TECHNICAL EFFICIENCY OF THE PUBLIC AND PRIVATE SECTOR BANKS IN INDIA

Presented by

Kaustubh (wmp08019)

Ketan (wmp08020)

Kirti (wmp08021)

Manish (wmp08022)

Mudit (wmp08023)

Nikhil (wmp08024)

Presentation Outline• Banking Sector in India

• Public and Private Sector Banks

• Efficiencies in banking

• Technical Efficiency

• Measures of Technical Efficiency (TE)

• Differences in technical efficiency in the public and private sector

banks

• Reasons for Differences

• References

Banking Sector in India• Dominates Financial Services industry in India

• Sound banking system – a medium for economic growth

• Bankex grown at compounded annual rate of 31% in last decade

Banks under scope of this study

• Public Sector Banks:

>50 % stake owned by Government

Shares Listed in Stock Exchange

Total 27 PSB

• Private Banks

Majority of the stake owned by Private shareholders

Total 30 Private Banks

Efficiency in Banking

Economic Efficiency can be divided in two parts :

• Technical Efficiency : Technical or physical component refers to the ability to avoid waste by

producing as much output as input usage allows, or by using as little input as production allows.

Thus the analysis of technical efficiency can have an output augmenting orientation or input

conserving orientation.

• Allocative Efficiency : Allocative efficiency is a type of economic efficiency in which

economy/producers produce only that type of goods and services which are more desirable in the

society and also in high demand. The point of allocative efficiency is a point where marginal benefit

is equal to marginal cost (MB=MC).

Technical Efficiency (TE)• Technical efficiency means that resources are transformed into goods and services without waste,

that producers are doing the best job possible of combining resources to make goods and services.

There is no waste of material inputs. The maximum amount of production is obtained from the

given resource inputs. In essence, production is achieved at the lowest possible opportunity cost.

• If a firm is operating at point ‘A’ using input ‘X1’, its actual output is ‘Y1’ and the corresponding potential output is ‘Y*

1’ which is on the frontier ‘FF’, then the technical efficiency of the firm is given by the ratio Y1/ Y*

1.

ACHIEVING TECHNICAL EFFICIENCY

There are 2 approaches to achieving Technical Efficiency as per the constraints of a particular industry/economy :

• Input Oriented Approach• To produce existing level of output with the minimum inputs.

• Output Oriented Approach• To produce maximal output from a given set of inputs.

Data and specification of inputs and outputs

Selection of Input & Output parameters for analysis of efficiencies is one of the most

challenging jobs for a researcher. There are two approaches for selecting Inputs &

Outputs for measuring efficiency:

•Production Approach

•Intermediation Approach

Production Approach (service provision or

value added approach)• Banks are viewed as producers of loans and deposits.

• Input includes physical variables (like labour, material, space or information

systems) or their associated cost.

• The output under this approach represents the services provided to the

customers and is best measured by the number and type of transactions,

documents processed or specialized services provided over a given time

period

Intermediation Approach

• Treats banks as financial intermediaries channeling funds

between depositors and creditors.

• Deposits along with operating cost and interest cost are

considered as inputs.

• Interest-earning assets, such as loans, securities, and

other investments are considered as outputs.

Probable Inputs/Outputs for Analysis

• Inputs Ratio of deposits to total liabilities Cost of deposits Ratio of intermediation cost to total assets Ratio of wage bills to total expense Ratio of burden to interest income

• Outputs (Credit + Investment)-Deposit ratio Ratio of net interest income to total assets (Net Interest Margin) Return on equity Ratio of non-interest income to total assets Ratio of net NPA to net advances Return on advances adjusted to cost of funds Return on investments adjusted to cost of funds

Methods of measuring Technical Efficiency

• Parametric Method : Stochastic Frontier Analysis (SFA), Thick Frontier

Approach (TFA), Distribution Free Approach (DFA)

• Non Parametric Method: Data Envelopment Analysis (DEA), Free Disposal

Hull (FDH)

• Semi parametric method: SPE

Data Envelopment Analysis (DEA)

• DEA uses the principles of linear programming theory to examine how a particular Decision Making Unit (DMU) like a bank – operates relative to other DMUs in the sample

• DMUs are used to define a piece-wise linear surface called the efficient frontier.

• The best practice DMUs get an efficiency score of 1 whereas the scores of inefficient DMUs lie somewhere between 0 and 1. Firms on the frontier are efficient, while firms off the efficiency frontier are inefficient

• Estimates various aspects of relative efficiency of homogenous decision making units

(DMUs).

Data Envelopment Analysis (DEA)

Methodology

• Ratios

• A commonly used method is ratios. Typically we take some output measure and divide it by some

input measure. Note the terminology here, we view branches as taking inputs and converting them

(with varying degrees of efficiency, as we shall see below) into outputs.

For our bank branch example we have a single input measure, the number of staff, and a single

output measure, the number of personal transactions. Hence we have:

Methodology

• Here we can see that Croydon has the highest ratio of personal transactions per staff member,

whereas Reigate has the lowest ratio of personal transactions per staff member.

As Croydon has the highest ratio of 6.94 we can compare all other branches to it and calculate their

relative efficiency with respect to Croydon. To do this we divide the ratio for any branch by 6.94

(the value for Croydon) and multiply by 100 to convert to a percentage. This gives:

• Branch        Relative efficiency

Croydon       100(6.94/6.94) = 100%

Dorking       100(2.75/6.94) = 40%

Redhill       100(4.71/6.94) = 68%

Reigate       100(2.09/6.94) = 30%

• The other branches do not compare well with Croydon, so are presumably performing less well. That is, they

are relatively less efficient at using their given input resource (staff members) to produce output (number of

personal transactions).

We could, if we wish, use this comparison with Croydon to set targets for the other branches.

For example we could set a target for Reigate of continuing to process the same level of output but with one

less member of staff. This is an example of an input target as it deals with an input measure.

An example of an output target would be for Reigate to increase the number of personal transactions by

10% (e.g. by obtaining new accounts).

Plainly, in practice, we might well set a branch a mix of input and output targets which we want it to achieve.

Graphical Analysis

 •The positions on the graph represented by Croydon and Redhill demonstrate a level of performance which is superior to all other branches. •A horizontal line can be drawn, from the y-axis to Croydon, from Croydon to Redhill, and a vertical line from Redhill to the x-axis. This line is called the efficient frontier.•You can see therefore how the name data envelopment analysis arises - the efficient frontier envelopes (encloses) all the data we have. •Branches on the efficient frontier are 100% efficient (have an efficiency of 100%). Hence, for our example, Croydon and Redhill have efficiencies of 100%. •Its not possible to say whether the efficiency can be improved or not

Graphical AnalysisQuantifying efficiency scores for inefficient DMU's

Consider now Dorking and Reigate in the figure above. We can see that, with respect to both of the ratios Croydon (for example) dominates both Dorking and Reigate. Plainly both Dorking and Reigate are less than 100% efficient. But how much? Can we assign an appropriate numerical value?

Consider Reigate, we have: number of staff 11 personal transactions ('000s) 23 personal transactions per staff member (23/11) = 2.09 business transactions ('000s) 12 business transactions per staff member (12/11) = 1.09 For Reigate the ratio personal transactions:business transactions = (23/12) = 1.92, i.e. there are 1.92 personal transactions for every business transaction. By definition this figure of 1.92 is also the ratio of: personal transactions per staff member:business transactions per staff member In other words (2.09/1.09) is also equal to 1.92 Consider the diagram below. You can see Reigate plotted on it. It can be shown that any branch with a ratio (personal transactions per staff member:business transactions per staff member) equal to 1.92 lies on the straight line from the origin through Reigate. You can see that line below. If you are geometrically minded then the slope (gradient) of this line is 1.92 - i.e. there are 1.92 personal transactions for every business transaction.

Graphical Analysis

Hence if Reigate were to retain the same business mix (i.e. 1.92 personal transactions for every business transaction) but to vary the number of staff it employs its performance would lie on the line from the origin through its current position as shown above. For example were Reigate to operate the same level of output with 9 staff we would have: number of staff 9 personal transactions ('000s) 23 personal transactions per staff member (23/9) = 2.56 business transactions ('000s) 12 business transactions per staff member (12/9) = 1.33personal transactions per staff member:business transactions per staff member = (2.56/1.33) = 1.92

You can hopefully see from the diagram above that the point corresponding to personal transactions per staff member = 2.56 and business transactions per staff member = 1.33 lies on the line from the origin through the current position of Reigate.

Graphical AnalysisIn DEA we numerically measure the (relative) efficiency of Reigate by the ratio:

100(length of line from origin to Reigate/length of line from origin through Reigate to efficient frontier)

For Reigate this is an efficiency of 36%.

The logic here is to compare the current performance of Reigate (the length of the line from the origin to Reigate) to the best possible performance that Reigate could reasonably be expected to achieve (the length of the line from the origin through Reigate to the efficient frontier).

Performing a similar calculation for Dorking we get an efficiency of 43%. The list of ratios with extra branches added given before.Branch Personal Business transactions transactions per staff member per staff member ('000s) ('000s) Croydon 6.94 2.78Dorking 2.75 1.25Redhill 4.71 3.24Reigate 2.09 1.09A 1.23 2.92B 4.43 2.23C 3.32 2.81D 3.70 2.68E 3.34 2.96

Graphical Analysis

There are a couple of points to note here:

•The above diagram is a lot easier to understand, make sense of, and generate insight from, than the list of ratios•As before, we have not used any new data here, merely looked at the existing data in a particular way

EXHIBITS

2009 2010 2009 20101 2 3 4 5

I. Depositsa) Up to 1 year 46.6 48.9 52.5 47.7b) Over 1 year andup to 3 years 27.1 27.5 36.1 38.4c) Over 3 years 26.2 23.6 11.4 13.9II. Borrowingsa) Up to 1 year 44.9 42 32.4 34.7b) Over 1 year andup to 3 years 18.8 11 22.2 23.9c) Over 3 years 36.3 46.9 45.4 41.4III. Loans and Advancesa) Up to 1 year 38.8 38 34.2 37.1b) Over 1 year andup to 3 years 33.4 33.8 35.5 34.2c) Over 3 years 27.8 28.2 30.2 28.7IV. Investmentsa) Up to 1 year 22.8 18.1 44.1 38.1b) Over 1 year andup to 3 years 14.5 12.3 20.7 21.6c) Over 3 years 62.7 69.5 35.1 40.2

sector banks sector banksPublic Private

Bank group/year Cost of Cost of Cost of Return on Return on Return on SpreadDeposits Borrowings Funds Advances Investments Funds

1 2 3 4 5 6 7 8=(7-4)1 Public sector banks2008-09 6.26 3.04 6.04 10.08 6.95 9.11 3.072009-10 5.68 1.37 5.34 9.1 6.72 8.36 3.022 Private sector banks2008-09 6.6 3.56 6.18 11.41 6.93 9.85 3.672009-10 5.36 1.95 4.83 9.89 6.25 8.6 3.77

Table : Cost of Funds and Returns on Funds - Bank Group-wise

Note : 1) Cost of Deposits = Interest Paid on Deposits/Average of current and previous year’s deposits.2) Cost of Borrowings = Interest Paid on Borrowings/Average of current and previous year’s borrowings.3) Cost of Funds = (Interest Paid on Deposits + Interest Paid on Borrowings)/(Average of current and previous year’s deposits plusborrowings).4) Return on Advances = Interest Earned on Advances /Average of current and previous year’s advances.5) Return on Investments = Interest Earned on Investments /Average of current and previous year’s investments.6) Return on Funds = (Interest Earned on Advances + Interest Earned on Investments)/(Average of current and previous year’s advancesplus investments).7) *- Includes IDBI Bank Ltd.Source: Calculated from balance sheets of respective banks.

Public Privatesector sectorbanks banks

1 2 3Gross NPAsClosing balance for 2008-09 44,957 16,926Opening balance for 2009-10 44,957 16,889Addition during 2009-10 29,701 2,833Recovered during 2009-10 18,966 1,686Written off during 2009-10 2,902 4,402Closing balance for 2009-10 59,926 17,639Gross NPAs as per centof Gross Advances2008-09 1.97 2.892009-10 2.19 2.74Net NPAsClosing balance for 2008-09 21,155 7,412Closing balance for 2009-10 29,644 6,506Net NPAs as per cent of Net Advances2008-09 0.94 1.292009-10 1.1 1.03

Table 3 : Trends in Non-performing Assets - Bank Group-wise

Item

Bank group Year

Amount Per cent* Amount Per cent* Amount Per cent* Amount Per cent*1 2 3 4 5 6 7 8 9 10

1 Public sector banks 2009 22,37,556 97.99 20,603 0.9 21,019 0.92 4,296 0.192010 26,73,534 97.81 28,791 1.05 25,383 0.93 5,750 0.21

2 Private sector banks 2009 5,68,093 97.1 10,592 1.81 5,035 0.86 1,345 0.232010 6,26,472 97.27 8,842 1.37 6,590 1.02 2,166 0.34

Table 4 : Classification of Loan Assets - Bank Group-wiseStandard Sub-standard Doubtful Loss

assets assets assets assets

2009 2010 2009 2010(5) (6) (7) (8)

Number of reporting banks 27 27 15 15 I.Interest Earned 273088 306488 18790 20565 a) Interest/discount on advances/bills 204457 225693 14194 15472 b) Income on Investments 62993 74562 4152 4818 c) Interest on balances with RBI and other inter-Bank Funds 4002 3909 388 211

d) Others 1636 2324 56 64 II.Other Income 42466 48388 2782 3084 a) Commission, exchange and brokerage 18440 22313 977 1066 b) Net Profit(loss) on sale and revaluation of investment 11002 11276 660 743 c) Net Profit(loss) on sale of land,building and other Assets 89 -9 11 2 d) Net profit(loss) on exchange transactions 4312 4403 309 274 e) Miscellaneous income 8624 10405 824 999Total(I+II) 315554 354876 21572 23649 III. Interest expended 193447 211940 12834 14076 a) Interest on deposits 174313 193141 12277 13464 b) Interest on RBI/inter-bank borrowings 6312 3906 214 138 c) Others 12822 14894 342 474 IV. Operating expenses 55504 65991 3939 4715 a) Payments to and provisions for employees 34564 41032 2225 2737 b) Rent, taxes and lighting 4444 5200 361 424 c) Printing and stationery 688 722 50 57 d) Advertisement and publicity 775 699 53 61 e) Depreciation on bank's property 2825 3193 243 269 f) Directors' fees, allowances and expenses 19 19 6 6 g) Auditors' fees and expenses 484 540 20 23 h) Law charges 238 288 17 18 i) Postage, telegrams, telephones, etc. 826 1007 90 102 j) Repairs and maintenance 948 1215 104 111 k) Insurance 2444 3052 170 199 l) Other expenditure 7250 9025 603 709 V.Net Interest Income(I-III) 79642 94548 5956 6489 VI. Provisions and contingencies 32231 37688 2390 2545 VII. Operating Profit(I+II-III-IV) 66604 76945 4799 4858 VIII. Profit (loss) during the year 34373 39257 2409 2312

For the year ended March 31( Amount in ̀crore )

TABLE 5: BANK GROUP-WISE EARNINGS AND EXPENSES OF SCHEDULED COMMERCIAL BANKSIN INDIA - 2008-09 AND 2009-10

Items Public Sector

Banks Private Sector

Banks

Technical Efficiency of BanksBank code Public Sector Banks TEB1 State Bank of India 0.892B2 State Bank of Bikaner and Jaipur 1B3 State Bank of Hyderabad 0.924B4 State Bank of Indore 0.881B5 State Bank of Mysore 0.948B6 State Bank of Patiala 0.935B7 State Bank of Saurashtra 0.54B8 State Bank of Travancore 0.902B9 Allahabad Bank 0.561B10 Andhra Bank 1B11 Bank of Baroda 0.69B12 Bank of India 0.838B13 Bank of Maharashtra 0.732B14 Canara Bank 0.536B15 Central Bank of India 0.6B16 Corporation Bank 0.988B17 Dena Bank 0.638B18 Indian Bank 0.791B19 Indian Overseas Bank 0.819B20 Oriental Bank of Commerce 0.874B21 Punjab & Sind Bank 0.759B22 Punjab National Bank 0.818B23 Sydicate Bank 0.591B24 UCO Bank 0.505B25 Union Bank of India 0.692B26 United Bank of India 0.601B27 Vijaya Bank 0.849B28 IDBI Bank 0.772

Bank code Private banks TEB29 Bank of Rajasthan 0.77B30 Development Credit Bank 0.895B31 ING Vysya Bank 0.639B32 Karnataka Bank 0.801B33 Nainital Bank 1B34 SBI Commercial & Int. Bank 0.653B35 Tamilnad Mercantile Bank 1B36 Bank of Rajasthan 0.567B37 Catholic Syrian Bank 0.672B38 Dhanalakshmi Bank 0.6B39 Federal Bank 0.873B40 Jammu & Kashmir Bank 0.797B41 Karur Vysya Bank 0.741B42 Lakshmi Vilas Bank 0.625B43 Ratnakar Bank 0.81B44 South Indian Bank 0.706B45 Centurion Bank of Punjab 1B46 HDFC Bank 1B47 ICICI Bank 1B48 IndusInd Bank 0.632B49 Kotak Mahindra Bank 1B50 UTI Bank 0.936B51 Yes Bank 1

Conclusion• Technical efficiency of Indian Banks are low (64% on average) .

• We speculate the reasons for low technical efficiency to be insufficient deposit base for

newer banks and too many social purposes of the government

• 1991-92 reforms included deregulatory policies and improved technical efficiency of banks

• Post 1997 banks lost efficiency due to more emphasis on stability

• Time lag in implementation of Government Policies and slow adjustment towards changing

environment are possible reasons for later improvement in efficiency.

• Financial reforms varied impact on the efficiency of the banking sector.

• Banking sector continues to show a high degree of inefficiency in the post-reform period.

Reasons for differences • Public banks cater mostly to government borrowing programs and hence obtaining

“significant fee based income from this source”

• Govt. Support, Public confidence in respect to safety of deposits

• Use of best operating practices among the efficient banks

• Difference in amount of waste of resources

• A weak ownership effect on the performance of banks exist in the Indian domestic banking

industry.

• Change in the orientation of PSB’s from social objectives towards profitability.

• PSB enjoy first mover advantage

DEA- Pros & Cons

• Advantages of DEA capable of handling multiple inputs and outputs capable of being used with any input-output measurement the sources of inefficiency can be analyzed and quantified for every evaluated unit

• Limitations of DEA If assumptions are weak, results can be inaccurate. Always gives relative measurement and not absolute. Results are sensitive to the selection of inputs and outputs

References• http://mpra.ub.uni-muenchen.de/39299/1/MPRA_paper_39299.pdf

• http://www.igidr.ac.in/money/Evaluation%20of%20technical,%20pure%20technical%20and

%20scale%20efficiencies%20of%20Indian%20Banks.pdf

• http://vu.academia.edu/AminathShiuny/Papers/578978/

Efficiency_of_Indian_commercial_banks_during_the_reform_period

• http://rbidocs.rbi.org.in/rdocs/Content/PDFs/A1_V32070212.pdf