Review on the Productive Efficiency of Banks in Developing Country

Banks are found to have substantially lower average efficiency than indicated by previous studies. Efficiency is determined by sample size, the number of inputs and outputs of the model, the choice of input and outputs and the degree of homogeneity of the sample. Homogeneity appears to be one of the stronger drivers of average efficiency. Some intermediation models may be biased toward finding higher average efficiency and lack criteria to determine whether the intermediation process is profitable. The average bank is found to be competitive, but the low average efficiency scores found seems to be a result of a small percentage of banks that temporarily manage to attain some degree of super-efficiency. The inputs and the outputs used in data envelopment analysis are standardized by utilizing accounting definitions and foundational finance concepts. This allows modeling a bank’s productive process for the measurement of total productive efficiency and provides a way to include the profitability of a bank productivity process. This standardized model can then be extended to analyze other industries. The Indian banking sector, which was predominantly controlled by the government, was liberalized in early 1990s. The resultant competitive forces, coupled with more stringent regulatory framework, have created pressure on the banks to perform. Efficiency has become critical for banks’ survival and growth. This paper analyzes the performance of the Indian banking sector, measured and compared in two stages: Through the construct of productive efficiency using the non-parametric frontier methodology, DEA and finding the determinants of productive efficiency through TOBIT model. Inputs and outputs are measured in monetary value and efficiency scores determined for the period 1999- 2003. The study shows that SBI and its group have the highest efficiency, followed by private banks, and the other nationalized banks. The results are consistent over the period, but efficiency differences diminish over period of time. The capital adequacy ratio is found to have a significantly positive impact on the productive efficiency. In this thesis we study about the Productive Efficiency of Banks & Financial Institution in India