Efficiency

International Journal of Productivity and Performance Management
Evaluation of technical efficiency and ranking of public sector banks in India: An

analysis from cross-sectional perspective
Sunil Kumar Rachita Gulati
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IJPPM
57,7
Evaluation of technical efficiency

and ranking of public sector
banks in India
540
An analysis from cross-sectional perspective
Received October 2007

Revised March 2008
Accepted March 2008
Sunil Kumar and Rachita Gulati

Punjab School of Economics, Guru Nanak Dev University, Amritsar, India
Abstract
Purpose The purpose of this paper is to evaluate the extent of technical efficiency in 27 public
sector banks operating in India and to provide strict ranking to these banks.
Design/methodology/approach Two popular data envelopment analysis (DEA) models, namely,
CCR model and Andersen and Petersens super-efficiency model, were utilized. The cross-section data
for the financial year 2004/2005 were used for obtaining technical efficiency scores.
Findings The results show that only seven of the 27 banks are found to be efficient and thus,
defined the efficient frontier; and technical efficiency scores range from 0.632 to 1, with an average of
0.885. Thus, Indian public sector banks, on an average, waste the inputs to the tune of 11.5 percent.
Andhra Bank has been observed to be the most efficient bank followed closely by Corporation Bank.
Further, the banks affiliated with SBI group turned out to be more efficient than the nationalized
banks. The regression results incisively indicate that the exposure to off-balance sheet activities, staff
productivity, market share and size are the major determinants of the technical efficiency.
Practical implications The practical implication of the research findings is that apart from the
proportional reduction of all inputs equivalent to the amount of technical inefficiency, most of the
inefficient public sector banks need to reduce the use of the physical capital and augment non-interest
income to project themselves on the efficient frontier.
Originality/value This paper is the first to provide a strict ranking of Indian public sector banks
on the basis of super-efficiency scores.
Keywords Process efficiency, Banks, India, Public sector organizations, Performance measures
Paper type Research paper
International Journal of Productivity

and Performance Management
Vol. 57 No. 7, 2008
pp. 540-568
q Emerald Group Publishing Limited
1741-0401
DOI 10.1108/17410400810904029
Introduction
With the advent of banking reforms in 1992, Indian banks, especially public sector
banks (PSBs), have been gradually exposed to the rigorous domestic and international
competition. Owing to the entry of de nova domestic private and foreign banks, Indian
banking sector underwent drastic changes in terms of competitive landscape and
banking practices. The declining trends in Herfindahls Concentration Index, Top
5-banks Concentration Ratio and net-interest margin (i.e. interest spread) during the
post-reforms period bear testimony of the fact that over the years, competition in the
Indian banking sector has increased substantially (Barman, 2007). Consequently, the
The authors would like to thank the anonymous referees of the journal for providing extremely
constructive comments to improve the contents and quality of the paper. Nevertheless, all
mistakes, errors or omissions remain the authors responsibility.
share of PSBs in total assets of Indian banking industry has constantly declined
(Mohan, 2005). In the existing competitive environment, the issue of the resource use
efficiency of Indian banks particularly of the PSBs has become critical because only the
efficient banks can withstand the forces of competition and achieve sustainable growth
along with maintaining their market share.
Against this backdrop, it seems pertinent to appraise the technical efficiency (TE) of
PSBs in the production process[1]. The present study is an attempt in this direction.
This study has been conducted with the purpose of evaluating technical efficiency and
ranking the PSBs using the cross-sectional data. This has been accomplished through
the execution of two most popular DEA models, namely, CCR model and Andersen and
Petersens super-efficiency model[2]. Using linear programming technique, DEA
enables one to derive a single measure of technical efficiency that encompasses all
incommensurable inputs and outputs. Besides this, DEA provides benchmarks and
targets for the performance improvement.
The choice of DEA in the present context is driven by its intrinsic advantages over
other techniques for measuring the relative efficiency of banks[3]. First, DEA is a
non-parametric frontier approach and does not require rigid assumptions regarding
production technology or efficiency distribution. Second, DEA is particularly amenable
for small sample studies (like ours) where banks tend to produce reasonably
comparable types of outputs. Third, as a non-parametric frontier technique, DEA
identifies the inefficiency in a particular bank by comparing it to similar banks
regarded as efficient, rather than trying to associate a banks performance with
statistical averages that may not be applicable to that bank (Avkiran, 2006). Fourth,
DEA is one of the most popular approaches to measure the relative efficiency of banks.
This is well reflected by the fact that of the 122 studies reviewed in the extensive
survey carried out by Berger and Humphrey (1997) on the efficiency of depository
financial institutions, 62 studies (i.e. over 50 percent) employed DEA to examine the
efficiency of banking sector.
Nevertheless, DEA also suffers from some limitations. First, the efficiency estimates
by this technique are believed to be sensitive to measurement errors or other noise in
the data (Sharma et al., 1999). Second, because of inherent dimensionality constraint,
the efficiency measures obtained from DEA may also be sensitive to alteration in
sample size as well as the number of input and output variables. While addressing the
limitations of DEA especially pertaining to the measurement error and statistical noise,
Yildirim (2002) pointed out that in a DEA analysis, it is necessary to check the
sensitivity of the results obtained to different definitions of inputs and outputs, and to
the elimination of outliers. In the present study, we paid adequate attention to address
aforementioned limitations of DEA. The appropriateness of selected input and output
variables in terms of discriminatory power of the model has been checked on the basis
of a sensitivity analysis. Further, for addressing the issue of measurement error, we
scrutinized the data for outliers and errors in data entry before running DEA. In
particular, we followed Avkiran (2006) to detect outliers in the sample on the basis of
super-efficiency scores in the pre-DEA run. A post-DEA sensitivity analysis, which is
popularly known as Jack-knifing, has also been carried out to analyze the stability of
the reference set. The stability of the reference set indicates the overall robustness of
the results and it is said to occur if the efficient units identified by a particular DEA
Public sector
banks in India
541
IJPPM
57,7
542
run, get a place in the different reference sets that are observed by implementing the
same DEA model to different permutations on the sample.
The present study makes two notable contributions to the existing literature on
banking efficiency in India. To the best of our knowledge, none of the published studies
on the efficiency of Indian banking sector have carried out a sensitivity analysis to
check the appropriateness of selected input and output variables. As noted above, the
present study made an effort in this direction. Further, the literature on the efficiency of
Indian banking sector has focused either on the efficiency differences across different
groups defined on the basis of ownership or the analysis of the impact of banking
reforms on the efficiency of Indian banking sector or both. Also, these studies reported
only the efficiency scores and did not specify any non-zero input and output slacks for
the potential efficiency improvement at the level of individual banks. In the present
study, a slack analysis for inefficient banks has also been conducted to work out the
potential efficiency improvement in these banks. The strict ranking of banks and the
factors explaining the efficiency differences among banks are the other areas in the
empirical research on the efficiency of Indian banking industry where a scant attention
has been paid. Our study also focuses on these neglected research areas.
To sum up, the aim of this paper is three-fold:
(1) to obtain a measure of technical (in)efficiency for individual public sector banks;
(2) to rank the public sector banks on the basis of super-efficiency scores; and
(3) to explain the factors determining the technical efficiency of Indian public
sector banking industry.
The remainder of the paper is organized in the following ways. The next section briefly
discusses the structure of Indian banking industry. The following section reviews the
literature on the efficiency of Indian banking sector. The subsequent section describes
the DEA models used in the present study. The description of the data and the
specification of input and output variables are reported in the succeeding section. Also,
a sensitivity analysis to check the appropriateness of the chosen input and output
variables is presented in this section. The penultimate section presents the empirical
results. The final section outlines the most relevant conclusions along with the scope
for future research.
The structure of Indian banking sector
The Reserve Bank of India (RBI) is the central bank of the country, regulating the
operations of other banks, managing money supply, and discharging other myriad
responsibilities that are usually associated with a central bank. The banking system in
India comprises commercial and cooperative banks, of which the former accounts for
more than 90 percent of the total assets of banking system. Within the category of
commercial banks, there are two types of the banks:
(1) schedule commercial banks (i.e. which are listed in Schedule II of the Reserve
Bank of India Act, 1934); and
(2) non-scheduled commercial banks.
Depending on the pattern of ownership, scheduled commercial banks could also be
classified into three types:
(1) Public sector banks (PSBs) which include the State Bank of India (SBI) (majority
equity holding being with the RBI) and the associate banks of SBI (majority
holding being with SBI) and Nationalized banks (majority equity holding is
with the Government of India);
(2) Private sector banks consisting Indian private sector banks (which are further
bifurcated into old private banks i.e. the banks existing prior to 1992, and
new private banks i.e. the banks established after 1992), and foreign banks;
and
(3) Regional rural banks. The Local Area Banks fall in the category of
non-scheduled commercial banks and have a very small base of assets,
deposits and advances.
In India, PSBs have a country-wide network of branches and account for over 75
percent of total banking business. The contribution of PSBs in Indias economic and
social development is enormous and well documented. They have strong presence at
rural and semi-urban areas and employ a large number of staff. On the other hand, de
nova private sector banks are less labour-intensive, have limited number of branches,
have adopted modern technology, and are more profitable. Though foreign banks are
equipped with better technology, and risk management skills but they confine their
operations in major urban centres. The regional rural banks serve the needs for rural
credit and have a diminutive share (about 3 percent) in the commercial banking
industry of India. Table I provides summary details of different types of commercial
banks (excluding regional rural banks) as on the end March, 2005. It has been observed
that the market share of PSBs in terms of investments, advances, deposits and total
assets is over 70 percent. About 88 percent of branches of the commercial banks in
India belong to PSBs. Further, their share in the total employment provided by
commercial banking industry is about 87 percent. In brief, PSBs command a lions
share of Indian banking industry.
In the post-reforms years, the PSBs got fierce competition, particularly in urban
centres, from private banks especially from de nova domestic private banks that were
better equipped with banking technology and practices. Consequently, the market
share of PSBs in terms of investments, advances, deposits and total assets has declined
constantly since 1992/1993 (see Table II). It is evident from the table that the PSBs are
still dominating players in the Indian banking sector, albeit their market share has
dipped in the deregulatory regime. The growth of PSBs is still high on the agenda of
the policy makers because of their gargantuan role as an effective catalytic agent of
socio-economic change in the country. During the last 15 years, the policy makers
adopted a cautious approach for introducing reform measures in the Indian banking
sector on the basis of the recommendations of Narasimham Committee I (1991),
Narasimham Committee II (1998), and Verma Committee (1999). The principle
objective of the reforms process was to improve the efficiency of PSBs in their
operations and to inculcate competitive spirit in them. Against this background, we
confined our analysis to public sector banks which constitute most significant segment
of Indian banking sector.
Public sector
banks in India
543
Table I.
Structure of commercial
banking in India (as on
March 2005)
31
60
88
III. Foreign banks in India

Market share (%)
IV. Total Indian private and foreign banks(II III)

Market share (%)
V. Total commercial banks (I IV)

Market share (%)
55,537
100.0
6,566
11.8
245
0.4
6,321
11.4
48,971
88.2
13,896
25.0
35,075
63.2
857,714
100.0
109,004
12.7
16,386
1.9
92,618
10.8
748,710
87.3
278,269
32.4
470,441
54.8
Number
Branches
Staff
Source: Authors calculations from statistical tables relating to banks in India (2004/2005)
Notes: Excludes regional rural banks; 1 Crore 10 Millions
29
20
28
II. Indian private sector Banks

Market share (%)
I. Public sector banks (a b)

Market Share (%)
a. State Bank of India Group
Market Share (%)
b. Nationalized Banks and IDBI Ltd.
Market share (%)
No. of banks
867,215
100.0
181,486
20.9
42,518
4.9
138,968
16.0
685,729
79.1
260,704
30.1
425,025
49.0
Investments
1,150,326
100.0
295,655
25.7
75,318
6.5
220,337
19.2
854,671
74.3
284,727
24.8
569,944
49.5
1,835,002
100.0
399,150
21.8
86,505
4.7
312,645
17.0
1,435,852
78.2
505,649
27.6
930,203
50.7
Rupees in Crores
Advances
Deposits
544
Bank group
2,353,869
100.0
579,930
24.6
154,128
6.5
425,802
18.1
1,773,939
75.4
627,075
26.6
1,146,864
48.7
Total assets
IJPPM
57,7
Year
1992/1993
1993/1994
1994/1995
1995/1996
1996/1997
1997/1998
1998/1999
1999/2000
2000/2001
2001/2002
2002/2003
2003/2004
2004/2005
Deposits
87.9
86.8
85.9
85.4
83.6
82.6
82.6
81.9
81.4
80.5
79.6
77.9
78.2
Market share (%)

Investments
Advances
85.9
86.3
87.0
87.6
85.3
83.5
81.5
80.6
80.1
77.2
78.7
78.0
79.1
89.3
87.3
85.1
82.2
79.9
80.1
80.5
79.4
78.9
74.4
74.3
73.2
74.3
Total sssets
87.2
87.1
85.2
84.4
82.7
81.6
81.0
80.2
79.5
75.3
75.7
74.5
75.4
Source: Authors calculations from statistical tables relating to banks in India (various issues)
Banking efficiency in India: a brief review of literature

In their extensive international literature survey, Berger and Humphrey (1997) pointed
out that, out of 130 efficiency analyses of financial institutions covering 21 countries,
only about 5 percent examined the banking sectors of developing countries. They also
noted that a vast majority (about 75 percent) of the efficiency literature focused on the
banking markets of well-developed countries with particular emphasis on the US
market. The relatively scant literature on the banking efficiency in emerging markets
like India, focuses mainly on the efficiency differentials among banks with different
ownership status and asset size. In India, the research on banking efficiency is still in
its infancy.
Bhattacharyya et al. (1997) examined the impact of partial liberalization during
mid-1980s on the productive efficiency of different categories of banks using DEA.
Their study covered 70 commercial banks in the period 1986-1991. They found that
PSBs had the highest efficiency followed by foreign banks. The private banks were
found to be least efficient. Also, they found a temporal improvement in the
performance of foreign banks; virtually no trend in the performance of private banks;
and a temporal decline in the performance of public sector banks.
Das (1997) utilized non-parametric frontier methodology to derive efficiency
measures for 65 major banks using the cross-section data for the year 1995. The results
indicate that Indian banks, in general, were more technically efficient than allocatively
efficient. In addition, most of the observed technical inefficiency was not scale related.
The study also found no significant differences in any of the efficiency measures
between public and private sector banks. Except scale efficiency, foreign banks
differed significantly from public and private sector banks.
Das (2000) analyzed the technical and allocative efficiency of 27 PSBs using the
cross-section data for the year 1998. It has been found that PSBs had the scope of
producing 1.23 times as much output from the same inputs. The results further indicate
that banks belonging to State Bank of India group are, in general, more efficient than
the nationalized banks. Furthermore, the inefficiency that existed in PSBs was more a
Public sector
banks in India
545
Table II.
Market share of public
sector banks: 1992/1993
to 2004/2005
IJPPM
57,7
546
result of both technical and allocative inefficiency. The study provided a negative
relationship between non-performing assets and efficiency, and size and efficiency.
Saha and Ravisankar (2000) provided a rating of 25 PSBs using DEA. Their study
was confined to the period from 1991/1992 to 1994/1995. It has been observed that
barring few exceptions, the PSBs have in general improved their efficiency scores over
the study period. United Bank of India, UCO Bank, Syndicate Bank and Central Bank
of India were found to be at lower end of the relative efficiency scale. Also, Corporation
Bank, Oriental Bank of Commerce, State Bank of India, Canara Bank, State Bank of
Hyderabad, Bank of Baroda and Dena Bank were found to be consistently efficient
banks.
Mukherjee et al. (2002) made an attempt to explore technical efficiency and
benchmark the performance of 68 commercial banks using DEA. For this, they utilized
the data for the period 1996-1999. It has been observed that in India, PSBs are more
efficient than both private and foreign banks. Also, the performance of PSBs improved
over the study period. Besides this, publicly owned banks were rated uniformly in
terms of self-appraisal as well as peer-group appraisal.
Sathye (2003) examined the technical efficiency of Indian banking sector using the
cross-section data for the year 1997/1998. The technique of DEA has been applied for
obtaining efficiency scores for 94 banks. Two models have been constructed to show
how efficiency scores vary with change in the inputs and outputs. The study showed
that the mean efficiency score of Indian banks compares well with the world mean
efficiency score and the efficiency of private sector commercial banks as a group was,
paradoxically lower than that of PSBs and foreign banks. The study recommends that
the existing policy of reducing non-performing assets and rationalization of staff and
branches may be continued to obtain efficiency gains and make the Indian banks
internationally competitive.
Ram Mohan and Ray (2004) made a comparison of technical, allocative and revenue
maximization efficiency among public, private and foreign banks. A balanced panel
data set for 58 banks has been utilized for computing DEA based efficiency scores.
Their study covered the period 1992-2000. They found that PSBs performed
significantly better than private sector banks but not differently from foreign banks on
the revenue maximization measure. Further, the superior performance of PSBs is to be
ascribed to higher technical efficiency rather than higher allocative efficiency. It has
also been noted that State Bank of India turned out to be efficient on all counts.
Chakrabarti and Chawla (2005) applied DEA to evaluate the relative efficiency of
Indian banks during the period 1990-2002. They utilized two models to specify
input-output vectors and labeled those models as quantity and value approaches.
The results of the study suggested that on the value basis, the foreign banks, as a
group, have been considerably more efficient than all other bank groups, followed by
the Indian private banks. However, from the quantity perspective, the Indian private
banks seem to be doing the best while the foreign banks are the worst performers. The
authors attributed this to the general policy of foreign banks to cherry-pick more
profitable businesses rather than offering banking services to a wider section. Further,
PSBs have, in comparison, lagged behind their private counterparts in terms of
performance.
The survey of literature provides that owing to the differences in sample size,
specification of input and output variables and the period of study, there has been a
striking contrast among the findings of the different studies. It is worth noting here
that the studies (like that of Bhattacharyya et al., 1997; Mukherjee et al., 2002; and
Chakrabarti and Chawla, 2005) which included deposits as one of the outputs reported
higher efficiency of public sector banks than that of domestic private and foreign
banks. Further, all the above-reviewed studies that concentrated on the efficiency
differences between domestic and foreign banks suffer from a major methodological
flaw. To arrive at the estimates of efficiency, these studies pool the data under the
assumption that both domestic and foreign banks share a common technology and
have identical frontiers. Since the domestic and foreign banks in India operate under
different regulatory environments and provide service to different markets, the
assumption of a common frontier is not justified. Therefore, some caution needs to be
exercised when comparing the results of such studies with the present one that
includes homogeneous group of banks operating under same regulatory environment
and have similar managerial objectives.
Methodology
Data envelopment analysis
The DEA is a linear (mathematical) programming based method first originated in the
literature by Charnes et al. (1978) as a reformulation of the Farrells (1957)
single-output, single-input radial measure of technical efficiency to the multiple-output,
multiple-input case. The subsequent technical development of DEA is extensive,
certainly to the point of precluding a survey in this instance. Interested parties are
directed to those provided by Seiford and Thrall (1990), Ali and Seiford (1993), Charnes
et al. (1994), Ray (2004) and Cooper et al. (2007). What follows is a general discussion of
DEA, with primary attention directed to model formulation. DEA calibrates the level of
technical efficiency (TE) on the basis of an estimated discrete piece-wise frontier (or so
called efficient frontier or best-practice frontier or envelopment surface) made up by a
set of Pareto-efficient decision making units (DMUs)[4]. In all instances, these
Pareto-efficient DMUs located on the efficient frontier, compared to the others, use
minimum productive resources given the outputs (input-conserving orientation), or
maximize the output given the inputs size (output-augmenting orientation) and are
called the best-practice performers or reference units or peer units within the sample of
DMUs. These Pareto-efficient DMUs have a benchmark efficiency score of unity that
no individual DMUs score can surpass. In addition, it is not possible for the
Pareto-efficient unit to improve any input or output without worsening some other
input or output. It is significant to note that the efficient frontier provides a yardstick
against which to measure the relative efficiency of all other DMUs that do not lie on the
frontier. The DMUs which do not lie on the efficient frontier are deemed relatively
inefficient (i.e. Pareto non-optimal DMUs) and receives a TE score between 0 and 1.
The efficiency score of each DMU can be interpreted as the radial distance to the
efficient frontier. In short, the DEA forms a non-parametric surface frontier (more
formally a piecewise-linear convex isoquant) over the data points to determine the
efficiency of each DMU relative to this frontier.
A graphical conceptualization of the technique is represented in Figure 1. The
best-practice or efficient frontier is constructed from the most technically efficient
DMUs in the sample. Figure 1 illustrates a two-dimension efficient frontier in input
space (i.e. an isoquant L y) in which all four DMUs (A, B, C and D) produce the same
Public sector
banks in India
547
IJPPM
57,7
548
Figure 1.
Measurement of technical
efficiency and input slack
amount of output y, but with varying amounts of inputs x1 and x2 . The efficient frontier
in input space is defined by DMUs C and D that require minimum inputs to produce the
same level of output. These units are labeled as efficient DMUs and have TE score
equal to 1. On the other hand, DMUs A and B are inefficient because both A and B
requires more of each input to produce the same amount of output. The measures of TE
for DMUs A and B are defined as TE A OA0 =OA and TE B OB0 =OB, respectively.
It is significant to note that both TE A and TE B are less than 1. Further, the inefficient
DMU B can move on to the efficient frontier (and in a way get the status of efficient
DMU in Farrells sense) by a radial (proportion) reduction in inputs by amount BB0 .
Similarly, the required radial (proportion) reduction in inputs for DMU A for getting
the status of efficient DMU in Farrells sense is AA0 . However, despite this radial
reduction in inputs by amount AA0 , the DMU A cannot labeled as a Pareto-efficient
DMU since a further reduction of input x2 is still possible by amount A0 C (an input
slack) with no reduction in output. Besides input-slack, we can also envisage
output-slack in a DEA analysis. The output-slack is defined as the output that is
under-produced (Avkiran, 1999a). For graphical conceptualization of the presence of
output slack, we need to consider an output-oriented framework with two outputs ( y1
and y2) and single input (x) so as to show how the one output can be expanded even
after proportional augmentation (i.e. radial increase) of the both the outputs for
reaching the efficient frontier (that can be shown by a production possibility curve).
Owing to the space considerations, the interested readers are referred to the works of
Coelli et al. (2005) and Jacobs et al. (2006).
Several different mathematical programming DEA models have been proposed in
the literature (see Charnes et al., 1994; and Cooper et al., 2007). Essentially, each of these
models seeks to establish which of n DMUs determine the envelopment surface. The
geometry of this surface is prescribed by the specific DEA model employed. In the
present study, we have utilized the CCR model to reduce the multiple-input,
multiple-output situation for each DMU (i.e. bank in our case) to a scalar measure of
technical efficiency. The results obtained using CCR model groups the DMUs into two
sets: efficient and inefficient. Since our interest lies in a comprehensive ranking beyond
this simple dichotomized classification, we have also utilized super-efficiency DEA
model proposed by Andersen and Petersen (1993).
Public sector
banks in India
CCR model
To illustrate CCR model, consider a set of decision making units (DMUs) j 1; 2; :::; n,
s
utilizing quantities of inputs X [ Rm
to produce quantities of outputs Y [ R . We
can denote xij the amount of the ithinput used by the DMU j and yrj the amount of the
rth output produced by the DMU j. Assuming constant returns-to-scale (CRS), strong
disposability of inputs and outputs and convexity of the production possibility set, the
technical efficiency score for the DMU k (denoted by TE k ) can be obtained by solving
following model (Charnes et al., 1978):
549
min TE uk 2 1
uk ;l;s2
;s
r
i
m
X
i1
s2
i
s
X
!
s
r
r1
subject to:
ii
n
X
lj yrj 2 s
r yrk
r 1; 2; . . .; s
j1
iii
n
X
lj xij s2
i uk xik
i 1; 2; . . .; m
j1
iv s2
i ; sr $ 0
v lj $ 0
j 1; 2; . . .; n
The solution to model (1) is interpreted as the largest contraction in inputs of DMU
k that can be carried out, given that DMU k will stay within the reference
technology. The restrictions ii ) and iii ) form the convex reference technology. The
restriction iv) restricts the input slack ( s2

i ) and output slack (sr ) variables to be
non-negative. The restriction v) limits the intensity variables to be non-negative.
Parameter 1 is a non-Archimedean infinitesimal. Since the model measures the
efficiency of single DMU (i.e. DMU k), it needs to be solved n times to obtain
*
efficiency score of each DMU in the sample. The optimal value uk reflects the TE
*
score of DMU k. This efficiency score is within a range from zero to one,0 , uk # 1,
*
2*
*
with a high score implying a higher efficiency. If uk 1 and si sr 0 then
DMU k is Pareto-efficient. For DMU k, we define the technical inefficiency score
*
*
(TIE k ) as 1 2 uk . In fact, 1 2 uk gives the necessary reduction in all inputs of DMU
k to be rated as fully efficient. It is worth mentioning here that the model (1) is an
input-oriented model since the objective is to utilize minimum level of inputs with
the same level of production.
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550
Super-efficiency model
It is significant to note that all efficient DMUs have the same efficiency scores equal
to 1 in the CCR model. Therefore, it is impossible to rank or differentiate the
efficient DMUs with the CCR model. However, the ability to rank or differentiate the
efficient DMUs is of both theoretical and practical importance. Theoretically, the
inability to differentiate the efficient DMUs creates a spiked distribution at
efficiency scores of 1. This poses analytic difficulties to any post-DEA statistical
inference analysis. In practice, further discrimination across the efficient DMUs is
also desirable to identify ace performers. For getting strict ranking among efficient
DMUs, Andersen and Petersen (1993) proposed the super-efficiency DEA model.
The core idea of super-efficiency DEA model is to exclude the DMU under
evaluation from the reference set. This allows a DMU to be located on the efficient
frontier i.e. to be super-efficient. Therefore, the super-efficiency score for efficient
DMU can, in principle, take any value greater than or equal to 1. This procedure
makes the ranking of efficient DMUs possible (i.e. the higher the super-efficiency
score implies higher rank). However, the inefficient units which are not on the
efficient frontier, and with an initial DEA score of less than 1, would find their
relative efficiency score unaffected by their exclusion from the reference set of
DMUs.
In the super-efficiency DEA model, when the linear programme (LP) is run for
estimating the efficiency score of DMU k, the DMU k cannot form part of its reference
frontier and hence, if it was a fully-efficient unit in the original standard DEA model
(like CCR model in the present study) it may now have efficiency score greater than 1.
This LP is required to be run for each of the n DMUs in the sample, and in each of these
LPs, the reference set involves n-1 DMUs. In particular, Andersen and Petersens model
for estimating super-efficiency score for DMU k (denoted by TE k;super ) can be outlined
as below:
!
m
s
X
X
super
k;super
2
uk
21
si
sr
i supermin2 TE
uk
;l;si ;sr
i1
r1
subject to:
ii
n
X
lj yrj 2 s
r yrk
r 1; 2; . . .; s
j1
jk
iii
n
X
super
lj xij s2
xik
i uk
i 1; 2; . . .; m
j1
jk
iv s2
i ; sr $ 00
v lj j k $ 0
j 1; 2; . . .; n
Besides providing the ranks to efficient DMUs, the results of super-efficiency DEA
model can be used in sensitivity testing, identification of outliers, and as a method of
circumventing the bounded range problem in a second stage regression method so that
standard ordinary least squares regression method can be used instead of Tobit
regression (Coelli et al., 2005).
Public sector
banks in India
Data and specification of inputs and outputs

In the banking literature, there is a considerable disagreement among researchers about
what constitute inputs and outputs of banking industry (Casu, 2002; Sathye, 2003). Two
different approaches appear in the literature regarding the measurement of inputs and
outputs of a bank. These approaches are the production approach and intermediation
approach (Humphrey, 1985). The intermediation approach views the banks as using
deposits together with purchased inputs to produce various categories of bank assets.
Outputs are measured in monetary values and total costs include all operating and interest
expenses (see Sealey and Lindley, 1977 for a discussion). In contrast, the production
approach views banks as using purchased inputs to produce deposits and various
categories of bank assets. Both loans and deposits are, therefore, treated as outputs and
measured in terms of the number of accounts. This approach considers only operating
costs and excludes the interest expenses paid on deposits since deposits are viewed as
outputs. Although the intermediation approach is most commonly used in the empirical
studies, neither approach is completely satisfactory, largely because the deposits have
both input and output characteristics which are not easily disaggregated empirically.
Berger and Humphrey (1997) suggested that the intermediation approach is best
suited for analyzing bank level efficiency, whereas the production approach is well
suited for measuring branch level efficiency. This is because, at the bank level,
management will aim to reduce total costs and not just non-interest expenses, while at
the branch level a large number of customer service processing take place and bank
funding and investment decisions are mostly not under the control of branches. Also,
in practice, the availability of flow data required by the production approach is usually
exceptional rather than in common. Therefore, following Berger and Humphrey (1997),
we have selected a modified version of intermediation approach as opposed to the
production approach for selecting input and output variables in the present study.
The data on input and output variables have been culled out from Performance
Highlights of Public Sector Banks: 2004/05, a publication of Indian Banks Association
(IBA). The study is confined to 27 PSBs operating in the year 2004/2005. It is worth
noting here that in the year 2004/2005, there were 28 PSBs. At the outset, we have a
suspicion that IDBI Ltd., a de nova public sector bank, may be an outlier. For
confirming whether this bank is an outlier or not, we employed Andersen and
Petersens super-efficiency model which yields efficiency score greater than 1 for the
efficient DMUs. We followed the Avkirans (2006) rule of thumb for the identification of
potential outliers which states that an efficient DMU with super-efficiency score equal
to 2 or above is a potential outlier. With the extremely high super-efficiency score of
4.4, IDBI Ltd. appeared as a clear outlier. Therefore, we dropped this bank from the
sample and confined our analysis to the remaining 27 PSBs.
In the present study, the output vector contains two output variables:
(1) interest spread ( y1); and
(2) non-interest income ( y2).
551
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552
The output variable interest spread is also known as net-interest income and is
computed by subtracting interest expenses from interest income. This variable
connotes net income received by the banks from their traditional activities like
advancing of loans and investments in government and other approved securities. The
output variable non-interest income accounts for income from off-balance sheet items
such as commission, exchange and brokerage, etc. The inclusion of non-interest
income enables us to capture the recent changes in the production of services as
Indian banks are increasingly engaging in non-traditional banking activities. As
pointed out by Siems and Clark (1997), the failure to incorporate these types of
activities may seriously understate bank output and this is likely to have statistical
and economic effects on estimated efficiency.
It is worth noting here that the choice of output variables is consistent with the
managerial objectives that are being pursued by the Indian banks. In the post-reform
years, intense competition in the Indian banking sector has forced the banks to reduce
all the input costs to the minimum and to earn maximum revenue with less of less
inputs. Further, the inclusion of deposits and loans in the output vector as reported in
the studies of Mukherjee et al. (2002) and Chakrabarti and Chawla (2005) is not in
consonance of policy objectives of the Indian banks and thus, seems irrational in the
efficiency analysis of Indian banks that confined to the post-reforms period. In this
context, Ram Mohan and Ray (2004) rightly remarked:
Using deposits and loans as outputs would have been appropriate in the nationalized era
when maximizing these was indeed the objective of a bank but they are, perhaps, less
appropriate in the reforms era. Banks are not simply maximizing deposits and loans; they are
in the business of maximizing profits. If inputs are treated as pre-determined, this amounts to
maximizing revenue.
In this study, the inputs used for computing the efficiency scores are:
.
physical capital (x1);
.
labour (x2); and
.
loanable funds(x3).
The number of full-time staff has been used as a measure of labour input. The input
variable physical capital represents the book value of premises and fixed assets net of
depreciation. The input variable loanable funds is obtained by adding both deposits
and borrowings. All the input and output variables except labour are measured in
Rupee lacs (note that 10 lacs 1 million).
Since DEA results are influenced by the size of the sample, some discussion
on the adequacy of sample size is warranted here. The size of the sample
utilized in the present study is consistent with the various rules of thumb
available in literature. Cooper et al. (2007) provides two such rules that can be
expressed as:
n $ max{m s; 3m s}
where:
n number of DMUs; m number of inputs and s number of outputs:
The first rule of thumb states that sample size should be greater than equal to product
of inputs and outputs. While the second rule states that number of observation in the
data set should be at least three times the sum of number of input and output variables.
Given m 3 and s 2, the sample size (n 27) used in the present study exceeds the
desirable size as suggested by the abovementioned rules of thumb to obtain sufficient
discriminatory power. The sample size in this study is feasible and larger than that
used in some of the studies in the DEA literature (see for example, Avkiran, 1999b).
Appropriateness of selected input and output variables: a sensitivity analysis
In DEA, the distribution of efficiency scores is very sensitive to the choice of input and
output vectors. Thus, the selection of input and output variables for the DEA study
requires a careful thought as the distribution of efficiency scores and rank order of
DMUs are likely to be affected by the selection of variables and their number.
Therefore, we checked whether the choice of inputs and outputs in the current analysis
is appropriate or not. For this purpose, we carried out a sensitivity analysis by
considering eight distinct cases that contain different set of inputs and outputs under
the intermediation approach. In all cases, we applied CCR model for computing
efficiency scores. It is worth-mentioning here that these combinations of input and
output variables are not uncommon in the literature and have been considered in the
most of the analyses of banking efficiency in India. For instance, Mukherjee et al. (2002)
included the number of branches as one of the inputs in their study. Das (2000)
considered deposits, borrowings and number of employees as inputs and interest
spread and non-interest income as outputs in his study. Bhattacharyya et al. (1997)
included advances, investment and deposits in the output vector. Table III reports the
results of the sensitivity analysis.
Case A is the baseline case and the remaining seven cases have been used in our
sensitivity analysis in order to capture various aspects of technical efficiency.
Following Chen and Yeh (1999), we adopted the rejection criteria for a particular case in
favour of Case A when first, correlation coefficient of TE scores of baseline Case A with
a specific case is high because a high correlation indicates almost identical results
provided by the two cases, and/or second, there are larger number of efficient banks in
a specific case than Case A since too many efficient banks reduce the discrimination
capability of the performance evaluation results. The results of sensitivity analysis
provides that all the cases including different set of input and output variables have
been rejected in favour of Case A on the basis of aforementioned rejection criteria.
Thus, we consider Case A as most preferred case. In sum, our choice of input and
output variables is also appropriate on the basis of discriminatory power of the model.
Empirical results
In this section, the TE scores obtained from the input-oriented CCR model have been
provided and their contents are discussed. It is significant to note that input-oriented
efficiency measures address the question: By how much can input quantities be
proportionally reduced without altering the output quantities produced? Table IV
presents the TE scores of 27 PSBs, along with the magnitude of technical inefficiency
(TIE). The results indicate that Indian public sector banking industry has been
characterized with large asymmetry among banks as regards their TE scores that
ranges between 0.632 and 1. The average of TE scores turned out to be 0.885 for 27
Public sector
banks in India
553
Table III.
Results of sensitivity
analysis on the baseline
DEA model
0.945*
9
0.898
0.103
0.649
Rejected
U
U
U
U
U
U
U
7
0.885
0.102
0.632
Preferred
U
U
U
U
Case B
0.376**
13
0.971
0.038
0.866
Rejected
U
U
U
U
U
Case C
0.389**
13
0.972
0.038
0.866
Rejected
U
U
U
U
U
U
Case D
0.241
10
0.969
0.038
0.866
Rejected
U
U
U
U
U
Case E
0.254
10
0.970
0.037
0.866
Rejected
U
U
U
U
U
U
Case F
0.644*
18
0.987
0.024
0.890
Rejected
U
U
U
U
U
U
U
U
Case G
0.582*
17
0.987
0.024
0.890
Rejected
U
U
U
U
U
U
U
Case H
Notes: * indicate that the correlation coefficient is statistically significant at 5% levels of significance; ** indicate that the correlation coefficient is
statistically significant at 1% levels of significance. The term Rejected connotes that the particular Case is rejected in favour of Case A on the basis of a
priori decision criteria (see text for decision criteria)
Source: Authors Calculations
Panel B
Estimated results
Correlation with Case A
Number of efficient banks
Mean efficiency score
Standard deviation
Minimum efficiency
Inference
Panel A
Outputs
Advances
Investments
Interest Spread(Net-interest Income)
Non-interest Income
Inputs
Labour
Physical Capital
Loanable Funds
Number of Branches
Case A
(Baseline model)
554
Items
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57,7
1
1
1
1
1
1
1
0.974
0.960
0.945
0.923
0.918
0.890
0.889
0.869
0.865
0.859
0.859
0.844
0.816
0.806
0.804
0.801
0.796
0.759
0.676
0.632
Technical efficiency scores
Note: Technical inefficiency (%) (1 2 Technical efficiency score) *100

Source: Authors calculations
Andhra Bank
Corporation Bank
State Bank of Bikaner and Jaipur
State Bank of Travancore
Punjab and Sind Bank
State Bank of Patiala
State Bank of Mysore
Indian Overseas Bank
State Bank of Saurashtra
Oriental Bank of Commerce
State Bank of Indore
Vijaya Bank
Central Bank of India
Punjab National Bank
Bank of Baroda
State Bank of India
Syndicate Bank
State Bank of Hyderabad
Indian Bank
United Bank of India
Allahabad Bank
Dena Bank
Canara Bank
Union Bank of India
Bank of Maharashtra
UCO Bank
Bank of India
Banks
0
0
0
0
0
0
0
2.55
3.97
5.52
7.69
8.17
10.95
11.14
13.07
13.54
14.11
14.13
15.58
18.41
19.36
19.58
19.86
20.43
24.08
32.38
36.83
Technical inefficiency (%)
1.281
1.193
1.108
1.080
1.080
1.052
1.051
0.974
0.960
0.945
0.923
0.918
0.890
0.889
0.869
0.865
0.859
0.859
0.844
0.816
0.806
0.804
0.801
0.796
0.759
0.676
0.632
Super-efficiency scores
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
Rank
Public sector
banks in India
555
Table IV.
Technical efficiency and
super-efficiency scores
for public sector banks
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57,7
556
PSBs (see Table V). This suggests that an average PSB, if producing its outputs on the
efficient frontier instead of at its current (virtual) location, would have needed only 88.5
percent of the inputs currently being used. In other words, the magnitude of TIE in
Indian public sector banking industry is to the tune of 11.5 percent. This suggests that,
by adopting best practice, PSBs can, on an average, reduce their inputs of physical
capital, labour and loanable funds by at least 11.5 percent and still produce the same
level of outputs. However, the potential reduction in inputs from adopting best
practices varies from bank to bank. Alternatively, PSBs have the scope of producing
1.13 times (i.e. 1/0.885) as much as outputs from the same level of inputs.
Of the 27 PSBs, 7 (i.e. 26 percent) banks were found to be technically efficient since
they had a relative TE score of 1. These banks together define the best-practice or
efficient frontier and, thus, form the reference set for inefficient banks. The production
process of these banks is functioning well and thus, characterizing no waste of inputs. In
DEA terminology, these banks are called peers and set an example of good operating
practices for inefficient banks to emulate. The remaining 20 (i.e. 74 percent) banks have
TE scores less than 1 which means that they are relatively technically inefficient. The
results, thus, indicate a presence of marked deviations of the banks from the best-practice
frontier. These inefficient banks can improve their efficiency by reducing inputs.
Further, TE scores among the inefficient banks range from 0.632 for Bank of India to
0.974 for Indian Overseas Bank. This finding implies that Bank of India and Indian
Overseas Bank can potentially reduce their current input levels by 36.8 percent and 2.6
percent, respectively while leaving their output levels unchanged. This interpretation of
efficiency scores can be extended for other inefficient banks also. On the whole, we
observed that TIE levels ranged from 2.6 percent to 36.8 percent among inefficient PSBs.
Ranking of efficient banks
As noted above, CCR model only allows the ranking of inefficient banks and assign the
efficiency score equal to 1 to all efficient banks. Thus, basic CCR model fails to provide
strict ranking to efficient banks. Andersen and Petersen (1993) developed a modified
version of DEA which allows even the ranking of efficient banks. Their basic idea was to
Statistics
Table V.
Descriptive statistics of
technical efficiency scores
for Indian public sector
banking industry
N
ATE
SD
Minimum
Q1
Median
Q3
Maximum
ATIE(%age)
Interval
All banks
Efficient banks
Inefficient banks
SBI Group
NB Group
27
0.885
0.102
0.632
0.806
0.889
1.000
1.000
11.5
(0.783;0.987)
7
1.000
0.000
1.000
1.000
1.000
1.000
1.000
0.0
(1.000;1.000)
20
0.844
0.088
0.632
0.802
0.859
0.911
0.975
15.6
(0.756;0.932)
8
0.951
0.062
0.859
0.879
0.980
1.000
1.000
4.9
(0.889;1.013)
19
0.857
0.104
0.632
0.801
0.859
0.945
1.000
14.3
(0.753;0.961)
Notes: ATE Average technical efficiency; SD Standard deviation; Q1 First quartile;

Q 3 Third quartile; ATIE(%age) Average technical inefficiency (1-ATE) * 100; and
Interval (ATE-SD; ATE SD)
compare the bank under evaluation with a linear combination of all other banks
excluding the one under reference in the sample. Under this approach, it is possible for an
efficient bank to increase its input vector proportionally while preserving efficiency. The
bank obtains, in that case, an efficiency score above 1. Thus, this approach provides an
efficiency rating of efficient banks similar to the rating of inefficient banks. Table IV also
provides the super-efficiency scores of PSBs and their ranks. At the ladder of efficiency
ranking, Andhra Bank emerges as numero uno bank which is followed in accordance of
their ranking by Corporation Bank, State Bank of Bikaner and Jaipur, State Bank of
Travancore, Punjab and Sind Bank, State Bank of Patiala, and State Bank of Mysore.
Public sector
banks in India
557
Discrimination of inefficient banks

Besides discriminating the efficient banks, we also made an attempt to separate out 20
inefficient banks. For this, we utilized the quartile values of TE scores obtained from
CCR model as cut-off points to segregate the inefficient banks into four categories (see
Table VI). Among these categories, the banks belonging to most inefficient and
marginally inefficient category requires special attention.
In the most inefficient category, those banks have been included which attained
the TE score below the value of first quartile. The candidates of this group are worst
performers in the sample and may be considered as target banks in any probable
recapitalization and consolidation exercise that may take place in Indian banking
industry. It is significant to note that these banks lack vitality in terms of the efficiency
of resource utilization. The banks that have attained the TE score above the third
quartile value but less than 1 are included in marginally inefficient category. This is
worth mentioning here that these banks are operating at a high level of operating
efficiency even though they are not fully efficient. In fact, these banks are marginally
Category I
(Most inefficient)
Category II
(Below average)
Category III
(Above average)
Category IV
(Marginally inefficient)
Canara Bank (23)
Syndicate Bank (17)

(13)

(8)
Union Bank of India

(24)
State Bank of
Hyderabad (18)

(14)
State Bank of
Saurashtra (9)
Bank of Maharashtra
(25)
Indian Bank (19)
Bank of Baroda(15)
Oriental Bank of
Commerce (10)
UCO Bank (26)

(20)
State Bank of India (16) State Bank of Indore

(11)
Bank of India (27)
Allahabad Bank (21)

Dena Bank (22)
Vijaya Bank (12)
Notes: The Most inefficient category includes those banks which have TE score below the first
quartile; Those banks are included in the Below average category whose TE score lies between first
and second quartile; The Above average category consists of the banks wherein TE score lies
between median and third quartile; The banks with TE scores above the third quartile are included in
the Marginally inefficient category; Figures in brackets are ranks; Q1 0.802, Median 0.859, and
Q3 0.911
Table VI.
Classification of
inefficient public sector
banks
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558
inefficient and operate close to the efficient frontier. Further, these banks can attain the
status of efficient banks by bringing little improvements in the resource utilization
process. In fact, these banks are would-be champions. Therefore, the regulators must
pay special attention to enhance their efficiency.
Group affiliation and efficiency differences
As noted above, the PSBs in India can be bifurcated into two broad groups namely, State
Bank of India (SBI) group (comprising eight banks), and Nationalized Banks (NB) group
(containing 19 banks). Besides evaluating the relative efficiency of individual banks, we
also made an attempt to examine whether group affiliation affects the efficiency of banks
or not. For this, we compared the average TE scores of both SBI and NB groups. Table V
also provides the summary statistics of TE scores for SBI and NB groups. The results
indicate that if the frontier technology had been imposed then banks in SBI and NB
groups could produce their outputs with only 95.1 percent and 85.7 percent of their
currently used level of inputs, respectively. The potential for input saving is, thus, 4.91
percent and 14.31 percent for SBI and NB groups, respectively. Thus, the banks in SBI
group are more efficient than the nationalized banks. In order to identify whether the
efficiency differences between these groups are statistically significant, we utilized the
Wilcoxon Mann-Whitney test (see Cooper et al., 2007; and Sowlati, 2007 for the application
of this test). The null hypothesis is that both SBI and NB groups have the same population
of the TE scores. The results support the rejection of null hypothesis at the significance
level of 1 percent[5]. Therefore, the banks affiliated with SBI group outperform the banks
that belong to NB group in terms of technical efficiency. Thus, it can be safely concluded
that group affiliation influences the performance of public sector banks.
Slack analysis
The optimum solution of linear programme (1) provides non-zero input and output
slacks corresponding to input and output constraints. As noted above, slacks exist only
for those DMUs that are identified as inefficient in a particular DEA run. These slacks
provide the vital information pertaining to the areas which an inefficient bank needs to
improve on in its drive towards attaining the status of efficient one. Coelli et al. (2005)
clearly pointed out that both the Farrell measure of TE and any non-zero input and
output slacks should be reported to provide an accurate indication of technical
efficiency of a firm in a DEA analysis. Thus, the slacks should be interpreted along
with the efficiency values. However, slacks represent only the leftover portions of
inefficiencies; after proportional reductions in inputs or outputs, if a DMU cannot reach
the efficient frontier (to its efficient target), slacks are needed to push the DMU to the
frontier (target) (Ozcan, 2008). The presence of non-zero slacks for a DMU implies that
the DMU under scrutiny can improve beyond the level implied by the estimate of
technical efficiency (Jacobs et al., 2006). In the input-oriented DEA model, the
input-slack represents the input excess and output slack indicates the output which is
under-produced (Avkiran, 1999a; and Ozcan, 2008).
Table VII provides the input and output slacks for 20 inefficient PSBs in India. For
interpreting the contents of the table, consider the case of a single bank, say, Oriental
Bank of Commerce. The TE score of Oriented Bank of Commerce is 0.945, implying
that the bank could become technically efficient (under the Farrells definition)
provided if all of its inputs are proportionally reduced by 5.5 percent (i.e. (1-TE score)
Bank
Loanable Physical Non-interest Interest

spread
income
capital
funds
Labour
(Rs. Lac)
(Rs. Lac)
TE score (Number) (Rs. Lac) (Rs. Lac)
State Bank of India

0.865
State Bank of Hyderabad
0.859
State Bank of Indore
0.923
State Bank of Saurashtra
0.96
Allahabad Bank
0.806
Bank of Baroda
0.869
Bank of India
0.632
Bank of Maharashtra
0.759
Canara Bank
0.801
0.89
Dena Bank
0.804
Indian Bank
0.844
0.974
Oriental Bank of Commerce
0.945
0.889
Syndicate Bank
0.859
UCO Bank
0.676
Union Bank of India
0.796
0.816
Vijaya Bank
0.918
Number of banks with slacks
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
702
(4.0)
0
(0)
1
0
(0)
0e
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
740690
(15.2)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
1
0
(0)
0
(0)
0
(0)
0
(0)
32829
(44.8)
17265
(20.1)
10123
(12.4)
0
(0)
0
(0)
31569
(42.0)
10934
(37.3)
17750
(39.5)
12179
(26.9)
1389
(3.7)
17690
(18.3)
3121
(8.2)
1193
(3.0)
23028
(28.0)
3395
(16.9)
75
(0.3)
14
12360.6
(1.7)
0
(0)
2064.9
(11.6)
13171.5
(115.5)
7346.4
(11.5)
25096.1
(19.2)
2503.5
(2.2)
1988.0
(5.2)
1397.5
(0.9)
38966.2
(42.3)
5142.9
(16.5)
14516.9
(25.5)
35539.5
(55.5)
25646.6
(50.8)
47870.6
(28.6)
34059.7
(60.3)
22723.1
(44.1)
29456.7
(38.5)
3046.1
(6.4)
15456.9
(43.7)
19
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
(0)
0
Notes: e indicates that slack value is positive but very negligible and thus, considered as zero; the
figures in parentheses are the percentages of slacks to actual values
Public sector
banks in India
559
Table VII.
Slack analysis of
inefficient public sector
banks
IJPPM
57,7
560
100). However, even with this required proportional reduction in all inputs, this bank
would not be Pareto-efficient, as it would be operating on the vertical section of the
efficient frontier. In order to project this bank to a Pareto-efficient point, some further
slack adjustments are necessary because non-zero input and output slacks appear for
this bank. Ultimately, Oriental Bank of Commerce has to make three adjustments in
order to operate at the efficient frontier. First, it has to reduce all inputs by 5.5 percent.
Second, it has to reduce loanable funds and physical capital by another 15.2 percent
and 3.7 percent, respectively. Third, it has to augment non-interest income by 50.8
percent. The first type of adjustment is known as radial adjustment while second and
third types of adjustments are known as slack adjustments. The similar explanation
can be extended for other inefficient banks.
The analysis of slacks for all inefficient banks delineates that among the input
variables, 14 banks have non-zero slacks for physical capital, one bank has non-zero
slacks for loanable funds and one bank has non-zero slack for labour. With regard to
non-zero slacks for output variables, it has been observed that 19 banks have non-zero
slacks for non-interest income. Further, no non-zero slack has been observed for interest
spread. This suggests that besides the proportional reduction of all inputs by the
observed amount of technical inefficiency, most of the inefficient banks in Indian public
sector banking industry need to reduce the use of physical capital and to augment the
level of non-interest income, for projecting themselves on the efficient frontier.
Jack-knifing analysis
To investigate the robustness of the DEA results in terms of stability of reference set,
we followed Myrtveit and Stensrud (1999), Mostafa (2007a, b) and performed a
procedure known as Jack-knifing. For this, we dropped all the efficient banks one by
one and studied the impact of their removal on the average TE and composition of the
reference set. Since we have seven efficient banks in our original DEA analysis, we ran
seven additional DEA analyses. Table VIII presents the results of Jack-knifing
analysis. It has been noted that none of the efficient bank observed in the DEA analysis
is extreme because its removal did not bring any significant change in average TE of
Indian public sector banking industry. Further, the composition of reference set
Table VIII.
Results of jack-knifing
analysis
Bank removed from the analysis
Average of
technical
efficiency
scores
Number of
efficient
banks
State Bank of Bikaner and Jaipur

State Bank of Mysore
State Bank of Patiala
State Bank of Travancore
Andhra Bank
0.901
0.880
0.882
0.881
0.880
7
6
6
6
6
Corporation Bank
Punjab and Sind Bank
0.907
0.880
9
6
New bank in the reference set

None
None
None
None
Indian Overseas Bank,
Oriental Bank of Commerce,
and Vijaya Bank
None
remained unaltered in five cases out of seven DEA runs. We also tested the similarity
of efficiency ranking between the model with all the banks included and those based on
dropping out each efficient bank one at a time by the Spearmans rank correlation
coefficient. The correlation coefficient zoomed up from 0.974 to 1.000 and found
statistically significant at 1 percent level of significance. The high rank correlation
coefficient indicates that ranking are stable in regard to efficient banks defining the
efficient frontier. On the basis of Jack-knifing analysis, we can safely conclude that the
results of the present study are quite robust.
Public sector
banks in India
561
Determinants of technical efficiency: a regression analysis

Finally, in order to investigate the possible determinants of bank efficiency, we
followed Tripe (2005) and utilized the regression analysis in which the bank-specific
super-efficiency scores are regressed on a set of independent variables relevant to the
banking business. As stressed by Mester (1996), the findings of post-DEA regression
analysis are intended mainly to indicate where banks might look for clues towards
increasing their efficiency. Table IX provides the description and expected signs of the
predictors included in the regression analysis.
With the exception of the predictor SIZE, all the remaining predictors in the model
bear a uni-directional relationship with the technical efficiency (i.e. dependent
variable)[6]. For example, the ratio of non-performing loans to total advances is a good
indicator of loan-quality (LQ) and a strictly negative relationship has been
hypothesized between LQ and technical efficiency since the lower of this ratio
would facilitate higher efficiency in the banking operations. The existing literature on
banking efficiency is not ascertained about the sign of coefficient of the variable SIZE.
If the coefficient on this variable is negative it would support the information
advantage hypothesis put forward by the authors such as Nakamura (1993) and Mester
et al. (1998) that small banks have greater access to credit information and less agency
problems since management might be closer to both the customer and the loan officer.
Predictor
Symbol
Description
(1) Size
SIZE
(2) Profitability
ROA
logTotal assets
Net profit
Total assets
Deposit of ith Bank
100
Total deposits of 27 PSBs
Net NPA
Net advances
Business i:e:deposits advances
Staff
Non-interest income
100
Total assets
Priority sector advances
100
Total advances
(3) Market share in deposits
MS
(4) Loan quality
LQ
(5) Staff productivity
SP
(6) Exposures to offbalance

sheet activities
(7) Advances to priority sector
Source: Authors elaboration
OFFBALANCE
PRIORITY
Expected
sign
^
Table IX.
Description and expected
sign of the predictors
IJPPM
57,7
562
On the other hand, if the sign of the coefficient is positive it would be in agreement with
the expense preference hypothesis postulated by Rhodes and Rutz (1982) and Clark
(1986). This approach contends that managers of small banks may invest in less risky
loan and investments so as to enjoy a quiet life and in the process reject loans that
could have generated additional profits and revenues for the bank.
In the present study, we applied Best subsets regression routine available in the
statistical software MINITAB for Windows Version 14. The routine uses the maximum
R-square criterion. For k predictors, the software lists out 2k-1 best regression equations.
The routine first selects the one-predictor regression model giving the highest value of
R-square. After printing information on this model, the routine selects next best
one-predictor model on the basis of second highest R-square value. Next, the routine
finds the two-predictor model with the highest R-square, and prints information on it and
selects the next best two-predictor model on the basis of second highest R-square. The
process continues until all k predictors are used. Thus, the last equation considers all the
k predictors. Given k 7 in the present case, the routine selected 13 regression equations
(see Table X). An examination of Table X provides the following facts:
.
The variable OFFBALANCE has turned out to be highly significant in all the
regression equations in which it was included. Also, its sign agreed with a priori
considerations in all the regression equations.
.
Barring one case (regression equation 8), the variable SIZE turned out to be
significant in all the regression equations in which it was included. However, it
has a negative coefficient in all the regression equations.
.
With the exception of one case (regression equation 4), the variable SP has been
noticed to be statistically significant in all the regression equations that include
this variable as a predictor. Besides this, its sign was in agreement with a priori
expectations in all the regression equations.
.
The coefficient of the predictor LQ though has the expected sign in all the three
regression equations in which it was included but was statistically insignificant
in all of these.
.
The coefficient of the variable ROA though has the sign contrary to a priori
consideration, but has been observed to be insignificant in both the regression
equations in which it was included.
.
The variable PRIORITY has been observed to be significant in only one
regression equation (out of six in which it was included) but its coefficient has the
sign contrary to a priori expectations in all the regression equations. Further, it
has been noticed to be statistically insignificant in five cases.
.
The sign of the coefficient of the variable MS is positive in all the six regression
equations in which it was included. Nevertheless, it was significant only in three
equations.
Out of 13 regression equations, we selected the regression equation 10 as the most
preferred equation because it yielded the highest value of adjusted R- square(i.e. R 2 ).
Also, most of the regression coefficients of this equation agree with a priori
considerations and are statistically significant. The value R 2 65:7% indicates that
the chosen model to explain inter-bank variations in technical efficiency has a
reasonable goodness of fit[7]. The preferred regression equation manifests that the
20.1488**
(2 2.65)
2 0.0496
(2 1.58)
2 0.159**
(2 2.74)
2 0.139**
(2 2.61)
2 0.149**
(2 2.69)
2 0.139**
(2 2.44)
2 0.141**
(2 2.51)
20.0711**
(2 2.55)
20.0824**
(2 2.29)
20.0672**
(2 2.25)
SIZE
0.008285
(1.87)
0.000923
(1.82)
0.00834
(1.80)
0.00925
(1.99)
0.00645
(1.39)
0.0101**
(2.41)
PRIORITY
20.0030
(2 0.06)
20.0715
(2 0.93)
ROA
0.000614
(1.79)
0.000666**
(2.15)
0.000798**
(2.48)
0.000816**
(2.59)
0.000768**
(2.46)
0.000755**
(2.32)
0.000982*
(3.16)
0.000923*
(2.86)
0.000993**
(2.68)
0.00110*
(2.92)
SP
20.02314
(21.21)
20.0101
(20.78)
20.0109
(20.80)
LQ
0.199*
(3.61)
0.245*
(4.19)
0.229*
(4.31)
0.245*
(4.60)
0.217*
(4.16)
0.234*
(4.48)
0.208*
(3.87)
0.220*
(4.46)
0.212*
(4.16)
0.222*
(3.92)
0.235*
(4.13)
0.216*
(3.68)
OFFBALANCE
68.1%
65.7%
66.7%
65.7%
61.2%
59.1%
60.0%
54.4%
55.5%
42.9%
46.5%
17.3%
35.2%
R2
F
13.57
5.24
10.42
9.00
9.54
9.15
8.24
7.93
6.62
8.04
6.68
6.38
5.81
R 2
32.6%
14.0%
42.0%
38.1%
49.6%
48.5%
52.7%
51.6%
51.9%
57.5%
56.7%
55.4%
56.4%
Notes: * indicates that regression coefficient is significant at 1% level of significance; ** indicates that regression coefficient is significant at 5% level of
significance
13
12
11
10
0.0154
(1.69)
0.0173**
(2.01)
0.0185**
(2.10)
0.0173
(1.95)
0.0189**
(2.14)
0.014
(1.58)
0.597*
(6.66)
2.18*
(3.95)
1.65*
(3.47)
0.370**
(2.42)
1.47*
(3.25)
20.078
(20.34)
2.57*
(3.11)
0.847
(1.35)
2.77*
(3.19)
2.44**
(2.43)
2.23**
(2.54)
2.02**
(2.25)
2.10**
(2.36)
MS
Constant
S.No.
Public sector
banks in India
563
Table X.
Best subsets regression
results
IJPPM
57,7
564
coefficient of MS is significantly different from zero and has the expected sign. Thus,
PSBs with high market share in the industrys deposits are more efficient than those
having smaller share. The coefficient of SIZE is negative and observed to be
significantly related to bank efficiency. This finding suggests that efficiency at larger
PSBs is lower than their peers and agrees with the results of Akhigbe and McNulty
(2003), Craigwell et al. (2003), Girardone et al. (2004) and supports the information
advantage hypothesis of Nakamura (1993) and Mester et al. (1998), which proposes that
there would be less agency problems between the bank and the loan officer since senior
management is closer. Another factor which significantly explains the technical
efficiency of Indian PSBs has been observed to be SP which captures the productivity
of staff. The results of preferred model indicate that the banks with high staff
productivity have high level of technical efficiency. The most influencing determinant
of banking efficiency turned out to be OFFBALANCE which was statistically highly
significant and its coefficients had sign in agreement with a priori expectation. Thus,
the PSBs with extensive exposures to off-balance sheet activities are more efficient.
The finding that OFFBALANCE is a significant factor in explaining technical
efficiency is not surprising since this determinant of efficiency is more related to the
ability of the banks to generate non-interest income. In the post-reforms period since
1992, the Indian banks are concentrating more and more on non-traditional activities
and the share of non-interest income from commission, exchange and brokerage, etc., in
total income is rising substantially. In the year 2005, this share was 16.62 percent
against 10.72 percent in the year 1992. The results, further, delineate that the positive
sign of the coefficient of PRIORITY is not logical and theoretically relevant. Also, its
coefficient turned out to be statistically insignificant. Accordingly, the proposition that
more advances to priority sector in relation to total advances leads to lower technical
efficiency does not appear to hold good in Indian public sector banking industry in the
current scenario. However, this may be a valid proposition in the pre-reforms years (i.e.
before 1992).
Conclusions and future research
The objective of this paper is to evaluate the extent of technical (in)efficiency in the
Indian public sector banking industry. Also, the strict ranking of the PSBs on the basis
of super-efficiency scores is sought. The TE scores for individual PSBs have been
obtained by using two popular DEA models namely, CCR model and Andersen and
Petersens super-efficiency model. The analysis is confined to a cross-section of 27
public sector banks operating in the year 2004/2005. The results show that TE scores
range from 0.632 to 1, with an average of 0.885. Thus, the overall level of technical
inefficiency in Indian public sector banking industry has been found to be around 11.5
percent. The banks affiliated with SBI group outperform the nationalized banks in
terms of operating efficiency.
The results of CCR model provide that seven banks with TE score equal to 1 define
the efficient frontier and the remaining 20 banks have TE score less than 1 and thus,
operate away from this frontier. On the basis of super-efficiency scores, Andhra Bank
emerges as numero uno bank which is followed closely by Corporation Bank. The
jack-knifing analysis provides that the efficiency results are quite robust because none
of the efficient bank has been observed to be extreme, and the composition of reference
set remained unaltered in the most of cases. The slack analysis provides that in
addition to the proportional reduction in all inputs by the amount of observed technical
inefficiency, most of the inefficient public sector banks need to reduce the use of the
physical capital and augment non-interest income to move on to the efficient frontier.
On the basis of the results of regression analysis, the study concludes that:
.
PSBs with high market share in the industrys deposits are more efficient than
those having smaller share;
.
technical efficiency of large PSBs is lower than their small peers (i.e. size does not
matter in Indian public sector banking industry);
.
PSBs with high staff productivity have high level of technical efficiency; and
.
PSBs with extensive exposures to off-balance sheet activities are more efficient.
The future work could extend our research in various directions not considered in this
study. First, one could decompose the technical efficiency into its non-additive
mutually exclusive components:
.
pure technical efficiency; and
.
scale efficiency.
Second, using the data over a longer period, one may perhaps analyze the
inter-temporal variations in technical efficiency of individual PSBs.
Notes
1. In the present study, the concept of technical efficiency refers to the ability of the banks to
transform multiple resources into multiple financial services.
2. CCR model is named after its originators Charnes et al. (1978).
3. Other popular techniques for measuring relative efficiency of banks are Stochastic Frontier
Analysis (SFA), Thick Frontier Analysis (TFA), Distribution Free Approach (DFA) and Free
Disposal Hull (FDH). Except FDH, the remaining techniques can be clubbed as the parametric
frontier approaches which require the specification of the functional form of the frontier.
4. In DEA, the organization under study is called a DMU (Decision Making Unit). The
definition of DMU is rather loose to allow flexibility in its use over a wide range of possible
applications. Generically, a DMU is regarded as the entity responsible for converting inputs
into outputs and whose performance are to be evaluated (Cooper et al., 2007). In the present
context, the DMUs refer to public sector banks.
5. In the present study, we have to test H 0 : mSBI mNB againstH A : mSBI . mNB where
mSBI andmNB refer to the mean efficiency of SBI and NB groups, respectively. The calculated
value of statistic T has been observed to be 2.277 which is greater than critical value of Z
(standard normal variate) equal to 1.645 at 5 percent level of significance for a right tailed
test. Thus, we reject H 0 and conclude that mean efficiency of SBI group is statistically
greater than the mean efficiency of NB group.
6. Here, the uni-directional relationship implies either strictly negative or positive relationship.
7. Ramanathan (2002) provided that as a rule of thumb, the value of R 2 in the range of 60
percent to 70 percent may be reasonable to indicate the adequacy of the model in a
cross-section data analysis.
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About the authors
Sunil Kumar is a Reader in Economics at Punjab School of Economics, Guru Nanak Dev
University, Amritsar, Punjab, India since 1994. He received a mark of distinction for his MSc
(Hons.) in Economics degree. He has also completed his MPhil and PhD degrees from Punjab
School of Economics. He has credited more than two dozen research papers in various journals
including Prajnan: Journal of Social and Management Sciences, Global Business Review,
Productivity (Journal of National Productivity Council), Artha Vijnana: Indian Journal of
Development Economics, The Indian Journal of Economics. He also wrote a research book
entitled, Productivity and Factor Substitution: Theory and Analysis. At present, five research
scholars are working for PhD degree under his guidance. His professional memberships include
the Indian Society of Regional Science and Indian Economic Association. Sunil Kumar is the
corresponding author and can be contacted at: sunil12eco@yahoo.com
Rachita Gulati is currently a PhD candidate at Punjab School of Economics, Guru Nanak Dev
University, Amritsar, Punjab, India. She received MSc (Hons.) in Economics degree with
distinction and qualified prestigious National Eligibility Test for Lectureship and Junior
Research Fellowship. Ms. Gulatis research interests include the performance measurement using
Data Envelopment Analysis and Stochastic Frontier Analysis and Indian banking sector. Prior
to joining Ph.D. degree, she taught at BBK DAV College for Women, Amritsar, Punjab, India in
the capacity of lecturer in Economics.
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International Journal of Productivity and Performance Management

Evaluation of technical efficiency and ranking of public sector banks in India: An

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Evaluation of technical efficiency

An analysis from cross-sectional perspective

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Received October 2007

Sunil Kumar and Rachita Gulati

International Journal of Productivity

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III. Foreign banks in India

IV. Total Indian private and foreign banks(II III)

V. Total commercial banks (I IV)

Notes: Excludes regional rural banks; 1 Crore 10 Millions

II. Indian private sector Banks

I. Public sector banks (a b)

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Market share (%)

Banking efficiency in India: a brief review of literature

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restriction iv) restricts the input slack ( s2

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Data and specification of inputs and outputs

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Technical efficiency scores

Note: Technical inefficiency (%) (1 2 Technical efficiency score) *100

Technical inefficiency (%)

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Notes: ATE Average technical efficiency; SD Standard deviation; Q1 First quartile;

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Discrimination of inefficient banks

Canara Bank (23)

Syndicate Bank (17)

Central Bank of India

Indian Overseas Bank

Union Bank of India

Punjab National Bank

Indian Bank (19)

UCO Bank (26)

United Bank of India

State Bank of India (16) State Bank of Indore

Bank of India (27)

Allahabad Bank (21)

Vijaya Bank (12)

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Loanable Physical Non-interest Interest

State Bank of India

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Bank removed from the analysis

State Bank of Bikaner and Jaipur

Source: Authors calculations