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Indian Business Environment Essay

Abstract

One of the major objectives of Indian banking sector reforms was to encourage operational self-sufficiency, flexibility and competition in the system and to increase the banking standards in India to the international best practices. The second phase of reforms began in 1997 with aim to reorganization measures, human capital development, technological up-gradation, structural development which helped them for achieving universal benchmarks in terms of prudential norms and pre-eminent practices. This paper seeks to determine the impact of various market and regulatory initiatives on efficiency improvements of Indian banks.

Efficiency of firm is measured in terms of its relative performance that is, efficiency of a firm relative to the efficiencies of firms in a sample. Data Envelopment Analysis (DEA) has used to identify banks that are on the output frontier given the various inputs at their disposal. The present study is confined only to the Constant-Return-to-Scale (CRS) assumption of decision making units (DMUs). Variable returns to scale (VRS) assumption for estimating the efficiency was not attempted. It was found from the results that national banks, new private banks and foreign banks have showed high efficiency over a period time than remaining banks.

II. Reforms and Banking system

In the post liberalization-era, Reserve Bank of India (RBI) has initiated quite a few measures to ensure safety and consistency of the banking system in the country and at the same point in time to support banks to play an effective role in accelerating the economic growth process. One of the major objectives of Indian banking sector reforms was to encourage operational self-sufficiency, flexibility and competition in the system and to increase the banking standards in India to the international best practices 4. Although the Indian banks have contributed much in the Indian economy, certain weaknesses, i.e. turn down in efficiency and erosion in profitability had developed in the system, observance in view these conditions, the Committee on Financial System(CFS) was lay down. Reserve Bank of India has implemented banking sector reforms in two phases. The first reform focused on introduction of several prudential norms, major changes in the policy framework, and formation of competitive atmosphere.

The second phase of reforms began in 1997 with aim to reorganization measures, human capital development, technological up-gradation, structural development which helped them for achieving universal benchmarks in terms of prudential norms and pre-eminent practices. The Financial sector reforms were undertaken in 1992 based on the recommendations of the CFS. Later, The Narsimham Committee has provided the proposal for reforming the financial sector. The committee also argued that ‘economic reforms in the real sector of economy will, however, fail to realize their full potential without a parallel reform of the financial sector.

It focused on several issues like, releasing of more funds to banks, deregulation in interest rates, capital adequacy, income recognition, disclosures and transparency norms etc. However, financial sector reforms focused on improving the competitive efficiency of the banking system. The financial reform process has commenced since 1991 which was made the banking sector healthy, sound, well- capitalized and become competitive. The competitive pressures to improve efficiency in the banking sector has resulted in a switch from traditional paper based banking to electronic banking, use information technology and shift of emphasis from brick and mortar banking to use of ATMs.

INDIAN BUSINESS ENVIRONMENT IN BANKING INDUSTRY

Indian banking industry, the backbone of the country’s economy, has always played a key role in prevention the economic catastrophe from reaching terrible volume in the country. It has achieved enormous appreciation for its strength, particularly in the wake of the worldwide economic disasters, which pressed its worldwide counterparts to the edge of fall down. If we compare the business of top three banks in total assets and in terms of return on assets, the Indian banking system is among the healthier performers in the world. This sector is tremendously competitive and recorded as growing in the right trend (Ram Mohan, 2008). Indian banking industry has increased its total assets more than five times between March 2000 aThe overall development has been lucrative with enhancement in banking industry efficiency and productivity. It should be underlined here is financial turmoil which hit the western economies in 2008 and the distress effect widened to the majority of the other countries but Indian banking system survived with the distress and showed the stable performance.

Indian banks have remained flexible even throughout the height of the sub-prime catastrophe and the subsequent financial turmoil. The Indian banking industry is measured as a flourishing and the secure in the banking world. The country’s economy growth rate by over 9 percent since last several years and that has made it regarded as the next economic power in the worldnd March 2010, The Indian banking industry is measured as a flourishing and the secure in the banking world. The country’s economy growth rate by over 9 percent since last several years and that has made it regarded as the next economic power in the world. Our banking industry is a mixture of public, private and foreign ownerships. The major dominance of commercial banks can be easily found in Indian banking, although the co-operative and regional rural banks have little business segmentIn the post liberalization-era, Reserve Bank of India (RBI) has initiated quite a few measures to ensure safety and consistency of the banking system in the country and at the same point in time to support banks to play an effective role in accelerating the economic growth process.

One of the major objectives of Indian banking sector reforms was to encourage operational self-sufficiency, flexibility and competition in the system and to increase the banking standards in India to the international best practices. Although the Indian banks have contributed much in the Indian economy, certain weaknesses, i.e. turn down in efficiency and erosion in profitability had developed in the system, observance in view these conditions, the Committee on Financial System. Reserve Bank of India has implemented banking sector reforms in two phases. The first reform focused on introduction of several prudential norms, major changes in the policy framework, and formation of competitive atmosphere. The second phase of reforms began in 1997 with aim to reorganization measures, human capital development, technological up-gradation, structural development which helped them for achieving universal benchmarks in terms of prudential norms and pre-eminent practices.

The Financial sector reforms were undertaken in 1992 based on the recommendations of the CFS. Later, The Narsimham Committee has provided the proposal for reforming the financial sector. The committee also argued that ‘economic reforms in the real sector of economy will, however, fail to realize their full potential without a parallel reform of the financial sector. It focused on several issues like, releasing of more funds to banks, deregulation in interest rates, capital adequacy, income recognition, disclosures and transparency norms etc. However, financial sector reforms focused on improving the competitive efficiency of the banking system. The financial reform process has commenced since 1991 which was made the banking sector healthy, sound, well- capitalized and become competitive. (CFS) was lay down. Liberalisation of India’s banking sector

• Liberalisation of India’s banking sector begun since 1992, following the Narasimhan Committee’s Report (December 1991)
• Important recommendations of the Committee were –

[i] reduction of statutory pre-emptions (SLR and CRR)
[ii] deregulation of the interest rates
[iii] opening up the sector to foreign and domestic private banks [iv] adoption of prudential regulations relating to capital adequacy, asset classification and provisioning standards

Service firms such as ITC Hotels and ANZ Grindlays Bank found direct marketing very effective in retailing customers and weathering competition. • The Indian banking system is growing in a robust manner. • The Indian banking system complies with international standards of prudential regulation. • The Indian banking system is opening up for entry of foreign banks. • Despite the growth, Indian banking system is not entirely inclusive. • There is good opportunities for the banking industry – domestic and foreign – for expansion to fill the gap.

A decade after the Narasimham report was published and in the light of new challenges from the norms laid down by the WTO and Basel II, it is imperative to have a close look at the performance of banks in the last decade or so to assess the success of the reform process. INDIA inherited a very weak banking system following Independence. However, the nationalisation programme (1969) helped this sector achieve remarkable success in many respects. The stability among depositors, penetration into rural India and the consequent reduction in poverty and diversification out of agriculture were some of its laudable achievements. Given the predominantly bank based nature of financial system, the banking industry gained the reputation of one of the most protected in the country.

However, in the 1990s a chain of events such as introduction of modern technologies, competition from new players in the liberalised market place, and enhanced emphasis on governance to protect shareholder interest changed the way banks conducted business. The Indian banking sector with its diversity of ownerships — State Bank of India and its associates, nationalised banks, private domestic banks and foreign banks also faced a similar set of challenges. Although the public sector banks acquired a dominant presence thanks to the regulatory environment, several of them performed poorly in the late 1980s. To preserve the soundness of the financial system, especially the banking segment, the Government set up the Narasimham Committee.

The Committee (in 1991) made far-reaching recommendations that formed the basis of banking reforms. Some of the comprehensive reform measures suggested included: Stricter income recognition and asset classification, higher capital adequacy ratio, phased deregulation of interest rate, lowering statutory liquidity ratio (SLR) and cash reserve ratio (CRR), entry deregulation, and branch-de-licensing. These measures mainly aim to improve the efficiency/profitability of banking industry. A decade and half after the Narasimham report was published and in the light of the World Trade Organisation and Basel II norms, it is imperative to have a close look at the performance of banks in the last decade or so to assess the success of the reform process.

Performance indicators

Commonly-used measures to assess the performance of the banking industry are: Return on Asset (ROA), Operating Profit Ratio (OPR), Net Interest Margin (NIM), Operating Cost Ratio (OCR) and Staff Expenditure Ratio (SER). The first two are generally considered profitability measures, while the others, the efficiency indices. These five measures have been considered in this analysis for two sub-periods: Pre-liberalisation (1992-1995) and post-liberalisation (2000-2003). The total number of banks considered for two sub-periods were 64 (eight State Banks, 19 nationalised banks, 19 private banks and 18 foreign banks) and 87 (8, 19, 28 and 32 respectively).

Overall performance improvement

A comparison of performance indices during the study period reveals that the reform measures helped to improve the overall performance of industry. This is reflected in the improvement of all performance indicators barring the net interest margin (see Table). Interestingly, the ROA, treated as a proxy for risk-adjusted return, increased from (-) 0.28 per cent in the pre-liberalisation period to 0.79 per cent (against more than 1 per cent in other merging markets such as Singapore, Malaysia and Korea) post-liberalisation, indicating a significant rise in the ability of banks to convert their assets into net earnings. Another interesting aspect is that despite a marginal fall in the net interest margin from 2.84 to 2.73 (which might be due to policy change), the banking industry has managed to improve its OPR by increasing its non-interest fee-based income and reducing its operating costs/staff expenses.

The evidence indicates that after the reform initiation period, the banks have increasingly been providing off balance sheet items such as derivatives, which generate major part of non-interest income. The proportion of operating costs/staff expenses has declined mainly due to computerisation and the voluntary retirement scheme. The property rights theorists believe that the private banks are more efficient than their counterparts in the public sector. This view is corroborated by the public choice theorists who argue that the specific X inefficiency factors are more prevalent in the public sector, irrespective of market conditions. Further, many cross-country findings report an increased government ownership as a deterrent to the development of the banking system.

The Indian banking scenario seems to be consistent with the above, as the privately owned (foreign as well as domestic) banks seem to be superior to their public counter parts with respect to all performance indicators except the NIM. Despite a fall in their OPR and NIM between 1992-95 and 2000-03, the private banks successfully managed to reduce their operating expenditures, particularly the staff expenditures, thereby successfully maintaining their status. Among private banks, the foreign banks seem to be superior in terms of three out of five the criteria used.

Within the public domain, the State Banks tend to be superior with respect to ROA, OCR and SER, while the nationalised banks seem to show better performance in terms of OPR and NIM. Thus, although there is a significant improvement in the overall performance of banks as one moves from the post-reform period to the late-reform period, one finds certain anomalies such as a fall in the NIM (except in the case of the nationalised banks), a fall in the ROA of private domestic banks, a reduction in the OPR of private domestic and foreign banks and a rise in the OCR/SER of foreign banks.

Convergence or divergence

Apart from the overall improvement across the board, another important criterion to evaluate the success story is to check whether the competitive force has led to any convergence in the performance of different ownership groups in the post-liberalisation period. Exposure to the competitive forces is often argued as a panacea to shake poorly performing banks out of their slumber. Although the public banks compared poorly with private banks during the initial period, they made a significant improvement in the later period by responding well to the new challenges of competition and consolidation, mostly following a gradual and cautious approach.

The pay off is well reflected in the increase in their ROA, OPR and NIM. Some possible reasons for the better performance of public banks could be they still undertake most of the government borrowing programmes, thereby generating significant fee based income; the market discipline imposed by the listing of most public sector banks has also probably contributed to this improved performance; and  the reform measures have changed their business strategies particularly greater diversification of non-fund based business and emergence of treasury and foreign exchange business. The study reveals that the OPR across four ownership groups tend to converge.

The NIM tend to converge across private and public sectors while the OCR continues to remain significantly different across ownership groups. The above analyses indicate that the banking sector performs reasonably well with respect to the goals set by the Narasimham Committee, particularly in the context of the poorly performing banks and showing some encouraging signs to meet the Basel II norms by 2006. However, one should not go over board in reading these numbers to evaluate the success of the Indian banking sector, particularly from the perspective of a developing economy such as ours.

Policy-makers should be extra cautious in giving free a reign to the banking sector in pursuing “profit and risk” based strategies. Recent trends in non-synergy based consolidation, growing disinclination to lend money towards productive purposes and to the unprofitable sectors such as agriculture, self-help groups, infrastructure and to small and medium sized enterprises, its growing engagement in non-productive treasury operations and conspicuous consumer lending will seriously impair the role of banks as public instruments of development. Therefore, maintaining a balance between these two objectives will remain a challenge to the banking sector for some time to come.

Bibliography-
* www.thehindubusinessline.com

* iimahd.ernet.in/assets/snippets/
*


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