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 100(6.94/6.94) = 100% 100(2.75/6.94) = 40% 100(4.71/6.94) = 68% 100(2.09/6.94) = 30%

Croydon Dorking Redhill Reigate

 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 xaxis. 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 Analysis
Quantifying 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
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.

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) = 1.33 personal transactions per staff member:business transactions per staff member = (2.56/1.33) = 1.92

Graphical Analysis
In 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 2.78 Dorking 2.75 1.25 Redhill 4.71 3.24 Reigate 2.09 1.09 A 1.23 2.92 B 4.43 2.23 C 3.32 2.81 D 3.70 2.68 E 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
1 I. Deposits a) Up to 1 year b) Over 1 year and up to 3 years c) Over 3 years II. Borrowings a) Up to 1 year b) Over 1 year and up to 3 years c) Over 3 years III. Loans and Advances a) Up to 1 year b) Over 1 year and up to 3 years c) Over 3 years IV. Investments a) Up to 1 year b) Over 1 year and up to 3 years c) Over 3 years Public sector banks 2009 2010 2 3 46.6 27.1 26.2 44.9 18.8 36.3 38.8 33.4 27.8 22.8 14.5 62.7 48.9 27.5 23.6 42 11 46.9 38 33.8 28.2 18.1 12.3 69.5 Private sector banks 2009 2010 4 5 52.5 36.1 11.4 32.4 22.2 45.4 34.2 35.5 30.2 44.1 20.7 35.1 47.7 38.4 13.9 34.7 23.9 41.4 37.1 34.2 28.7 38.1 21.6 40.2

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

Bank group/year

Cost of Deposits

Cost of Borrowings

Cost of Funds

Return on Advances

Return on Investments

Return on Funds

Spread 7 8=(7-4)

1 2 3 4 5 6 1 Public sector banks 2008-09 6.26 3.04 6.04 10.08 6.95 2009-10 5.68 1.37 5.34 9.1 6.72 2 Private sector banks 2008-09 6.6 3.56 6.18 11.41 6.93 2009-10 Cost of Deposits = Interest Paid on Deposits/Average of current and9.89 5.36 1.95 4.83 Note : 1) previous years6.25 deposits.

9.11 8.36 9.85 8.6

3.07 3.02 3.67 3.77

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

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

Item 1 Gross NPAs Closing balance for 2008-09 Opening balance for 2009-10 Addition during 2009-10 Recovered during 2009-10 Written off during 2009-10 Closing balance for 2009-10 Gross NPAs as per cent of Gross Advances 2008-09 2009-10 Net NPAs Closing balance for 2008-09 Closing balance for 2009-10 Net NPAs as per cent of Net Advances 2008-09 2009-10

Public sector banks 2 44,957 44,957 29,701 18,966 2,902 59,926

Private sector banks 3 16,926 16,889 2,833 1,686 4,402 17,639

1.97 2.19 21,155 29,644 0.94 1.1

2.89 2.74 7,412 6,506 1.29 1.03

Table 4 : Classification of Loan Assets - Bank Group-wise

Bank group

Year

1 1 Public sector banks 2 Private sector banks

2 2009 2010 2009 2010

Standard Sub-standard Doubtful Loss assets assets assets assets Amount Per cent* Amount Per cent* Amount Per cent* Amount Per cent* 3 4 5 6 7 8 9 10 22,37,556 97.99 20,603 0.9 21,019 0.92 4,296 0.19 26,73,534 97.81 28,791 1.05 25,383 0.93 5,750 0.21 5,68,093 97.1 10,592 1.81 5,035 0.86 1,345 0.23 6,26,472 97.27 8,842 1.37 6,590 1.02 2,166 0.34

TABLE 5: BANK GROUP-WISE EARNINGS AND EXPENSES OF SCHEDULED COMMERCIAL BANKS IN INDIA - 2008-09 AND 2009-10 ( Amount in ` crore ) Items For the year ended March 31 Public Sector Private Sector Banks Banks 2009 (5) Number of reporting banks I.Interest Earned a) Interest/discount on advances/bills b) Income on Investments c) Interest on balances with RBI and other inter-Bank Funds d) Others II.Other Income a) Commission, exchange and brokerage b) Net Profit(loss) on sale and revaluation of investment c) Net Profit(loss) on sale of land,building and other Assets d) Net profit(loss) on exchange transactions e) Miscellaneous income Total(I+II) III. Interest expended a) Interest on deposits b) Interest on RBI/inter-bank borrowings c) Others IV. Operating expenses a) Payments to and provisions for employees b) Rent, taxes and lighting c) Printing and stationery d) Advertisement and publicity e) Depreciation on bank's property f) Directors' fees, allowances and expenses g) Auditors' fees and expenses h) Law charges i) Postage, telegrams, telephones, etc. j) Repairs and maintenance k) Insurance l) Other expenditure V.Net Interest Income(I-III) VI. Provisions and contingencies VII. Operating Profit(I+II-III-IV) VIII. Profit (loss) during the year 27 273088 204457 62993 4002 1636 42466 18440 11002 89 4312 8624 315554 193447 174313 6312 12822 55504 34564 4444 688 775 2825 19 484 238 826 948 2444 7250 79642 32231 66604 34373 2010 (6) 27 306488 225693 74562 3909 2324 48388 22313 11276 -9 4403 10405 354876 211940 193141 3906 14894 65991 41032 5200 722 699 3193 19 540 288 1007 1215 3052 9025 94548 37688 76945 39257 2009 (7) 15 18790 14194 4152 388 56 2782 977 660 11 309 824 21572 12834 12277 214 342 3939 2225 361 50 53 243 6 20 17 90 104 170 603 5956 2390 4799 2409 2010 (8) 15 20565 15472 4818 211 64 3084 1066 743 2 274 999 23649 14076 13464 138 474 4715 2737 424 57 61 269 6 23 18 102 111 199 709 6489 2545 4858 2312

Technical Efficiency of Banks

Bank code B1 B2 B3 B4 B5 B6 B7 B8 B9 B10 B11 B12 B13 B14 B15 B16 B17 B18 B19 B20 B21 B22 B23 B24 B25 B26 B27 B28 Public Sector Banks State Bank of India State Bank of Bikaner and Jaipur State Bank of Hyderabad State Bank of Indore
State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Allahabad Bank Andhra Bank Bank of Baroda Bank of India

Bank of Maharashtra
Canara Bank

Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab & Sind Bank Punjab National Bank Sydicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank IDBI Bank

TE 0.892 1 0.924 0.881 0.948 0.935 0.54 0.902 0.561 1 0.69 0.838 0.732 0.536 0.6 0.988 0.638 0.791 0.819 0.874 0.759 0.818 0.591 0.505 0.692 0.601 0.849 0.772

Bank code B29 B30 B31 B32 B33 B34 B35 B36 B37 B38 B39 B40 B41 B42 B43 B44 B45 B46 B47 B48 B49 B50 B51

Private banks Bank of Rajasthan Development Credit Bank ING Vysya Bank Karnataka Bank Nainital Bank SBI Commercial & Int. Bank Tamilnad Mercantile Bank Bank of Rajasthan Catholic Syrian Bank Dhanalakshmi Bank Federal Bank Jammu & Kashmir Bank Karur Vysya Bank Lakshmi Vilas Bank Ratnakar Bank South Indian Bank Centurion Bank of Punjab HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank UTI Bank Yes Bank

TE 0.77 0.895 0.639 0.801 1 0.653 1 0.567 0.672 0.6 0.873 0.797 0.741 0.625 0.81 0.706 1 1 1 0.632 1 0.936 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 PSBs 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%20sca

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

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

uring_the_reform_period

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