Efficiency Evaluation of Banking Sector in India Based on Data Envelopment Analysis

Abstract

Banks deal with people’s most liquid asset (cash), and run a country’s economy.  The banking system in India is significantly different from that of other nations because of the country’s unique economic, social and geographic characteristics. India has a large population and land size, a diverse culture, and extreme disparities in income, which are marked among its regions. There are high levels of illiteracy among a large percentage of its population but, at the same time, the country has a large reservoir of managerial and technologically advanced talents. Between about 30 and 35 percent of the population resides in metro and urban cities and the rest is spread in several semi-urban and rural centers. The country’s economic policy framework combines socialistic and capitalistic features with a heavy bias towards public sector investment. However, the last couple of decades have witnessed continuous change in regulation, technology and competition in the global financial services industry. Rising cost-income ratios and declining profitability reflect increased competitive pressure. To assess the stability of the banking system, it is therefore crucial to benchmark the performance of banks operating in India. An efficient banking system contributes in an extensive way to higher economic growth in any country. Thus, studies of banking efficiency are very important for policy makers, industry leaders and many others who are reliant on the banking sector. This paper investigates the technical efficiency of major representatives of Indian commercial banks. For this purpose, the data envelopment analysis (DEA) model was used with four input variables (viz. Deposits, Interest expenses, Operating expenses, Assets) and four output variables advances & loans, investments, net interest income, and non-interest income. DEA is a nonparametric method of measuring the efficiency of a Decision Making Unit (DMU) such as a firm, a public sector unit (Bank in this case), first introduced in the operations research by Charnes, Cooper and Rhodes (CCR) (European Journal of Operational Research [EJOR], 1978). DEA is a technique of determining efficiency of DMU’s based on multiple inputs and multiple outputs.