Chapter II: Developments in Commercial Banking (Part 1 of 4) - आरबीआई - Reserve Bank of India
Chapter II: Developments in Commercial Banking
(Part 1 of 4)
The overall performance of the scheduled commercial banks (SCBs) showed a distinct turnaround during 1999-2000. All the major financial indicators viz., operating profit, net profit, income, expenditure, interest expended, operating expenses and spread posted noticeable improvement (Table II.1). There was also a gain in the health of the banking sector in terms of a reduction in gross and net NPAs as percentage of total assets and an improvement in the capital to risk weighted assets ratio (CRAR). The crucial issue to be addressed now is how to further improve upon the gains and sustain them over the medium term as reform policies progress. This brings to the fore the importance of enhancing efficiency in banks in the context of the evolving regulatory framework. In this context, it is necessary to measure efficiency in Indian banks which in the current transitional period, have to subserve considerations that go beyond maximisation of profits (Box II.1).
Box II.1: Measurement of Efficiency in Indian Banks
An important aspect of the functioning of financial entities relates to measurement of efficiency of the banking system. Such measurement can be done either in respect of banks or of individual branches of a bank. The information so obtained can be used for assessing how efficiency is affected by deregulation, mergers and market structures as well as its effect on scale and scope economies of the entity. It can also be used to determine managerial efficiency relative to a certain threshold by identifying the best and worst practices (associated with high and low measured efficiency, respectively). Measurement of efficiency helps to distinguish as between financial entities to rank their performance and also to assess their position vis-à-vis certain benchmark levels.
One could view efficiency in two ways - technical efficiency and economic efficiency. The former arises when a (banking) firm minimises its inputs, given outputs while in the latter case, the banking firm would maximise its outputs, given inputs. Technical efficiency is thus input saving and the economic efficiency represents output augmenting efficiency. Economic efficiency is a much broader concept in the sense that it involves choosing optimal levels and combinations of inputs and/or outputs, based on reactions to market prices. Economic efficiency involves technical efficiency, but not vice versa. When efficiency is estimated, it would be usually in terms of ‘economic’ efficiency, unless otherwise specified.
International experiences regarding average efficiency estimates of banks across countries reveal wide divergences in efficiency estimates. A study of banks in Norway, Sweden and Finland showed that banks in Sweden were the most efficient. Two other cross-country studies covered 11 OECD countries and 8 developed countries, respectively. In the first study (Fecher and Pestieau, 1993), the average efficiency of financial services (banking and insurance) was determined for 11 OECD countries for the period 1971-86. The mean average efficiency was 0.82 with a range of 0.67 (for Denmark) to 0.98 (for Japan). In another study using the non-parametric technique to a cross-section of 427 banks in 8 developed countries (Pastor et.al., 1997), the mean efficiency value was 0.86 with a range of 0.55 (for UK) to 0.95 (for France). However, it is important to recognise that cross-country comparisons are often difficult to interpret because the regulatory and economic environment encountered by financial entities are different across nations and also because the level and quality of services associated with deposits and loans in different countries could differ.
In the Indian banking system, the commercial banks serve manifold purposes. While commercial considerations have been recognised as important, especially since 1992-93, the objective of maintaining the safety and soundness of the system is also given emphasis (Das 1997). These considerations would imply different combinations of outputs and inputs giving rise to different efficiency estimations. The different portfolio combinations, the risks involved, and provisioning requirements would need to be reckoned in working out the net rates of return. In view of the complexities inherent in such exercises, empirical studies have proceeded in two broad directions. The first set of exercises has been one of estimating technical efficiency of commercial banks, which reveal that there is ample scope for improving the technical efficiency of the banking system in India. The second set of studies have focused on estimating cost functions and measuring economies of scale with the implicit assumption that banks operate on an efficiency frontier. However, studies in India are in a state of infancy and considerable work needs to be done before one could concretise the inferences.
Country experiences reveal that efficiency measures could be used to improve the predictive accuracy of forecasting banking problems and crises and provide basis for tailoring policy decisions to raise efficiency levels. In the US for instance, banks and Savings and Loan (S&L) institutions with low efficiency failed at higher rates than institutions with higher efficiency (Berger and De Young, 1997). Similarly, studies on universal banking using efficiency techniques would help policy makers to parameterise degree of scale and scope economies needed for organisational restructuring. These issues are highly relevant to India at present since improvement in efficiency of banks would help further diversify and develop the financial sector.
References
Berger, A.N. and D.B.Humphrey (1997), ‘Efficiency of Financial Institutions: International Survey and Directions for Future Research’, European Journal of Operational Research, 98, pp. 175-212.
Berger, A.N. and R De Young (1997), ‘Problem Loans and the Cost Efficiency of Commercial Banks’,
Journal of Banking and Finance, Vol. 21, pp. 841-870.
Bauer, P.W., A. Berger, G.D.Ferrier and D.B.Humphrey (1998), ‘Consistency Conditions for Regulatory Analysis of Financial Institutions: A Comparison of Frontier Efficiency Methods’, Journal of Economics and Business, 50, pp. 85-114.
Das Abhiman (1997), ‘Technical, Allocative and Scale Efficiency of Public Sector Banks in India’, Reserve Bank of India Occasional Papers, Vol.
18 No:2/3 June-September.
Fecher, F. and P. Pestieau, (1993), ‘Efficiency and Competition in OECD Financial Services’ in "The Measurement of productive efficiency; Techinques and Applications." edited by H.O. Fried, C.A. K.
Lovell and S.S. Schmidt Oxford University Press, New York, PP 374-385.
Pastor, J F. Perez and J. Quesada (1997), ‘Efficiency Analysis in Banking Firms: An International Comparison’, European Journal of Operational Research, 98, pp. 396-408.
2.2 Public sector banks (PSBs) continued to hold more than four-fifths of the total assets of all SCBs. The State Bank of India and its seven associated banks continued to occupy a dominant position with their total assets accounting for 37.7 per cent of the assets of public sector banks (PSBs) and 30.3 per cent of the total assets of the entire scheduled commercial banks during 1999-2000. The share of nationalised banks constituted 49.9 per cent in the total assets of SCBs. In the total assets of the private sector banks, the share of old private sector banks constituted 57.0 per cent but accounted for only 7.0 per cent of the total assets of the SCBs. The share of 8 new private sector banks was 43.1 per cent in the total assets of all private sector banks and 5.3 per cent of the total assets of SCBs. The total assets of foreign banks as at end-March 2000 constituted 7.5 per cent of the total assets of the SCBs. What is more interesting than shares is the sharp rise in assets of new private sector banks (52.8 per cent) followed by old private sector banks (18.7 per cent), State Bank group (17.7 per cent), nationalised banks (14.5 per cent) and foreign banks (8.2 per cent) in 1999-2000. This shows that Indian private sector banks fared better in terms of assets expansion than PSBs and foreign banks.
1. Assets and Liabilities Structure of Scheduled Commercial Banks
2.3 The analysis of assets and liabilities of scheduled commercial banks is done on the basis of two sources of data: one based on the returns provided under Section 42 (2) of the Reserve Bank of India Act and the other based on balance sheets of the banks. An analysis of the balance sheet data of the SCBs for the 1999-2000 indicates that the assets of the banking sector continued to witness an impressive growth rate at 16.8 per cent on top of the rise of 19.5 per cent recorded in 1998-1999. The share of investments and loans and advances in total assets rose to 37.3 per cent and 39.9 per cent respectively. During 1999-2000, the structure of liabilities of SCBs remained largely unchanged as compared with the previous year. The share of capital of SCBs in total liabilities declined from 1.9 per cent in 1998-99 to 1.7 per cent in 1999-2000, while that of reserves and surplus increased marginally to 4.0 per cent during 1999-2000 from 3.9 per cent in 1998-99. The share of deposits in total liabilities at 81.1 per cent remained more or less unchanged. The details of the consolidated balance sheets of individual bank groups are given in Tables II.2 to II.5. The data based on Section 42 (2) returns (Table II.6) indicate that SCBs recorded a decline in the share of cash and balances held with the Reserve Bank and the ratio of such balances to agregate deposits of SCBs came down to 7.7 per cent in 1999-2000 from 9.5 per cent in 1998-99 reflecting the reduction of the CRR. The share of balances with banks and money at call and short notice of SCBs, as given by balance sheet data, also declined by more than 2 percentage points to 7.3 per cent.
Deposits
2.4 During 1999-2000, deposits as per the returns under Section 42 (2) of the RBI Act exhibited a lower growth of 13.9 per cent (Rs.99,319 crore) than 19.3 per cent (Rs.1,15,540 crore) in 1998-99. This development is, in part, indicative of the statistical bias introduced by the fact that the data as on the last reporting Friday of the year pertained to March 24, 2000, with one full week ahead of the last working day of the year, viz., March 31, 2000, dampening the impact of the year-end bulge in deposits on account, for instance, of interest rate applications. Demand deposits increased by Rs.9,943 crore (8.5 per cent) which was lower than Rs.14,910 crore (14.5 per cent) recorded during 1998-99. Time deposits also registered a lower increase of Rs.89,376 crore (15.0 per cent) than Rs.1,00,630 crore (20.3 per cent) during 1998-99 (Table II.6).
Bank Credit
2.5 Notwithstanding the lower growth in deposits during 1999-2000, bank credit enabled to a great extent by reductions in reserve requirements, recorded a higher order of expansion during the year and supported the recovery in industrial output. Both food credit and non-food credit accelerated during the year. Bank credit grew by 18.2 per cent (Rs.67,121 crore) in 1999-2000 as compared with 13.8 per cent (Rs.44,758 crore) in 1998-99. The expansion in food credit by Rs.8,875 crore (52.8 per cent) during 1999-2000 was more than double that of Rs.4,331 crore (34.7 per cent) during 1998-99. The non-food bank credit showed a higher order of expansion of 16.5 per cent (Rs.58,246 crore) as compared with an increase of 13.0 per cent (Rs.40,427 crore). As a result, the credit-deposit ratio moved up to 53.6 per cent as on March 24, 2000 from 51.7 per cent as on March 26, 1999 (Table II.6).
Investment and Cash Balances
2.6 Investments of scheduled commercial banks in government and other approved securities increased by Rs.54,350 crore (21.3 per cent) in 1999-2000 as compared to a rise of Rs.35,889 crore (16.4 per cent) recorded in 1998-99. The investment-deposit ratio (on an outstanding basis) increased to 38.0 per cent as on March 24, 2000 from 35.7 per cent as on March 26, 1999. The cash balances-deposits ratio, declined to 7.7 per cent as on March 24, 2000 from 9.5 per cent as on March 26, 1999. The cash balances of scheduled commercial banks declined by Rs.5,161 crore (7.6 per cent) in 1999-2000 as against an increase of Rs.6,604 crore (10.8 per cent) in 1998-99 (Table II.6).
2.7 The scheduled commercial banks can also invest their funds in various market instruments, viz., commercial paper, PSU bonds and the bonds floated by the corporate sector. The investments of SCBs in these instruments stood at Rs.61,429 crore as on March 24, 2000 showing an increase of 26.8 per cent (Rs.12,983 crore) over the level of Rs.48,446 crore as on March 26, 1999. The increase in these investments (including bills rediscounted) coupled with non-food bank credit aggregated to Rs.71,133 crore during 1999-2000 as compared with Rs.56,556 crore in 1998-99. In recent years, SCBs have increased their investments in instruments that fall outside the purview of SLR participation in response to growing relaxation of such regulations on banks’ investments in such securities. In October 1993, scheduled commercial banks were allowed to invest in shares and debentures of corporates (including PSU bonds) up to 5.0 per cent of their incremental aggregate deposits of the previous year with a sub-ceiling of 1.5 per cent for corporate shares devolving as part of underwriting obligations. The sub-ceiling of 1.5 per cent was abolished in January 1994. Investments in PSU bonds were excluded from the 5.0 per cent ceiling in January 1994. Further, they were allowed to purchase shares and debentures in the secondary market within the existing 5.0 per cent ceiling in October 1996. Preference shares/non-convertible debentures/bonds of private sector bodies were excluded from the 5.0 per cent limit in April 1997. The current restriction on banks’ investments relates to only ordinary shares, convertible debentures of corporates and units of equity oriented mutual funds. The ceiling on such investments has since been modified to 5.0 per cent of outstanding advances as on March 31 of the previous year, from the earlier prescription of 5.0 per cent of the incremental deposits in the previous year.
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