Productivity growth and efficiency change in Indian banking : Technology effect vs catch‐up effect

Purpose – The purpose of this paper is to understand the influence of technology change in the banking sector by employing data envelopment analysis (DEA) and also to determine the change in total factor productivity (TFP) and its components, namely technical change and technical efficiency change. Design/methodology/approach – The DEA method has been used to assess the efficiency of the entire banking sector and the bank groups. The purpose has been to investigate TFP change and its components' (obtained using Malmquist index) influence on the growth in the banking sector as well as in the four bank groups. In doing so, for each bank group the levels of technical efficiency, technical efficiency change, efficiency change and TFP change have been estimated. Further investigation has been done to determine if significant differences in these exist between the different bank groups in terms of size, time period and ownership. The determinants of productivity have been assessed. Findings – The TFP growth over the entire period (1995‐2006) was driven by technical change as compared to efficiency change, showing that technology and innovation had a greater impact than efficiency change, or the catch‐up effect. The fixed effects estimates of the determinants of TFP change and its components show that size, ownership and time period exert significant effect on technical change. Practical implications – The results of the analysis presented in this paper suggest that policies that result in efficiency change are likely to have little impact on the future prospects of the banking sector relative to policies that foster the adoption of the latest technologies. This has exactly been the focus of Reserve Bank of India and though some banks may consider it as an imposition of technology, the result of this requirement appears to be positive as is apparent from this paper's analysis. Originality/value – The value of this paper comes from the empirical testing that in the Indian banking sector growth in the more recent period came from technology change or frontier shifts as compared to efficiency change. Also, growth is larger due to frontier shifts than due to efficiency change. This endorses Lucas' findings regarding the focus on the positive impacts of deregulation and competition in the Indian banking sector.