Microeconomics Project Presentation

Technical Efficiency in the Public Sector and Private Sector Banks in India

Technological and Economic Efficiency

Technological efficiency occurs when it is not possible to increase output without increasing inputs Technological efficiency is an engineering matter Economic efficiency occurs when the cost of producing a given output is as low as possible Economic efficiency depends on the prices of the factors of production. Something that is technologically efficient may not be economically efficient. But something that is economically efficient is always technologically efficient.

What is Technical Efficiency?

Definition Conditions under which firms combine inputs to produce a given output as inexpensively as possible Input Efficiency A particular allocation of inputs into the production process is technically efficient if the output of one good cannot be increased without decreasing the output of another good Output Efficiency Goods must also be produced in combinations that match peoples willingness to pay for them Production Efficiency - Production efficiency measures whether the economy is producing as much as possible without wasting precious resources. Theoretically, production efficiency will include all of the points along the Production Possibility Frontier, but this is difficult to measure in practice

What is Production Possibility Frontier?

The description of the best possible combinations of two goods to produce using all of the available resources. Shows the trade-off between more of one good in terms of the other. Assumes: input endowments given, technology given, time given and efficient production.

The slope of the Production Possibility Frontier measures the marginal opportunity cost of producing one good in terms of the amount of the other good foregone. Helps one understand and distinguish between comparative advantage and absolute advantage

Comparative and Absolute Advantage

The person with the lower marginal opportunity cost of an activity has the comparative advantage at that activity. This means that the person with the comparative advantage can produce the activity by giving up the smallest amount of the alternative activity. Absolute advantage: if your country uses fewer resources to produce a given unit of output than the other country. Comparative advantage: if your country can produce the output at a lower marginal cost in terms of other goods foregone than the other country. Every country (or person, or economy) has a comparative advantage at some activity. Absolute advantage is not important and may not always happen. Sometimes people or countries have the absolute advantage in nothing! Yet trade possibilities still exist. Its all about comparative advantage.

A Typical PPF Picture

The production possibilities curve focuses on productive efficiency and ignores distribution. The marginal opportunity cost of guns in terms of butter is increasing as we move down the PPF! The PPF is typically bowed-out or linear.

It is not bowed-in
just attainable
B

unattainable

inefficient Butter
C

just attainable

Guns

Efficiency
Efficiency involves achieving a goal as cheaply as possible. Efficiency has meaning only in relation to a specified goal. Any point within the production possibility curve represents inefficiency. Inefficiency getting less output from inputs which, if devoted to some other activity, would produce more output. Any point outside the production possibility curve represents something unattainable, given present resources and technology.

An Example
The principle of increasing marginal opportunity cost states that opportunity costs increase the more you concentrate on an activity. In order to get more of something, one must give up ever-increasing quantities of something else.
1 pound of 15 A butter 14 12 Butter 9 5 5 pounds of butter 0 4 guns 4 7 9 B C D E F 11 12 Guns 1 gun

Shifts In Production Possibility Curve

Society can produce more output if:
Technology is improved. More resources are discovered. Economic institutions get better at fulfilling our wants.
Biased Technological Change Butter C B

Neutral Technological Change Butter C A

Guns

0 A

Guns

The Project

TECHNICAL EFFICIENCY IN PRIVATE AND PUBLIC BANKS

Introduction
It has been well documented in the literature that the efficiency of banking system is germane to the performance of the entire economy because only an efficient system guarantees the smooth functioning of nations payment system and effective implementation of the monetary policy. The opening up of the financial sector in 1990 followed by RBIs reform program which intended to create a viable, competitive and efficient banking system in India that resulted in entry of many private banks both Indian and increased the competition among the commercial banks in India

Usage of Efficiency of Banks

Society benefits when a countrys banking system becomes more efficient, offering more services at a lower cost The information obtained from banking efficiency analyses can be used either
to inform government policy by assessing the effects of deregulation, mergers, or market structure on efficiency to address research issues by describing the efficiency of an industry, ranking its firms, or checking how measured efficiency may be related to the different efficiency techniques employed Or to improve managerial performance by identifying best practices and worst practices associated with high and low measured efficiency, respectively, and encouraging the former practices and while discouraging latter

Data Envelopment Analysis Model (DEA)

DEA is a technique to assess the efficiency of production units (in this case, the banks) relative to a set of similar units operating in the same business environment (here, the banking industry). It can identify the benchmark units in comparison to the peers to determine the best practice.

A bank is said to be technically efficient if it produces more outputs using less input resources.
In particular, there are several different approaches of measuring output, usually classified into two broad approaches:
the production approach the intermediation approach.

The present study adopts an intermediation approach.

Efficiency Analysis 2003-2008

As mentioned before, It is extremely difficult to measure output against all Input Parameters, Banks were measured across following Input parameters
Borrowings Deposits Fixed assets Net worth Operating Expenses Advances and Loans Investments Net Interest Income Non-Net Interest Income

Output was measured against following parameters

Efficiency Analysis 2003-2008

It was found that 59.2% of the sample banks were efficient, and 40.8% of the sample banks were inefficient. Also, 60.0% of the public banks and 52.6% of the private banks were efficient. For the efficient private banks, borrowings and deposits were properlyutilized, while fixed assets, net worth, and operating expenses were underproductive. Finally, for the efficient public banks, borrowings and net worth were properly-utilized, while deposits and fixed assets were under-productive inputs. For the inefficient private banks, advances & loans, investments, and non-interest income were underproduced outputs. For the inefficient public banks, advances & loans and investments were the under-produced outputs.
Private %age efficient banks Public

52.60% Efficient banks

60.00%

Borrowings Deposits Fixed assets Net worth Operating expenses

90.00% 68.00% 24.00% 38.00% 28.00% Inefficient banks

76.67% 38.33% 38.33% 53.33% 51.67%

Advances & loans Investments Net interest income Non-interest income

68.89% 53.33% 33.33% 68.89%

55.00% 55.00% 37.50% 40.00%

Conclusion
The results of the study show that there was not much of a difference in the efficiency of public and private banks. There were, however, some significant differences in terms of utilization/ underutilization of inputs and under-production of outputs. Net worth was found to be under-productive for efficient private, while it was properly utilized by public banks. The banks may need to streamline funds to optimize their return on net worth. Fixed assets were found to be under-productive for efficient public and private banks. This may be due to capacity considerations.

Conclusion Contd
Operating expenses were found to be very under-productive for efficient private. Thus, great reduction in expenses would be desirable. Advances and loans and investments were found to be underproduced in inefficient public and private banks. Public and private banks may need to pursue more aggressive loans and investment policies.

Study Limitations
The sample size considered for the study is limited, and the study period considered is a five-year period only Also, the study used data envelopment analysis (assuming constant returns to scale) to compute the bank efficiency scores, using only five input variables and four output variables. In general, the efficiency scores computed using data envelopment analysis could be very sensitive to changes in the data, and depend heavily on the number and type of inputs and output factors considered

Appendix - Sample Size

Public Banks
Allahabad Bank
Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Corporation Bank Dena Bank IDBI Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab National Bank Punjab & Sind Bank State Bank of India Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank

Private Banks
Axis Bank Catholic Syrian Bank City Union Bank Development Credit Bank Dhanalakshmi Bank Federal Bank HDFC Bank ICICI Bank Indus Ind Bank ING Vysya Bank Jammu & Kashmir Bank Karnataka Bank Karur Vysya Bank Kotak Mahindra Bank Ltd Lakshmi Vilas Bank Ltd Bank of Rajasthan Ratnakar Bank Ltd South Indian Bank Tamilnad Mercantile Bank Ltd