India embarked on a strategy of economic reforms in the wake
of a serious balance-ofpayments crisis in 1991. A central plank of the
reforms was reform in the financial sector and, with banks being the
mainstay of financial intermediation, the banking sector. The objective
of the banking sector reforms was to promote a diversified, efficient
and competitive financial system with the ultimate objective of
improving the allocative efficiency of resources through operational
flexibility, improved financial viability and institutional
strengthening. Beginning from 1992, Indian banks were gradually exposed
to greater domestic and international competition. India’s approach to
banking reforms has been somewhat different from many other countries.
Whereas there has not been privatisation of public sector banks, through
a process of partial disinvestment a number of public sector banks have
been listed in Stock Exchanges and have become subject to market
discipline and greater transparency in this manner. Besides, newly
opened banks from the private sector and entry and expansion of several
foreign banks resulted in greater competition. Consequent to these
developments, there has been a consistent decline in the share of public
sector banks in total assets of commercial banks and a declining trend
of Herfindahl’s concentration index. Improvements in efficiency of the
banking system were reflected in a number of indicators, such as, a
gradual reduction in cost of intermediation (defined as the ratio of
operating expense to total assets) in the post reform period across
various bank groups (barring foreign banks), and decline in the
non-performing loans. As a result of these changes, there has been an
all-around productivity improvement in the Indian banking sector. While
the cost income-ratio (i.e., the ratio of operating expenses to total
income less interest expense) as well as net interest margin (i.e., the
excess of interest income over interest expense, scaled by total bank
assets) of Indian banks showed a declining trend during the post-reform
period, the business per employee of Indian banks increased over
three-fold in real terms exhibiting an annual compound growth rate of
nearly 9 percent. At the same time, the profit per employee increased
more than five-fold, implying a compound growth of around 17 percent.
Branch productivity also recorded concomitant improvements. Such
productivity improvements in the banking sector could be driven by two
factors: technological improvements, which expands the range of
production possibilities and a catching up effect, as peer pressure
amongst banks compels them to raise productivity levels. As far as the
future of Indian banking is concerned, a number of issues, such as the
credit to small and medium enterprises, customers’ interests and
financial inclusion, reducing procedural formalities, listing of the
public sector banks in the stock exchange and related market discipline
are of paramount importance.
The Performance of Economic Sectors and Their Growing Non-Performing Assets in India
