result in higher scope efficiency by reducing the cost to income ratio.