|
Let me at the outset congratulate
the Pakistan Society of Development Economists for organising this Conference.
Issues of productivity and efficiency have been at the centre-stage of discussions
in recent years. Nowhere is this truer than the financial sector, which is perceived
to be the ‘brain’ of the economy (Stiglitz, 1998). Even within the financial
sector, given the dominance of bank-based financial systems in most emerging
markets including ours and the systemic importance of banks in the financial
system, the banking sector continues to be the centre of attention for academia
and policymakers alike. Not surprisingly therefore, performance of the banking
sector has repercussions across the length and breadth of the economy. Judged
thus, the theme of the Conference immediately appealed to me in view
of its topicality and timeliness. As a central banker, the obvious topic for
me to speak on relates to productivity and efficiency in Indian banking.
The objective of reforms in general
is to accelerate the growth momentum of the economy, defined in terms of per
capita income. Typically, improvements in the growth rate can be effected through
three, not necessarily mutually exclusive channels: improving productivity of
capital, through investments in human capital and raising total factor productivity
(TFP).
The quality of functioning of the
financial sector can be expected to affect the functioning and productivity
of all sectors of the economy. Efficient financial intermediation should help
in improving economy-wide resource allocation thereby promoting productivity
growth all round. Thus discussion on economic efficiency and productivity should
involve analysis of developments in the financial sector. Improvements in the
financing of physical and human capital, both in terms of increasing magnitudes,
and in terms of allocative efficiency, should raise efficiency and productivity
across the economy. This approach justifies the choice of my topic today.
Financial intermediation is essential
to the promotion of both extensive and intensive growth. The efficient intermediation
of funds from savers to users enables the application of available resources
to their most productive uses. The more efficient a financial system is in such
resource generation and in its allocation, the greater is its contribution to
productivity and economic growth. As resource allocation improves and real returns
increase, savings would presumably respond and higher resource generation should
result. Thus, development of the financial system is essential to the generation
of higher productivity and economic growth.
I will structure my address along
the following lines. First, I will explore in brief the impact of banking sector
productivity on the rest of the economy. This is relevant in view of the fact
that any discussion on productivity and efficiency issues in banking would need
to be judged in conjunction with the level of financial development and other
country-specific features. This will be followed by a brief review of banking
sector reforms in India. The subsequent section will examine, in some detail,
the trends in productivity and efficiency in Indian banking. My concluding remarks
will be in the nature of the way ahead on areas germane to this sector at the
present juncture.
2. How does productivity in
banking influence the rest of the economy?
Economic history provides support
for the fact that financial development makes a fundamental contribution to
growth. Financial development helped in the promotion of industrialisation in
developed countries by facilitating the mobilisation of capital for large investments.
Well-functioning banks or other financial intermediaries such as venture capital
funds also spur technological innovation by identifying and funding entrepreneurs
who are perceived to have the best chances of developing new products successfully
and for implementing innovative production processes.
Recent research has provided robust
evidence supporting the view that financial development contributes to economic
growth.
- At the cross-country level, various measures
of financial development (including measures of financial sector assets, domestic
credit to private sectors and stock market capitalization) are found to be
positively related to economic growth.
- Other studies establish a positive relationship
between financial development and growth at the industry level (Rajan and
Zingales, 1998).
- Similarly, at the firm level, firms in countries
with deeper financial development are able to obtain more external funds and
thereby enabled to grow faster (Demirgúc-Kunt and Maksimovic, 1998).
A basic indicator of financial
development is the contribution of finance-related activities to GDP. The share
of real GDP originating from finance-related activities in India tripled from
just around 2 per cent during the 1970s to around 6 per cent during the 1990s
and further to 7 per cent during the first half of this decade. Within the services
sector, the share of finance rose from less than 5 per cent to more than 12
per cent over the same period (Table 1).
Table 1: Share of Real GDP originating
in Banking and Insurance
(per
cent)
|
Period
|
Share of banking and
insurance in GDP
|
Share of banking and insurance
in services
|
|
1970-71 to 1974-75
|
1.8
|
4.6
|
|
1975-76 to 1979-80
|
2.2
|
5.4
|
|
1980-81 to 1984-85
|
2.5
|
5.9
|
|
1985-86 to 1992-93
|
3.9
|
8.5
|
|
1993-94 to 1998-99
|
5.8
|
11.8
|
|
1999-2000 to 2003-04
|
6.7
|
12.3
|
Source: Computed from National Accounts Statistics, Central Statistical
Organisation.
The broad-based indicators of financial
development, as culled from the flow-of-funds accounts, are also testimony to
gradual widening and deepening of the economy. Most of the commonly tracked
ratios exhibited an upward trend during the 1970s and 1980s, while moderate
fluctuations in these ratios were observed during the 1990s (Table 2). What
is of interest is that the Finance Ratio, a proxy for financial deepening, witnessed
remarkable improvement over this period.
Table 2: Flow of Funds-based Indicators
of Financial Development
|
Period
|
FR
|
FIR
|
NIR
|
IR
|
|
1970-71 to 1974-75
|
0.2
|
1.4
|
0.8
|
0.8
|
|
1975-76 to 1979-80
|
0.3
|
1.8
|
1.0
|
0.7
|
|
1980-81 to 1984-85
|
0.3
|
2.4
|
1.4
|
0.7
|
|
1985-86 to 1989-90
|
0.4
|
2.4
|
1.4
|
0.7
|
|
1991-92
|
0.5
|
2.9
|
1.6
|
0.8
|
|
1994-95
|
0.5
|
2.4
|
1.2
|
0.9
|
|
1995-96
|
0.5
|
2.3
|
1.3
|
0.7
|
FR = Finance ratio =Total issues/National income (net national product at current
prices)
FIR = Financial inter-relations ratio =Total issues/net
domestic capital formation
NIR = New issue ratio = Primary issues/ net domestic
capital formation
IR = Inter-relations ratio = secondary issues (i.e.,
issues by banks and other financial institutions)/primary issues
Source: Reserve Bank of India
When we move away from these broad-based
indicators to more specific liquidity- and credit-based indicators, a similar
picture emerges. Illustratively, the ratio of aggregate deposits to GDP exceeded
50 per cent during the first half of the current decade; M3/GDP has averaged
around 50 per cent since the 1990s. At a slightly more disaggregated level,
while bank credit to government has witnessed some tapering off in the second
half of the 1990s, credit to the commercial sector averaged over 30 per cent
of GDP during the first half of the current decade (Table 3). These observations
are particularly relevant from the standpoint of the role of banks in the intermediation
process. Juxtaposed with the financial sector reforms, this suggests that the
enhanced freedom of banks since the liberalisation process has provided them
with the flexibility in resource mobilisation and deployment, which has manifested
itself in the uptrend in these ratios. Thus financial deepening has been taking
place continuously in India and is still in progress.
Table 3: Liquidity - and Credit-based
Indicators of Financial Development
(as per cent of GDP
at current market prices)
|
Period
|
Aggregate deposits
|
M3
|
Bank credit to Government
|
Bank credit to commercial
sector
|
|
1970-71 to 1974-75
|
16.4
|
25.9
|
13.3
|
15.6
|
|
1975-76 to 1979-80
|
24.1
|
33.0
|
14.0
|
21.8
|
|
1980-81 to 1984-85
|
30.0
|
39.1
|
18.7
|
26.9
|
|
1985-86 to 1989-90
|
36.1
|
45.4
|
22.9
|
30.3
|
|
1990-91 to 1994-95
|
39.6
|
49.3
|
23.6
|
29.0
|
|
1995-96 to 1999-00
|
43.8
|
53.8
|
21.9
|
28.6
|
|
2000-01 to 2004-05
|
54.7
|
65.3
|
24.9
|
33.5
|
Source: Reserve Bank of India
Studies by the Reserve Bank (RBI,
2000) on the association between finance and growth for an extended time span
from 1971-72 to 1999-2000 find that the causality between finance (proxied by
real M3 growth) and growth (proxied by real GDP growth) is bi-directional. However,
in the absence of any structural model underlying such relationships, these
‘causality’ estimates can only be interpreted in terms of the predictive content
of each of the variables. Subsequent research on the inter-linkage between finance
and growth in India has veered around to the view that the Indian growth process
has essentially been ‘finance-led’: expansion in the financial sector played
an enabling role in promoting capital accumulation, which, in turn, engendered
higher growth (Bell and Rousseau, 2001). Typically however, studies of this
genre tend to be susceptible to the time period and choice of variables, so
that a different period with another set of variables could possibly lead to
different conclusions. What is, however, accepted is that finance did play a
role in influencing the growth process in India, although such observations
related to financial deepening have little to say about efficiency and productivity
growth.
The aforesaid observations do not
take into account the changing dynamics of the financial system. The traditional
classification of the financial system as bank- or market-based often tends
to be static; in contrast, financial systems evolve and develop over time in
response to changes in the institutional environment, legal set up and other
country-specific features. This has been the case in India as well. Many of
you would be aware that, cross-country classifications of financial system have
typically classified India as a ‘bank-based’ system. This is not surprising,
since banks have traditionally been the dominant financial intermediaries. However,
the relative share of banks in total financial sector assets, which was nearly
three-fourths in the early 1980s, came down gradually over a period of time
and has hovered around the two-thirds mark since the 1990s (Ray & Sengupta,
2004).
More importantly however, following
the rapid growth of stock markets since the 1990s, the role of ‘market-based’
finance has been on the rise. The most commonly employed measure of financial
system orientation – the ratio of market capitalisation to bank assets - supports
this observation (Table 4). This suggests that not only have financial institutions
gained in terms of financial assets, but there is also considerable potential
for market financing to develop. However, the magnitude of market capitalisation
is obviously dependent on the vagaries of the stock market: it is not expected
to exhibit a consistent increase as a ratio of GDP, whereas the growth in bank
assets/GDP ratio is much more regular.
Table 4: Financial System Orientation
(as per cent of GDP
at current market prices)
|
As at end
|
Assets of scheduled commercial
banks
|
Market capitalisation
at BSE
|
Financial system orientation
|
|
(1)
|
(2)
|
(3)
|
(4)=(3)/(2)x100
|
|
December 1970
|
17.9
|
3.8
|
21.3
|
|
December 1975
|
21.0
|
2.6
|
11.0
|
|
December 1980
|
40.0
|
3.8
|
9.3
|
|
December 1985
|
46.8
|
7.4
|
15.2
|
|
March 1991
|
56.3
|
16.0
|
28.4
|
|
March 1995
|
51.6
|
43.1
|
83.5
|
|
March 2000
|
59.1
|
46.8
|
79.3
|
|
March 2003
|
69.0
|
23.2
|
33.7
|
|
March 2004
|
71.6
|
43.5
|
60.8
|
|
March 2005
|
75.9
|
54.7
|
72.1
|
BSE: The National Stock Exchange, Mumbai
Source: Computed from Handbook of Statistics on
the Indian Economy, RBI
Whereas financial deepening is
easier to measure, analysing productivity and efficiency changes in banking
is more complex and needs to be viewed in relation to the changing contours
of the banking industry in India.
3. Contours of Indian Banking
Sector Reforms
The transformation of the banking
sector in India needs to be viewed in light of the overall economic reforms
process along with the rapid changes that have been taking place in the global
environment within which banks operate. The global forces of change include
technological innovation, the deregulation of financial services internationally,
our own increasing exposure to international competition and, equally important,
changes in corporate behaviour such as growing disintermediation and increasing
emphasis on shareholder value. Recent banking crises in Asia, Latin America
and elsewhere have accentuated these pressures.
As many of you would be aware,
India embarked on a strategy of economic reforms in the wake of a serious balance-of-payments
crisis in 1991; a central plank of the reforms was reform in the financial sector
and, with banks being the mainstay of financial intermediation, the banking
sector. The objective of the banking sector reforms was to promote a diversified,
efficient and competitive financial system with the ultimate objective of improving
the allocative efficiency of resources through operational flexibility, improved
financial viability and institutional strengthening. A summary profile of the
banking industry over the last 15 years is presented in Table 5.
Table 5: Summary Profile of the
Banking Industry: 1990-91 to 2004-05
|
Year/Bank Group
|
1990-91
|
1995-96
|
2004-05
|
|
PSB
|
Private
|
Foreign
|
PSB
|
Private
|
Foreign
|
PSB
|
Private
|
Foreign
|
|
1. No. of banks
|
28
|
25
|
23
|
27
|
35(8)
|
29
|
28
|
29(9)
|
31
|
|
(a) Listed
|
None
|
None
|
NA
|
2
|
9(3)
|
NA
|
20
|
18(7)
|
NA
|
|
(b) Non-listed
|
|
|
|
25
|
26(5)
|
NA
|
8
|
11(2)
|
NA
|
|
2. Share
(in per cent) of
|
|
|
|
|
|
|
|
|
|
|
(a) Assets
|
91.4
|
3.7
|
4.9
|
84.5
|
6.5(1.5)
|
7.9
|
75.3
|
18.2(12.5)
|
6.5
|
|
(b) Deposits
|
92.0
|
4.0
|
4.0
|
85.4
|
6.6(1.3)
|
6.7
|
78.0
|
17.3(10.9)
|
4.7
|
|
(c) Credit
|
93.0
|
4.0
|
3.0
|
82.4
|
6.8(1.9)
|
8.9
|
73.2
|
20.0(13.9)
|
6.8
|
|
(d) Income
|
89.4
|
3.3
|
7.3
|
82.5
|
8.2
|
9.4
|
76.4
|
16.9
|
6.7
|
|
(e) Expenses
|
90.0
|
3.3
|
6.8
|
84.1
|
7.5
|
8.4
|
76.7
|
16.9
|
6.4
|
|
(f) Profit
|
68.5
|
4.1
|
27.4
|
-33.3
|
55.6
|
77.8
|
74.2
|
16.4
|
9.4
|
|
3. Memo
|
|
|
|
|
|
|
|
|
|
|
Bank asset / GDP
(per cent)
|
56.3
|
50.4
|
80.4
|
PSB: public sector banks; NA: Not
applicable; Listed: Banks listed on recognised stock exchanges.
Figures in bracket under Private
pertain to de novo private banks.
Source: Reserve Bank of India
As you are aware, the financial
system in India by the late 1980s was characterized by dominant government ownership
of banks and financial institutions, widespread use of administered and variegated
interest rates, and financial repression through forced financing of government
fiscal deficits by banks and through monetisation. Thus, although a great degree
of financial deepening had indeed taken place and financial savings had increased
continuously, financial markets were not really functioning, and there was little
price discovery in terms of the cost of money, i.e., interest rates. The efficiency
and productivity enhancing function of the financial system was severely handicapped.
Hence, a widespread financial sector reform effort has been underway since 1991.
Let me briefly sum up the major
areas of banking sector reforms:
- Financial repression through statutory pre-emptions
has been reduced, while stepping up prudential regulations at the same time.
- Interest rates have been progressively deregulated
on both the deposit and lending sides (Box I).
Restoration of the health of the
banking system has involved:
- Restoration of public sector banks' net worth
achieved through recapitalisation where needed (total cost less than one
per cent of GDP).
- Competition increased through entry of new
private sector banks and foreign banks.
- Higher levels and standards of disclosure
achieved to enhance market transparency.
- Bank regulation and supervision strengthened
towards international best practice.
- Micro prudential measures instituted.
- Supervision process streamlined with combination
of on-site and off-site surveillance along with external auditing.
- Risk based supervision introduced.
- Process of structured and discretionary intervention
introduced for problem banks through a prompt corrective action mechanism.
- Ownership of public sector banks has been
broadened through disinvestment up to 49 per cent, and banks have been listed
(Table 6).
- Mechanism for greater regulatory coordination
instituted for regulation and supervision of financial conglomerates.
- Measures taken to strengthen creditor rights
(still in process).
|
Box I
Interest Rate Deregulation
Deposit Rate Deregulation
- April 1992: (a) interest rates freed between
46 days and 3 years and over, but ceiling prescribed, (b) October 1995
: Ceiling removed for deposits over 2 years
- July 1996: Ceiling removed for deposits
over 1 year
- October 1997: Interest Rates on Term Deposits
Completely Deregulated
- 2004: Minimum maturity for term deposits
reduced to 7 days
Lending Rate Deregulation
- 1992-93: Six categories of lending rates
- 5 slabs for below Rs.2 lakh
- Minimum lending rate above Rs.2 lakh
- October 1994: Lending Rate freed for Loans
above Rs.2 lakh & Minimum Rate Abolished
- October 1996: Banks to specify maximum
spread over PLR
- 1997-98: Separate PLRs permitted for cash
credit/demand loans and term loans above 3 years. Floating Rate permitted.
- 1998-99: PLR made ceiling for loans upto
Rs.2 lakh
- 1999-00: Tenor linked PLR Introduced
- 2001-02: PLR made benchmark rate; sub
PLR permitted for loans above Rs.2 lakh
- 2002-03: Bank-wise PLRs made transparent
on RBI website
- 2003-04: Computation of Benchmark PLR
rationalized tenor linked PLRs abolished
|
Table 6: Private Shareholding in Public Sector Banks
(as on March 31, 2005)
|
Shareholding (in per
cent)
|
Number of banks*
|
|
Up to 10
|
4
|
|
More than 10 and up to
20
|
-
|
|
More than 20 and up to
30
|
5
|
|
More than 30 and up to
40
|
6
|
|
More than 40 and up to
49
|
6
|
* Comprising 19 nationalised banks,
State Bank of India and IDBI Ltd.
Source: Trend and Progress of Banking
in India, 2004-05, RBI.
As the banking system has been
liberalised and become increasingly market-oriented and financial markets have
developed concurrently, the conduct of monetary policy has also been tailored
to take into account the realities of the changing environment (switch from
direct to indirect instruments).
This macro approach to financial
monitoring has enabled policy makers to fine-tune their regulatory stance in
consonance with the changing market and institutional dynamics so as to balance
growth and stability concerns. For instance, despite the gradual tightening
of prudential norms, the ratio of non-performing loans (NPL) to total loans,
which was at a high of 15.7 per cent for scheduled commercial banks (SCBs) at
end-March 1997, has declined by more than two thirds to 5.2 per cent at end-March
2005 (Table 7). Net NPLs also witnessed a significant decline, driven by the
improvements in loan loss provisioning and improved recovery management, which
comprises over half of the total provisions and contingencies. Capital adequacy
of the banking sector also recorded a marked improvement and reached 12.8 per
cent at end-March 2005, well above the stipulated level of 9 per cent. Banks
have also been sensitised to develop robust risk management systems for credit
and operational risks and focus on their asset-liability maturity profile to
withstand adverse movements in market risk parameters such as interest rates
and take corrective measures.
Table 7: Non-performing Loans of
Different Bank Groups: 1994-2005
(per
cent to total advances)
|
Year
(end-March)
|
PSB
|
Old Private Banks
|
New Private Banks
|
Foreign Banks
|
Memo: NPL/total
loans
(per cent) - 2004
|
|
1994
|
24.8
|
NC
|
NC
|
NC
|
China: 15.6
|
|
1995
|
19.5
|
NC
|
NC
|
NC
|
Indonesia: 13.4
|
|
1996
|
18.0
|
NC
|
NC
|
NC
|
Korea: 1.7
|
|
1997
|
17.8
|
10.7
|
2.6
|
4.3
|
Malaysia: 11.6@
|
|
1998
|
16.0
|
10.9
|
3.5
|
6.4
|
Argentina: 17.5@
|
|
1999
|
15.9
|
13.1
|
6.2
|
7.6
|
Brazil: 3.9
|
|
2000
|
14.0
|
10.8
|
4.1
|
7.0
|
US: 0.8
|
|
2001
|
12.4
|
10.9
|
5.1
|
6.8
|
UK: 2.2
|
|
2002
|
11.1
|
11.0
|
8.9
|
5.4
|
Japan: 2.9
|
|
2003
|
9.4
|
8.9
|
6.7
|
5.3
|
|
|
2004
|
7.8
|
7.6
|
5.0
|
4.6
|
|
|
2005
|
5.5
|
6.0
|
3.6
|
2.8
|
Global range: [0.3 to 30.0]
|
@: relates to 2005. NC: Not compiled.
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
Another heartening development
in banks’ balance sheets, driven by the twin forces of international accounting
irregularities and regulatory initiatives has been the increasing focus on corporate
governance. As part of their Annual Report, banks presently disclose, under
the head ‘Report on corporate governance’, details of their boards of directors,
number of board meetings attended by members, details of the various sub-committees
of the boards and provided the banks are listed, information on their stock
price movements. This is complemented with the banks’ philosophy on corporate
governance and the enabling mechanisms undertaken by the banks to achieve their
philosophy. As you would be aware, such listing is an important component of
the process of ‘market discipline’, which complements the regulatory initiatives
undertaken by the authorities. To take the governance process in banks a step
further, we had some time back issued guidelines laying down transparent criteria
for determining the ‘fit and proper’ status of owners and directors in private
banks. Given our focus on a consultative approach to policy formulation, the
document was posted on the RBI website for encouraging a debate on this issue.
Based on the feedback received, the draft is being reviewed before final guidelines
can be issued to banks.
The whole policy reform
process has been designed to make the banking system more market oriented to
enable efficient price discovery and to induce greater internal efficiency in
the resource allocation process. Thus, whereas the efforts in the 1960s, 1970s
and 1980s were essentially devoted to financial deepening, the focus of reforms
in the past decade and a half has been engendering greater efficiency and productivity
in the banking system in particular, and in the financial sector as a whole.
How well have we succeeded?
4. Efficiency and productivity
analysis in banking
In recent times, a significant
body of literature has evolved which explores the performance of financial institutions
in the wake of financial liberalisation. These studies are essentially micro-economic
in nature and seek to analyse the efficiency and productivity of banking systems.
Such analysis is of relevance from the policy standpoint, because as the finance-growth
literature suggests, if banks become better-functioning entities, this is expected
to be reflected in safety and soundness of the financial system and ultimately,
lead to increases in the rate of economic growth. More importantly, such analysis
is useful in enabling policymakers to identify the success or failure of policy
initiatives or, alternatively, highlight different strategies undertaken by
banking firms which contribute to their successes.
A priori, deregulation is
expected to unleash competitive forces. Such competition would, in turn, enable
banks to alter their input and output mix, which when combined with technological
developments facilitates increase in output that raises overall bank productivity
and efficiency. Second, liberal entry of de novo private and foreign
banks as a part of the deregulation process is expected to raise bank efficiency,
productivity and technology levels, because de novo private/foreign banks
are associated with superior management practices and technology, which can
be fruitfully imbibed by those which are not. A third strand of thinking, borrowing
from the public choice framework, contends that different ownership structures
may engender different efficiency levels. The theoretical argument is straightforward:
lack of capital market discipline weakens owners’ control over management, enabling
the latter to pursue their own interests, and provides fewer incentives for
them to be efficient. Finally, as banking in the current world is technology
driven and technological progress itself is scale augmenting, the relationship
between bank size and efficiency becomes important. Skeptics, on the contrary,
argue that deregulation is, in general, accompanied by an increase in banks'
operational cost and could induce financial fragility due to over-expansion
of banking activity. Thus, productivity gains after deregulation could be temporary
and not sustainable in the long run. As a result, evidence in support of a unidirectional
relationship between deregulation and efficiency/productivity is not conclusive.
Besides various methods of
estimation, the efficiency and productivity studies in banking are constrained
by the absence of precise definitions of inputs and outputs of banks. As a result,
several approaches exist and the appropriateness of each approach varies according
to the circumstances (Box II).
|
Box II
Inputs and outputs of commercial
banks
Banks are typically multi-input
and multi-output firms. As a result, defining what constitutes ‘input’
and ‘output’ is fraught with difficulties, since many of the financial
services are jointly produced and prices are typically assigned to a bundle
of financial services. Additionally, banks may not be homogeneous with
respect to the types of outputs actually produced. In view of these complexities,
four approaches have come to dominate the literature on banking output:
the production approach, the intermediation approach, the
operating (income-based) approach and more recently, the modern
approach.
Under the production approach,
banks are primarily viewed as providers of services to customers. The
input set under this approach includes physical variables (e.g.,
labour, material, space or information systems) and the outputs represent
the services provided to customers and are best measured by the number
of deposit and loan accounts.
Under the intermediation
approach, financial institutions are viewed as intermediating funds
between savers and investors. Banks produce intermediation services through
the collection of deposits and other liabilities and their application
in interest-earning assets, such as loans, securities and other investments.
This approach includes both operating and interest expenses as inputs,
whereas loans and other major assets count as outputs. In principle, there
are three variant of intermediation approach, viz., the asset approach,
the user cost approach and value-added approach. The asset
approach is a reduced form modelling of the banking activity, focusing
exclusively on the role of banks as financial intermediaries between depositors
and final uses of bank assets. Deposits and other liabilities, together
with real resources (labor and physical capital) are defined as inputs,
whereas the output set includes earning assets such as loans and investments.
The user cost approach determines whether a financial product is
an input or an output on the basis of its net contribution to bank revenue.
If the financial returns on an asset exceed the opportunity cost of the
funds or alternately, if the financial costs of a liability are less than
the opportunity cost, they are considered as outputs; otherwise, they
are considered as inputs. The value-added approach identifies major
categories of produced deposits and loans as outputs because they form
a significant proportion of value added.
The operating approach
(or income-based approach) views banks as business units with
the final objective of generating revenue from the total cost incurred
for running the business. Accordingly, it defines banks’ output as the
total revenue (interest and non-interest) and inputs as the total expenses
(interest and operating expenses).
Finally, the modern approach
seeks to integrate some measure for risk, agency costs and quality of
bank services. In this approach, the individual components of CAMEL are
derived from the financial tables of the banks and are used as variables
in the performance analysis.
Source: Adapted from Berger
and Humphrey (1992) and Frexias and Rochet (1997)
|
Competition and profitability of Indian banks
Beginning from 1992, Indian banks
were gradually exposed to the rigours of domestic and international competition.
Newly opened banks from the private sector and entry and expansion of several
foreign banks resulted in greater competition in both deposit and credit markets.
Consequent to these developments, there has been a consistent decline in the
share of public sector banks in total assets of commercial banks. The evidence
of competitive pressure is well supported from the declining trend of Herfindahl’s
concentration index (Table 8). Notwithstanding such transformation, the public
sector banks still remain the mainstay, accounting for nearly three-fourths
of assets and income. It is also important to note that public sector banks
have responded to the new challenges of competition, as reflected in the increase
in the share of these banks in the overall profit of the banking sector. From
the position of net loss in the mid-1990s, in recent years the share of public
sector banks in the profit of the commercial banking system has become broadly
commensurate with their share in assets, indicating a broad convergence of profitability
across various bank groups. This suggests that, with operational flexibility,
public sector banks are competing relatively effectively with private sector
and foreign banks. The ‘market discipline’ imposed by the listing of most public
sector banks has also probably contributed to this improved performance. Public
sector bank managements are now probably more attuned to the market consequences
of their activities (Mohan, 2005).
Table 8: Herfindahl’s Index of Concentration
on Deposits and Credit of Scheduled Commercial Banks: 1992-2004
|
Year (end-March)
|
Deposit
|
Credit
|
|
1992
|
8.1
|
10.4
|
|
1993
|
7.6
|
10.1
|
|
1994
|
7.4
|
8.6
|
|
1995
|
7.0
|
7.9
|
|
1996
|
6.9
|
7.8
|
|
1997
|
6.7
|
7.3
|
|
1998
|
6.6
|
7.4
|
|
1999
|
7.1
|
7.2
|
|
2000
|
6.9
|
6.9
|
|
2001
|
7.3
|
6.7
|
|
2002
|
7.1
|
6.0
|
|
2003
|
6.9
|
6.0
|
|
2004
|
6.3
|
5.8
|
|
Source: Author's calculations
|
|
|
Since the late1990s, in line with the benign interest rate regime, both interest
income and interest expenditure of banks as proportions of total assets have
declined. However, interest expenditure declined faster than interest income,
resulting in an increase in net interest income. However, non-interest income,
which emanates mostly from fee-based activities, has been increasing consistently
in the post-reform period. For example, non-interest income as a proportion
of total assets of the banking sector increased from 1.2 per cent in 1993 to
more than 2 per cent in 2004 (Table 9). In this context, it is also appropriate
to mention that Indian banks, in particular the public sector banks, are yet
to catch-up fully with their foreign counterparts.
Table 9: Non-interest Income of
Scheduled Commercial Banks: 1992-2004
(as percentage
to total asset)
|
Year
(end-March)
|
Public Sector Banks
|
Indian Private Banks
|
Foreign
Banks
|
All Scheduled Commercial
Banks
|
|
1992
|
1.22
|
1.03
|
3.40
|
1.38
|
|
1993
|
1.19
|
1.13
|
0.99
|
1.17
|
|
1994
|
1.26
|
1.34
|
2.22
|
1.34
|
|
1995
|
1.26
|
1.43
|
2.46
|
1.36
|
|
1996
|
1.39
|
1.68
|
2.35
|
1.49
|
|
1997
|
1.32
|
1.64
|
2.54
|
1.45
|
|
1998
|
1.33
|
1.94
|
2.96
|
1.52
|
|
1999
|
1.22
|
1.36
|
2.46
|
1.33
|
|
2000
|
1.28
|
1.67
|
2.60
|
1.43
|
|
2001
|
1.22
|
1.28
|
2.47
|
1.32
|
|
2002
|
1.43
|
1.59
|
2.91
|
1.57
|
|
2003
|
1.66
|
2.45
|
2.64
|
1.86
|
|
2004
|
1.91
|
2.08
|
2.98
|
2.01
|
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
Efficiency of Indian banks
Improvements in efficiency of the
banking system are expected to be reflected, inter alia, in a reduction
in operating expenditure, interest spread and cost of intermediation in general.
Several indicators have been employed in the literature to compare banking production
costs across time. Illustratively, intermediation cost, defined as the ratio
of operating expense to total assets, witnessed a gradual reduction in the post
reform period across various bank groups barring foreign banks (Table 10). This
decline in intermediation cost needs to be weighed against the large expenditures
incurred in upgradation of information technology and institution of ‘core banking’
solutions. Admittedly, intermediation costs of banks in India still tend to
be higher than those in developed banking markets.
Table 10: Intermediation Cost*
of Scheduled Commercial Banks: 1992-2004
(as percentage
to total asset)
|
Year
(end-March)
|
Public Sector Banks
|
Indian Private Banks
|
Foreign
Banks
|
All Scheduled Commercial
Banks
|
|
1992
|
2.60
|
2.97
|
2.26
|
2.59
|
|
1993
|
2.64
|
2.71
|
2.70
|
2.65
|
|
1994
|
2.65
|
2.49
|
2.65
|
2.64
|
|
1995
|
2.83
|
2.35
|
2.73
|
2.79
|
|
1996
|
2.99
|
2.47
|
2.78
|
2.94
|
|
1997
|
2.88
|
2.36
|
3.04
|
2.85
|
|
1998
|
2.66
|
2.14
|
2.99
|
2.63
|
|
1999
|
2.65
|
2.04
|
3.40
|
2.65
|
|
2000
|
2.52
|
1.85
|
3.12
|
2.48
|
|
2001
|
2.72
|
1.87
|
3.05
|
2.64
|
|
2002
|
2.29
|
1.45
|
3.03
|
2.19
|
|
2003
|
2.25
|
1.99
|
2.79
|
2.24
|
|
2004
|
2.20
|
2.01
|
2.76
|
2.20
|
* Intermediation cost
= operating expenses.
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
At a more disaggregated level,
it is evident that Indian banks have improved their efficiency in the post reform
period as evidenced from the declining trend in per unit cost of output, irrespective
of the choice of outputs (Table 11). The operating cost per unit of earning
assets declined from 2.1 per cent in 1992 to 1.8 per cent in 2004; similarly,
operating cost per unit of total volume of business declined from 3.4 per cent
to 2.6 per cent during the same period. Among the components of operating expenses,
employee cost per unit of output witnessed a noticeable decline in the post-reform
period. This decline is discernible across all bank groups, and especially for
public sector banks in the post 2001 period consequent to the voluntary retirement
scheme across several nationalised banks. On the other hand, the change in physical
capital cost per unit of output has been marginal, reflecting the fact that
Indian banks maintained a steady flow of investments towards physical capital
formation, especially on automation and information technology.
Table 11: Operating Expense and
its Components of Scheduled Commercial Banks: 1992-2004
(per
cent)
|
Year (end-March)
|
Operating expense/ earning
assets@
|
Labour cost/ earning
assets@
|
Non-labour cost/earning
assets@
|
Operating expense/ total
business*
|
Labour cost/ total business*
|
Non-labour cost/ total
business*
|
|
1992
|
2.08
|
1.40
|
0.68
|
3.42
|
2.30
|
1.12
|
|
1993
|
2.14
|
1.43
|
0.72
|
3.51
|
2.34
|
1.17
|
|
1994
|
2.22
|
1.44
|
0.78
|
3.56
|
2.31
|
1.25
|
|
1995
|
2.32
|
1.54
|
0.78
|
3.74
|
2.48
|
1.26
|
|
1996
|
2.48
|
1.73
|
0.75
|
4.01
|
2.80
|
1.22
|
|
1997
|
2.36
|
1.60
|
0.76
|
3.84
|
2.60
|
1.24
|
|
1998
|
2.16
|
1.46
|
0.70
|
3.51
|
2.37
|
1.14
|
|
1999
|
2.21
|
1.47
|
0.74
|
3.55
|
2.35
|
1.20
|
|
2000
|
2.05
|
1.37
|
0.68
|
3.22
|
2.15
|
1.06
|
|
2001
|
2.16
|
1.47
|
0.69
|
3.36
|
2.28
|
1.07
|
|
2002
|
1.82
|
1.18
|
0.64
|
2.73
|
1.77
|
0.96
|
|
2003
|
1.81
|
1.13
|
0.69
|
2.65
|
1.65
|
1.00
|
|
2004
|
1.78
|
1.08
|
0.71
|
2.61
|
1.58
|
1.03
|
@ Earning assets = credit + investment
* Total business = deposit
+credit
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
From the efficiency standpoint,
the intermediation cost needs to be viewed in conjunction with non-interest
income. Till 2001, the burden (the excess of non-interest expenditure over non-interest
income as a percentage to total assets) of commercial banks hovered around 1
to 1.5 per cent (Table 12). This gap between intermediation cost and income
from fee-based activities has narrowed considerably in recent years. For example,
the burden of Indian commercial banks declined from 1.2 per cent in 1992 to
0.2 per cent in 2004. Moreover, there has been a lowering of the burden across
bank groups in recent years. The improvement in respect of Indian private banks
has been remarkable; their non-interest income in recent years has surpassed
their intermediation cost and has resulted in a negative burden.
Table 12: Burden* of
Scheduled Commercial Banks: 1992-2004
(as percentage
to total asset)
|
Year
(end-March)
|
Public Sector Banks
|
Indian Private Banks
|
Foreign
Banks
|
All Scheduled Commercial
Banks
|
|
1992
|
1.37
|
1.94
|
-1.14
|
1.21
|
|
1993
|
1.45
|
1.57
|
1.70
|
1.48
|
|
1994
|
1.39
|
1.16
|
0.42
|
1.30
|
|
1995
|
1.57
|
0.92
|
0.27
|
1.43
|
|
1996
|
1.60
|
0.78
|
0.43
|
1.44
|
|
1997
|
1.56
|
0.72
|
0.50
|
1.40
|
|
1998
|
1.33
|
0.19
|
0.03
|
1.11
|
|
1999
|
1.44
|
0.69
|
0.94
|
1.32
|
|
2000
|
1.24
|
0.18
|
0.53
|
1.05
|
|
2001
|
1.51
|
0.59
|
0.59
|
1.32
|
|
2002
|
0.86
|
-0.14
|
0.12
|
0.63
|
|
2003
|
0.59
|
-0.46
|
0.15
|
0.38
|
|
2004
|
0.29
|
-0.07
|
-0.22
|
0.19
|
*Burden=non-interest expense less non-interest income. It reflects the
extent to which non-interest expenses are recovered through non-interest income
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
The cost income-ratio (defined
as the ratio of operating expenses to total income less interest expense) of
Indian banks showed a declining trend during the post reform period. For example,
Indian banks paid roughly 45 per cent of their net income towards managing labour
and physical capital in 2004 as against nearly 72 per cent in 1993 (Table 13).
In other words, Indian banks recorded a net cost saving of nearly 27 per cent
of their net income during the post reform period. According to the data reported
in The Banker 2004, the cost-income ratio of world’s largest banks varied
markedly from a low of 48 per cent to a high of 116 percent and the ratio around
60 per cent is an indicative benchmark (RBI, 2005). In that respect, the cost-income
ratio of Indian banks is now comparable internationally. Among various ownership
patterns, public sector banks have tended to have relatively higher cost-income
ratio as against private banks and foreign banks.
This explanation needs to be viewed
in conjunction with the differential ownership profile of banks. Early studies
(Sarkar et al., 1998) found somewhat weak evidence to suggest that ownership
was an important determinant of performance. More recent studies exhibit mixed
evidence: while certain studies (Keova, 2003) suggest ownership to have some
effect on bank performance, others (e.g., Bhaumik and Dimova, 2004) veer around
the view that competition induced public sector banks to eliminate the performance
gap that existed between them and both domestic and foreign and private sector
banks. More recent research reported differences in the efficiency of Indian
commercial banks with different ownership status, level of non-performing loans,
size and asset quality (Das and Ghosh, 2006). More importantly, their
study uncovered evidence that public sector banks (PSBs) recorded higher efficiency
gains in the post-reform period. Clearly, the evidence here is not conclusive,
because comparisons are beset with several difficulties. Given the size and
variety of PSBs, it is possible to find banks that could equal the good private
sector banks as well as bad ones. In addition, PSBs have to reckon with ‘legacy’
problems, such as many of the non-performing assets that they have been saddled
with. Some PSBs operate in relatively backward areas with limited discretion
to pull out from such areas. The question still remains: whether there is a
better payoff in enabling PSBs to improve their performance while promoting
private sector banks, as compared with an alternative policy that provides for
transfer of ownership and control from the public to the private sector. Will
greater scope for mergers and acquisitions within and between public and private
sector add to greater efficiency?
Table 13: Cost-income ratio of Scheduled
Commercial Banks: 1992-2004
(per
cent)
|
Year
(end-March)
|
Public Sector Banks
|
Indian Private Banks
|
Foreign
Banks
|
All Scheduled Commercial
Banks
|
|
1992
|
58.4
|
58.9
|
30.9
|
55.3
|
|
1993
|
73.7
|
66.8
|
59.2
|
71.9
|
|
1994
|
73.1
|
57.3
|
41.2
|
68.1
|
|
1995
|
67.6
|
52.2
|
40.6
|
63.5
|
|
1996
|
66.7
|
51.5
|
45.6
|
63.3
|
|
1997
|
64.3
|
51.3
|
45.6
|
61.0
|
|
1998
|
62.7
|
48.5
|
43.1
|
58.9
|
|
1999
|
65.9
|
58.9
|
56.9
|
64.3
|
|
2000
|
63.2
|
48.6
|
48.5
|
59.9
|
|
2001
|
67.0
|
51.8
|
50.0
|
63.4
|
|
2002
|
54.9
|
45.6
|
49.1
|
53.1
|
|
2003
|
47.8
|
45.1
|
46.5
|
47.2
|
|
2004
|
45.1
|
46.6
|
42.8
|
45.1
|
Cost-income ratio= ratio of operating expenses to total income less interest
expense. It measures the extent to which non-interest expense devours net total
income.
Source: Computed from Statistical
Tables relating to Banks in India, RBI, various years.
Another important indicator of
efficiency of banks is net interest margin (NIM), defined as the excess of interest
income over interest expense, scaled by total bank assets. Broadly speaking,
this ratio reflects the allocative efficiency of financial intermediation, a
lower ratio being indicative of higher efficiency. It is quite reasonable to
believe that the decline in deposit rates ushered by the deregulation process
will be manifested in the lending behaviour of banks. In practice, however,
lending rates have tended to be sticky downwards and seem to operate with a
time lag. Historically the NIM of Indian banks is rather high. Around the onset
of the reform process in 1992, the NIM of Indian banks was about 3.3 percent
(Table 14). Thereafter, it recorded a relatively modest decline to around 3
per cent in recent years. And traditionally, it is the foreign banks, which
by virtue of their ability to mobilise low-cost deposits, have the highest NIMs,
whereas those for private banks have been the lowest in recent years. These
comparisons are not watertight: typically, small and medium banks had high NIM
until 1997. Thereafter, NIM for big banks recorded a rise. Contextually, it
may be mentioned that banks in most developed countries and several emerging
economies have NIM (as a percentage to total assets) of around 2 per cent. This
provides some indication that competition in banking still has some way to go
in India.
Table 14: Spread@
of Scheduled Commercial Banks: 1992-2004
(as percentage
to total asset)
|
Year
(end-March)
|
Public Sector Banks
|
Indian Private Banks
|
Foreign
Banks
|
All Scheduled Commercial
Banks
|
|
1992
|
3.22
|
4.01
|
3.90
|
3.30
|
|
1993
|
2.39
|
2.92
|
3.57
|
2.51
|
|
1994
|
2.36
|
3.01
|
4.20
|
2.54
|
|
1995
|
2.92
|
3.07
|
4.27
|
3.03
|
|
1996
|
3.10
|
3.10
|
3.76
|
3.15
|
|
1997
|
3.16
|
2.95
|
4.13
|
3.22
|
|
1998
|
2.91
|
2.46
|
3.97
|
2.95
|
|
1999
|
2.81
|
2.11
|
3.51
|
2.79
|
|
2000
|
2.70
|
2.13
|
3.85
|
2.72
|
|
2001
|
2.84
|
2.33
|
3.64
|
2.84
|
|
2002
|
2.73
|
1.58
|
3.25
|
2.57
|
|
2003
|
2.52
|
1.96
|
3.36
|
2.48
|
|
2004
|
2.97
|
2.24
|
3.47
|
2.87
|
@Spread = interest earned
– interest paid
Source: Report on Trend and Progress
of Banking in India, RBI, various years.
Productivity
Studies on productivity in Indian
banking have only begun to emanate of late. A recent study found that total
factor productivity growth has improved marginally in the post deregulation
period, but there was little evidence of narrowing of productivity differentials
across ownership categories following deregulation (Kumbhakar and Sarkar, 2003).
Among various productivity indicators, labour productivity indicators like business
per employee and profit per employee are most commonly used. In addition, business
per branch is also used to judge branch-level productivity. The business per
employee of Indian banks increased over three-fold in real terms from Rs.5.4
million in 1992 to Rs.16.3 million in 2004, exhibiting an annual compound growth
rate of nearly 9 per cent (Table 15). At the same time, the profit per employee
increased more than five-fold: from Rs.20,000 to Rs. 150,000 over the same period,
implying a compound growth of around 17 per cent. Branch productivity also recorded
concomitant improvements. Overall, the balance of evidence suggests distinctive
productivity improvements in the banking sector over the reform period. The
extant literature suggests that such improvements could be driven by two factors:
technological improvement, which expands the range of production possibilities
and a catching up effect, as peer pressure amongst banks compels them
to raise productivity levels. In the context of gradual deregulation of financial
sector, several factors could have been at work: a significant shift of the
best-practice frontier, driven by a combination of technological advances, financial
innovation and different strategies pursued by banks suited to their business
philosophy and risk-return profile, changing composition of banks’ input–output,
and reduction in total cost due to improvements in overall efficiency. While
it is difficult to pinpoint the relative mix of these factors in raising productivity,
the bottomline is clear: Indian banks witnessed significant productivity improvements,
post-reforms.
Table 15: Select Productivity
Indicators of Scheduled Commercial Banks
(Rs. million
at 1993-94 prices)
|
Year
|
Business per employee
|
Profit
per employee
|
Business per
branch
|
|
1992
|
5.4
|
0.02
|
109.9
|
|
1993
|
5.4
|
-0.05
|
110.4
|
|
1994
|
5.4
|
-0.04
|
109.2
|
|
1995
|
5.6
|
0.02
|
113.0
|
|
1996
|
6.0
|
0.01
|
119.6
|
|
1997
|
6.6
|
0.04
|
129.0
|
|
1998
|
7.5
|
0.05
|
144.9
|
|
1999
|
8.4
|
0.03
|
158.7
|
|
2000
|
9.7
|
0.05
|
179.4
|
|
2001
|
11.5
|
0.05
|
196.2
|
|
2002
|
13.7
|
0.09
|
214.9
|
|
2003
|
15.0
|
0.12
|
234.8
|
|
2004
|
16.3
|
0.15
|
254.5
|
Source: Statistical Tables relating to Banks in India
In a wider framework, cross-country
studies of deregulation and productivity growth of banks report divergent views.
Typically, cross-country comparisons are often fraught with difficulties, not
only because of the different regulatory and economic regimes encountered by
financial entities, but also owing to the differential quality of services associated
with deposits and loans in different countries. Maudos and Pastor (2001) analysed
the cost and profit efficiency across 14 EU economies, as well as Japan and
the USA. The results uncovered the evidence that, since the start of the 1990s
increasing competition has led to gains in profit efficiency in the USA and
Europe but not so in the Japanese banking system. Their results also show that
the variance in of profitability between countries would be considerably reduced
if inefficiencies were eliminated, efficiency gains thus being a very important
source of improvement in profitability. A recent study in the Asian context
analysed various efficiency measures of South-East Asian (Indonesia, Korea,
Malaysia, Philippines and Thailand) banks in the context of corporate governance
(Williams and Nguyen, 2005). Although the motivation of the study was different,
their empirical results found economic justification for the policy of bank
privatisation.
Let me encapsulate this section
by making some general comments on the efficiency and productivity growth of
Indian banks vis-à-vis leading Asian nations like China and Korea. As
far as real growth (adjusted for price movement and exchange rate fluctuations)
in banking business is concerned, Indian banks are favourably placed. In recent
years, the real growth of deposits and of loans of Indian banks were noticeably
higher than those of other Asian countries such as China and Korea. At the same
time, profitability of Indian banks, as determined by the return on assets,
is also much higher (Tables 16, 17, 18 and 19). The intermediation cost of Indian
banks seems to be relatively higher than that of Korea and China. Nonetheless,
higher operating cost in India is well compensated by the higher non-interest
income, as compared to other Asian countries. Finally, the labour productivity
of the top 4 banks in India (which includes one de novo private bank)
and the four state-owned Chinese banks indicates that except the private bank,
the top three public sector banks in India recorded much lower employee productivity.
However, in the absence of data on employment for banks in other countries,
it is difficult to ascertain the degree of labour productivity differentials
across countries.
Table 16: Spread (net interest margin)
of banks of major Asian countries
(as percentage
to total asset)
|
Year
|
China
|
Indonesia
|
Korea
|
Malaysia
|
Philippines
|
Thailand
|
India
|
|
1996
|
1.86
|
2.92
|
1.70
|
2.91
|
4.07
|
2.57
|
3.07
|
|
1997
|
2.27
|
2.76
|
1.80
|
2.94
|
4.21
|
3.00
|
2.83
|
|
1998
|
2.16
|
-9.38
|
1.69
|
3.32
|
4.52
|
0.74
|
2.66
|
|
1999
|
1.83
|
-3.11
|
2.03
|
2.67
|
3.16
|
0.69
|
2.56
|
|
2000
|
1.76
|
2.21
|
2.06
|
3.02
|
2.54
|
1.43
|
2.74
|
|
2001
|
1.78
|
3.16
|
2.12
|
2.83
|
2.60
|
1.69
|
2.54
|
|
2002
|
1.78
|
3.61
|
2.33
|
2.70
|
2.29
|
1.84
|
2.74
|
|
2003
|
1.87
|
4.22
|
2.50
|
2.61
|
2.30
|
1.99
|
2.84
|
Source: BankScope
Table 17: Intermediation cost (operating
expense) of banks of major Asian countries
(as percentage
to total asset)
|
Year
|
China
|
Indonesia
|
Korea
|
Malaysia
|
Philippines
|
Thailand
|
India
|
|
1996
|
1.23
|
2.39
|
2.24
|
1.42
|
3.52
|
1.50
|
2.77
|
|
1997
|
1.24
|
4.50
|
2.55
|
1.49
|
3.28
|
2.05
|
2.60
|
|
1998
|
1.40
|
4.04
|
2.53
|
1.68
|
3.67
|
2.54
|
2.58
|
|
1999
|
1.18
|
2.83
|
1.53
|
1.50
|
3.38
|
2.20
|
2.41
|
|
2000
|
1.12
|
2.72
|
1.46
|
1.70
|
3.32
|
1.98
|
2.57
|
|
2001
|
1.10
|
2.36
|
1.42
|
1.80
|
3.30
|
2.01
|
2.21
|
|
2002
|
1.05
|
2.73
|
1.39
|
1.73
|
3.16
|
1.78
|
2.22
|
|
2003
|
1.01
|
2.94
|
1.38
|
1.61
|
3.00
|
1.71
|
2.19
|
Source: BankScope
Table 18: Non-interest income of
banks of major Asian countries
(as percentage
to total asset)
|
Year
|
China
|
Indonesia
|
Korea
|
Malaysia
|
Philippines
|
Thailand
|
India
|
|
1996
|
0.26
|
0.99
|
1.06
|
0.98
|
2.12
|
0.68
|
1.44
|
|
1997
|
0.24
|
2.97
|
0.93
|
1.10
|
1.73
|
1.00
|
1.49
|
|
1998
|
0.13
|
1.31
|
0.20
|
1.16
|
1.96
|
1.03
|
1.38
|
|
1999
|
0.17
|
1.96
|
0.99
|
1.00
|
1.95
|
0.97
|
1.47
|
|
2000
|
0.22
|
1.51
|
0.74
|
1.01
|
1.59
|
0.62
|
1.33
|
|
2001
|
0.22
|
1.08
|
1.28
|
1.15
|
1.73
|
0.73
|
1.49
|
|
2002
|
0.25
|
1.30
|
0.91
|
1.11
|
2.11
|
0.93
|
1.83
|
|
2003
|
0.25
|
1.46
|
0.80
|
0.94
|
2.16
|
0.95
|
1.97
|
Source: BankScope
Table 19: Net profit of banks of
major Asian countries
(as percentage
to total asset)
|
Year
|
China
|
Indonesia
|
Korea
|
Malaysia
|
Philippines
|
Thailand
|
India
|
|
1996
|
0.29
|
1.01
|
0.17
|
1.40
|
2.06
|
-0.56
|
0.71
|
|
1997
|
0.30
|
-0.39
|
-0.84
|
1.03
|
1.63
|
-1.17
|
0.90
|
|
1998
|
0.20
|
-46.92
|
-3.10
|
0.04
|
0.85
|
-5.57
|
0.54
|
|
1999
|
0.17
|
-9.20
|
-1.40
|
0.96
|
0.10
|
-5.88
|
0.70
|
|
2000
|
0.21
|
0.46
|
-0.37
|
1.29
|
-0.03
|
-0.15
|
0.48
|
|
2001
|
0.20
|
0.87
|
0.76
|
0.68
|
0.48
|
1.46
|
0.69
|
|
2002
|
0.20
|
1.30
|
0.60
|
1.03
|
0.60
|
0.21
|
0.97
|
|
2003
|
0.12
|
1.61
|
0.15
|
1.08
|
1.08
|
0.63
|
1.14
|
Source: BankScope
A clear message emanating from
these findings is the role of technology in driving productivity and efficiency
improvements. In today's world of banking, technology is considered as the basic
tool of the 'process engineers' of the organisation. It is crucial for the design,
control, and execution of service delivery in banks. Therefore, a key driver
of efficiency and productivity in the banking industry today is the effective
use of technology. This is a crucial pre-requisite for capitalising on future
opportunities for the banking sector. In effect, it has become the key to servicing
all customer segments – offering convenience to retail customer, corporates
and government clients. The increasing sophistication, flexibility and complexity
of products and servicing offerings makes the effective use of technology critical
for managing the risks associated with banking business. However, the ‘technological
penetration’ in India has been quite modest. According to data reported in the
World Development Indicators database, as of 2002, the number of computers
per 1000 persons was about 7 in India compared to anywhere between 70-500 in
most emerging markets and even higher in most developed economies. Wide disparities
exist within the banking sector as far as technological capabilities are concerned:
the percentage of ‘computer literate’ employees as percentage of total staff
in 2000 was around 20 per cent in public sector banks compared with 100 per
cent in new private and around 90 per cent in foreign banks (Reserve Bank of
India, 2002). Data reported by the RBI suggests that nearly 71 per cent of branches
of public sector banks are fully computerized. However, computerization needs
to go beyond the mere ‘arithmeticals’, to borrow a term from the Report of the
Committee on Banking Sector Reforms (Government of India, 1998), and instead,
needs to be leveraged optimally to achieve and maintain high service and efficiency
standards. In fact, recent research on the role of technology in driving productivity
improvements in banking demonstrates that computer employees and IT capital
exhibit higher productivities than their respective non-computer employees and
non-IT capital, respectively (Huang, 2005). The challenge, therefore, remains
three fold: acquiring the ‘right’ technology, deploying it optimally and remaining
cost-effective whilst delivering sustainable returns to shareholders. In effect,
‘managing’ technology so as to reap the maximum benefits remains a key challenge
for the Indian banks.
5. Way Ahead
How do we see the future? In this
context, I would like to share with you some of the issues that need to be kept
in view while discussing productivity and efficiency in banks. Needless to state,
these issues remain relevant, in varying degrees, in economies that share similar
features in the banking sector, as ours.
First, many of you would be aware
that small and medium enterprises (SMEs) constitute an important segment of
the industrial and services sectors in India in view of their significant contributions
to employment generation as also exports. With the emergence of new activities
in the rural segment such as agri-clinics, contract farming and rural housing
with forward and backward linkages to SMEs, lending to SMEs has become a viable
revenue proposition for banks. The Reserve Bank has also initiated several measures
to streamline the flow of credit and address structural bottlenecks in credit
delivery to this segment. Salient among these include fixing of self-set targets
for financing, rationalisation of cost of loans, expanding the outreach of formal
credit, and formulation of comprehensive and more liberal policies for credit
extension. Public sector banks have also been advised to constitute specialized
SME branches in identified clusters/centers with preponderance of small and
medium enterprises. A noteworthy development in this context has been the passage
of the Credit Information Companies (Regulation) Act, 2005 in the Parliament.
The Act is expected to encourage setting up of credit information companies
and thereby, improve exchange of information on credit histories of borrowers.
Coupled with appropriate risk assessment models and mechanisms, this is expected
to lower transactions costs of banks. The overall effect of this process is
likely to be reflected in a lowering of the risk premium embedded in interest
rates charged to SMEs with positive spillovers for bank lending to the SME sector.
Although liberalisation of financial
services and competition has improved customer services, experience shows that
customers' interests are not always accorded priority. More importantly, concerns
have been raised with regard to banking practices that tend to exclude vast
segments of the population. In this context, the Reserve Bank has announced
its intention to implement policies to incentivise banks to provide extensive
services responsive to the needs of the under-privileged. As part of the process,
the Reserve Bank has recently advised all banks to make available a basic banking
‘no frills’ account either with ‘nil’ or very low minimum balances as well as
charges that would make such accounts accessible to vast sections of population.
The nature and number of transactions in such accounts could be restricted,
but made known to the customer in advance in a transparent manner. Banks have
been urged to give wide publicity to this facility so as to ensure greater financial
inclusion.
The growth performance of the Indian
economy during the last few years indicates a possible ratcheting up of the
trend rate of growth from around 6 per cent to around 8 per cent per year. Yet,
there is a need to undertake significant efforts to achieve higher rates of
growth in a sustained manner. The current levels of investment might not be
adequate to achieve such growth rates, even after accounting for reductions
in the existing incremental capital-output ratios. Looking beyond the aspect
of fiscal consolidation, action on several fronts needs to be pursued vigorously
to step up growth rates. First is the issue of investment in agriculture and
allied activities, a sector that produces 21 per cent of GDP, but supports nearly
60 per cent of the population. There is often substantial loss of output owing
to inadequate storage and transport facilities and paucity of adequate food
processing capacities. This necessitates greater public and private investment
on these post-harvest facilities to not only increase value addition, but also
to improve the agriculture-industry linkage. The second issue of import is the
simplification of procedures. Cumbersome procedural formalities introduce delays
and results in significant output losses. Added to these, the de-reservation
of items from exclusive production under SSI units is likely to permit the sector
reap economies of scale and scope and enhance competitiveness. The third is
the issue of finances. The incipient investment boom in infrastructure, industry
and services will yield best results only if enormous resource flows are successfully
intermediated at a low cost. This will depend on the ability of the financial
sector to process information properly and to intermediate the extant savings
into optimal investment by specific firms and sectors. The fourth aspect of
stepping up investment is to address the deficiencies in infrastructure. The
decline in public spending on infrastructure has not been adequately compensated
by the private sector, possibly owing to difficulties in the regulatory environment.
Therefore, nurturing an appropriate policy framework, with a conducive environment
for public-private participation, remains the key to accelerating investment
in infrastructure. The final aspect is the need to complement domestic investment
with higher foreign investment, primarily in the form of FDI. Such investment
is likely to trigger technology spillovers, assist human capital formation and
more generally, improve the efficiency of resource use.
Over the reform period, more and
more banks have begun to get listed on the stock exchange, which, in its wake,
has led to greater market discipline and concomitantly, to an improvement in
their governance aspects as well. This has led to a broadbasing of the ownership
of PSBs. Such diversification of ownership has also led to a qualitative difference
in their functioning, since there is induction of private shareholding as well
as attendant issues of shareholder’s value, as reflected by the market capitalisation,
board representation and interests of minority shareholders (Reddy, 2002). The
issue of mixed ownership as an institutional structure where government has
controlling interest is a salient feature of bank governance in India. Such
aspects of corporate governance in PSBs is important, not only because PSBs
dominate the banking industry, but also because, it is likely that they would
continue to remain in banking business. To the extent there is public ownership
of PSBs, the multiple objectives of the government as owner and the complex
principal-agent relationships needs to be taken on board. Given the increased
technical complexity of most business activities including banking and the rapid
pace of change in financial markets and practices, PSBs would need to devise
imaginative ways of responding to the evolving challenges within the context
of mixed ownership. All in all, this is an exciting phase for PSBs to grow and
prosper, and it is up to these banks to respond to the challenges.
Let me conclude: the address has
have traversed a modest terrain, focusing on the efficiency and productivity
changes in Indian banking. The patterns of efficiency and technological change
witnessed in Indian banking can be viewed as consistent with expectations in
an industry undergoing rapid change in response to the forces of deregulation.
In reaction to evolving market prospects, a few pioneering banks might adjust
quickly to seize the emerging opportunities, while others respond cautiously.
As deregulation gathers momentum, commercial banks would need to devise imaginative
ways of augmenting their incomes and more importantly their fee-incomes so as
to raise efficiency and productivity levels.
References
Bell, C and P. Rousseau (2001):
"Post Independence India: A Case of Finance-led Industrialization?",
Journal of Development Economics, 65, 153-175.
Berger, A. N and D.B. Humphrey
(1992): "Measurement and Efficiency Issues in Commercial Banking"
in Z. Griliches (ed.): Output Measurement in the Services Sector,
Chicago: University of Chicago Press, 245-279.
Bhaumik, S.K. and R.Dimova
(2004): "How Important is Ownership in a Market with Level-Playing
Field? The Indian Banking Sector Revisited", Journal of Comparative
Economics, 32, 165-180.
Bhide, M.G., A. Prasad and
S.Ghosh (2001): Emerging Challenges in Indian Banking, Working Paper
No.103, Centre for Research in Economic Development and Policy Reform, Stanford
University.
Das, A. and S. Ghosh (2006):
"Financial Deregulation and Efficiency: An Empirical Analysis of Indian
Banks during the Post-Reform Period", Review of Financial Economics
(forthcoming).
Demirgúc-Kunt, A., &
V. Maksimovic (1998): "Law, Finance and Firm Growth", Journal
of Finance, 53, 2107-37.
Frexias. X and J.C. Rochet
(1997): Microeconomics of Banking, Cambridge MA: MIT Press.
Government of India (1998):
Report of the Committee on Banking Sector Reforms (Chairman: Shri
M Narasimham), New Delhi.
Huang Tai-Hsin (2005): "A
Study on the Productivities of IT Capital and Computer Labor: Firm-level
Evidence from Taiwan’s Banking Industry", Journal of Productivity
Analysis, 24, 241–257.
Koeva, P. (2003): The Performance
of Indian Banks During Financial Liberalization. IMF Working Paper No.150,
Washington DC.
Kumbhakar, S. and S. Sarkar
(2003): "Deregulation, Ownership and Efficiency Change in Indian Banking:
Evidence from India", Journal of Money, Credit and Banking,
35, 403-414.
Maudos, J. and J.M. Pastor.
(2001): "Cost and profit efficiency in banking: An international comparison
of Europe, Japan and USA", Applied Economics Letters, 8, 383-387.
Mohan, R. (2005): "Financial
Sector Reforms: Policies and Performance Analysis", Economic Political
Weekly, Special Issue on Money, Banking and Finance (March), 40, 1106-1121.
Rajan, R.G., and L. Zingales
(1998): Financial Dependence and Growth. American Economic Review,
88, 559-86.
Rangarajan, C and N. Jadhav
(1992): "Issues in Financial Sector Reforms", In B. Jalan (ed.):
The Indian Economy, Delhi: Penguin Books India.
Ray, P. and I. SenGupta (2004):
"Systemic Restructuring of Banks: The Indian Experience", Journal
of the Indian Bankers Association.
Reddy, Y.V. (2002): "Public
Sector Banks and the Governance Challenge: Indian Experience", Lecture
Delivered at the World Bank, IMF and Brookings Institutions Conference,
April.
Reserve Bank of India (2000):
Report on Currency and Finance 1999-2000, RBI: Mumbai.
Reserve Bank of India (2002),
‘Expenditure Pattern and IT Initiatives of Banks’, RBI Bulletin,
December.
Reserve Bank of India (2005):
Report on Trend and Progress of Banking in India 2004-2005, RBI:
Mumbai.
Sarkar, J., S.Sarkar and S.K.Bhaumik
(1998): "Does Ownership Always Matter? Evidence from the Indian Banking
Industry", Journal of Comparative Economics, 26, 262-281.
Stiglitz, J.E. (1998): "More
Instruments and Broader Goals: Moving Towards the Post-Washington Consensus",
WIDER Annual Lecture, Helsinki.
Williams, J. and Nguyen, N.
(2005): "Financial Liberalization, Crisis, and Restructuring: A Comparative
Study of Bank Performance and Bank Governance in South East Asia",
Journal of Banking and Finance, 29, 2119–2154.
* Address Delivered by Dr. Rakesh Mohan, Deputy
Governor, Reserve Bank of India at the 21st Annual General Meeting and Conference
of the Pakistan Society of Development Economists at Islamabad in December 2005.
The assistance of Abhiman Das, Saibal Ghosh and Partha Ray in the preparation
of the paper is gratefully acknowledged. |