EFFICIENCY AND MARKET RETURN OF BANKING SECTOR 4 IN INDIA: AN EMPIRICAL EVALUATION

Abstract

Aftermath of deregulation, globalisation of economies, entry of foreign and private banks, the strong presence of capital market and global financial instability have created opportunities as well as many challenges in front of Indian banking sector to sustain its performance and profitability with the efficient flow of funds from borrowers to savers. Therefore, these regulatory, macro-economic and bank-specific factors may have a significant contribution to the overall performance of Indian banking sector which can be measured in terms of efficiency, productivity 10 and return/ value to investors. The motivation of this study is to perform a robust performance evaluation of Indian banking sector using frontier analysis techniques and investigate a statistically significant association between efficiency/ productivity and market performance aspect of Indian banks. Thus, this study aims to address following research questions in light of regulatory changes, financial crisis and the impact of market forces in Indian banking sector, namely: I. Whether the regulatory variables and micro-economic variables (including deregulation. policy changes, ownership. origin and bank-specific variables) influence the performance of the Indian banking sector measured in terms of efficiency and productivity? AM Whether the performance of the Indian banking sector measured in terms of efficiency and productivity iflfluenced by the uncontrollable macro-economic conditions (Financial disruption, change in Gross Domestic product (GDP), and inflation)? Have market performance of Indian banks statistically affected by their operational efficiency and productivity and if so then how much variation in market performance are explained by the operational performance? Can market performance and operational performance of Indian banks be linked together to develop a new measure of performance? This study adopts a stepwise analysis approach to achieve its ultimate objective. development of a new measure of efficiency linking both the operational efficiency and market performance of Indian banks. V variables which includes bank-specific variables (bank size, bank's expense-preference behaviour, bank's diversification strategy, non-performing assets, capital adequacy, profitability), macro-economic conditions (GDP growth, inflation rate and dummy variab!e to capture global financial crisis) and regulatory variab!es(ownership structure, origin of banks, age, listing on stock exchange, dummies for foreign origin specifications) using Tobit regression and Panel regression models respective!y. Resu!ts ofTobit pooled and Panel data regression exhibit bank size, bank's diversiFication strategy, bank's expense-preference behaviour, capital adequacy and profitabi!ity in the bank-specific variables as major determinants of efficiency of the Indian banking sector. Among the macro-economic indicators. GDP growth and inflation are found to be the significant drivers of efficiency of banks whereas age and listing on a stock exchange as qualitative variables have a significant relationship with the efficiency !evel of banks. Results of panel data regression models advocate that the productivity growth of banks driven by rnain!y bank's expense-preference behaviour, non-performing assets, GDP growth and inflation with the dummy representatives of financia! crisis, listing on the stock exchange and ownership structure. As the second stage, resu!ts exhibit positive and statistica!!y significant association between the listing on stock exchanges and efficiency! productivity !eve!. This study deve!ops statistical models between efficiency/ productivity measures and market performance indicators (arinual stock market return as market performance indicator and Market Va!ue Added & Economic Value Added as shareho!der va!ue indicators). To assess the statistica!ly significant association beteen market performance indicators and efficiency/ productivity indicators, a number of panel data regression models were deve!oped in the third stage of the study. The results of panel data regression models exhibit that the banks' operation endow with significant information towards annual market return and market value added. As the study found a significant association between efficiency measures and market performance indicators and considering this, the study further develops a new measure of efficiency termed as 'Market Return Efficiency'- maximisation of stock market return using a given level of inputs and outputs using Stochastic Frontier Analysis (SFA).