OPERATIONAL EFFICIENCY IN THE PRESENCE OF UNDESIRABLE BYPRODUCTS: AN ANALYSIS OF INDIAN BANKING SECTOR UNDER TRADITIONAL AND MARKET-BASED BANKING FRAMEWORK

Paper Number :WP24/2023
Publication Date :May 24, 2023

In the backdrop of an increase in market-based banking activities, we study the operational efficiency of the Indian banking sector during 2009-10 through 2017-18 considering Market Return as desirable outputs, in addition to Advances and Slippage as undesirable byproducts simultaneously. Using data envelopment analysis (DEA) method, we estimate six alternatives but interlinked operational efficiency scores (TES) of the Indian domestic commercial banks. In the second stage, we explain such TES in terms of bank-specific factors, banking industry competition scenario, and interest rate channel. We observe that the private sector banks as a group outperform those under public ownership. Moreover, although the private sector banks could maintain somewhat consistency in their operational efficiency performance over the sample period, public sector banks clearly show a declining tendency. Our second stage econometric estimation results show that the priority sector lending has a negative effect on TES. Interestingly, we get varying results for the relationship between maturity and TES depending on banks’ strategies on stressed assets management. Furthermore, our analyses result that banks are not so efficient in managing relatively larger-volume loans. While we find banks’ TES positively depends on the Credit-to-Deposit (CD) ratio, the overall operational efficiency of the banks to manage their credit risk portfolio improves with a reduction in the lending rate (LR). However, the interaction of lending activities and capital market shows that, with the increase in LR, corporate borrowers may switch to capital market to explore for desired funds, which may induce the banking sector to investment in capital markets and create a positive market sentiment.