Professional Documents
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A Statistical Analysis
Abstract
The economic reforms in India started in early nineties, but their outcome is visible now.
Major changes took place in the functioning of Banks in India only after liberalization. Due
to reforms in the 1990s, the depth and width of financial system in India has improved.
Though role of banks as financial intermediaries has reduced gradually, market share of
banks continues to remain the largest in the financial market (CRIS INFAC Banking Annual
Review: August, 2002). Increased competition, new information technologies and thereby
declining processing costs, the erosion of product and geographic boundaries, and less
restrictive governmental regulations have all played a major role for Public Sector Banks in
India to forcefully compete with Private and Foreign Banks.
For the last five years, several agencies in India started comparing the working of
Industries, B-Schools, Banks, etc. on their performance over the past, through surveys. This,
some times gives a feel that pushing a person into waters who has not learnt about swimming
and asking him to compete with other professional racers. Keeping this point in mind, the
authors have taken the survey results on banks over a period of time and compared Indian
Public Sector Banks among themselves as a closed model and later with other banks as an
open model using various Statistical Techniques like Cluster Analysis.
This article deals with clustering the banks during the period of study and then finding out
the common features of these clusters. The research also focuses on the factors that made the
banks moving from one cluster to another.
Banking in India was defined under Section 5(A) as "any company which transacts
banking, business" and the purpose of banking business defined under Section
5(B),"accepting deposits of money from public for the purpose of lending or investing,
above-mentioned primary functions, they are also permitted to do other types of business
referred to as Utility Services for their customers (Banking Regulation Act, 1949).
During Britishers' time, three Presidency Banks were opened in Bengal (1809), Bombay
(1840) and Madras (1843) with powers to issue Notes. In the year 1921, due to banking
crisis during First World War, the three Presidency Banks merged to form Imperial Bank of
India. In the year 1955, after Independence, Imperial Bank of India was nationalized and
renamed as State Bank of India (SBI) with a primary mandate to go to rural areas by
opening at least 400 branches immediately. In the year 1957, the seven banks that were
earlier catering to the rulers of different areas or States viz., Patiala, Bikaner, Jaipur, Indore,
1980, Government of India nationalized 14 and 6 major banks respectively. After the
merger of New Bank of India with Punjab National Bank during the era of Financial Sector
Reforms, the number of PSBs became 27, which are under present study.
The type and nature of businesses handled by the Public Sector Banks have not been merely
confined to primary functions. Class Banking was replaced with mass banking primarily by
the Public Sector Banks by opening branches in remote parts of the country even without
basic amenities of life. Profit was not the motive for these bank branches for about 3
decades. Their personnel undertook barefoot banking in godforsaken areas and implemented
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various poverty alleviation schemes as directed by Reserve Bank of India (RBI) or
Government of India and Sate Governments concerned. The authorities were confident of
delivering credit to the needy masses through the channel of Public Sector Banking in the
name of "Priority Sector Advances" combining the subsidy or margin money supported
schemes. All these were aimed at generating income or employment to large number of rural
In India, till the eighties, the banks operated in a protected environment characterized by
administered interest rates, high levels of pre-emption in the form of reserve requirements
and directed credit. Financial and Banking sector reforms were initiated in India in 1991
against the backdrop of challenges faced by the Indian banks from within and outside the
banking system in the country as well as forces of globalization operating worldwide. The
accent of the reform process was to improve productivity and efficiency of the financial
In the present scenario of banking industry, competition among the banks is very severe.
The banks have been trying to find new avenues not only to retain the present customer
strength but also attracting new customers by offering hassle-free services. In the process,
strategies of certain banks, specially Public Sector Banks, are aiming to divide customers
into different segments on the basis of the type of service they would like to render and also
trying to segregate their servicing counters in their respective branches to enable customer
to have easy access to a particular transaction (Srinivasa Rao,K.S. and Rama Rao,U.,
1998).
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On the other side, Foreign Banks and old and new Private Sector Banks in India, have
business hours, introduction of new products and services like "Any Where Banking",
etc.. These new tools enabled them to improve the quality of service and introduce Value
The Indian economy under Liberalization, Privatization and Globalization (LPG) throws
mind-boggling process for existence and growth of the sector. WTO was established in
1995 and signing of WTO Agreement by Indian Government meant greater competition
from foreign and domestic bankers in terms of speed, sophistication and professionalism.
The banks are now expected to maintain transparency in their operational and financial
statements. However, in the deregulated virtual market, small banks with high Return On
Equity (ROE) will have an edge over the large banks. In fact, modern commercial banks
have to be much more agile in order to stay in the competitive market. Adoption of
Information Technology is vital for survival and growth of the sector and will fix the future
2. Literature Review
Industry experts and researchers all over the world studied the changes taking place in
changes, etc. were experienced in recent decades. The authors summarized similar
analogies in Indian environment specifically in case of Public Sector Banks during the
reforms era.
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The New Instititutional Economics carried out a short review of bank failures, etc.
techniques of bank restructuring used in different countries designed to assist the policy
makers and financial sector professionals under different circumstances (Andrew Sheng,
1991).
has broadened its product line considerably; State Street Bank & Trust Company narrowed
processing costs, erosion of product and geographic boundaries, and less restrictive
governmental regulations etc - all played a role (Dwight B. Crane and Zvi Bodie, 1996).
Hasan, Iftekhar and Marton, Katherin (2003) analyzed the experiences and developments
privatization, and liberal policies towards foreign banks' helped to build a relatively stable
Went, Peter (2003) analyzed a merger between two Scandinavian Universal Banks to
determine arguments for the same. It was a response to changes in legislative and
integrating a smaller, more successful bank into a state-owned bank.. The most important
5
Kippers et al (2003) in their paper, presented a study, based on two rather unique data sets.
They used descriptive statistics and a sophisticated model, designed for this specific
purpose, to see whether two basic premises of the theories on optimal ranges are valid. In
contrast to the widely accepted assumptions, they found that individuals appear not to pay
efficiently and that are also not indifferent to use of coins and notes.
Following entry into European Community in 1986, Portugal transformed its repressed
banking system with deregulation and privatization. In such competitive banking system,
quantified the magnitude of efficiency gains over the years 1990-1995. The case of
Portugal provides unique information on the joint effect of deregulation and the granting of
new banking licenses on the change in operational efficiency of the banking system.
Rime et al (2003) examined the performance of Swiss banks from 1996 to 1999, using a
broad definition of bank output, evidence of large relative cost and profit inefficiencies. A
more narrow definition focuses on only traditional activities leading to efficiency estimates
that are even lower. Finally, evidence on scope economies is weak for the largest banks.
These results suggest few obvious benefits from the trend towards larger, universal banks
in Switzerland.
With the phenomenal growth of B2C e-commerce, most industries including banking and
financial services sector have been influenced, in one way or another. Customers have not
adopted B2C e-commerce in the same degree primarily because of risk concerns. This
services context by looking into the elements of e-banking. A conceptual model was
proposed with two main antecedents that influence customer's trust: perceived security and
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perceived privacy. Trust is being defined as a function of the degree of risk involved in the
e-banking transaction, and the outcome of trust is proposed to be reduced perceived risk,
A focus on branch banking is a necessity despite rising usage of online banking. Comments
from Raj Dhinsa, a senior analyst at market-watcher Jupiter Research, regarding Bank of
functions by the end of 2003, indicating that it is much less (Brooks, Rick and Forelle,
Charles, 2003).
Efforts of banks in the 1990s to push the account holders to Automated Teller Machines;
View of the author that the announced merger of Bank of America with FleetBoston
Financial Corporation could bring benefits to the customer; (Hallinan, Joseph T., 2003)
Comments on a banking rule that prohibited linking loans and services in the United States
debate over the "tied lending" rule is supposed to ensure that no one bank has dominance
over bank credit, according to bank regulator John D. Hawke Jr. (2003), Comptroller of the
Currency. The idea was that cross-selling and cross-marketing are ordinary business
In India, the RBI constituted several committees from time to time with different
eighties and nineties. Public Sector Banks have started experiencing the ill effects of
traditional methods adopted till then. Change in policy at the apex level, advent of
technology, threat of competition from foreign and private sector banks was felt during the
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remarkable changes in products and policies of the banks in India. A list of the Committees
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1999 Vasudevan Upgrading the existing technology in Commercial Banks
1999 Y V Reddy International Financial Standards and Codes
1999 N K Puri Introduction of a comprehensive Return to efficiently
monitor the international claims and liabilities, etc
2000 S R Mittal Different aspects of Internet Banking for regulation etc
2001 A S Ganguly Consultative Group of Directors in Banks and F I s
2002 G Ramachandran Review of working of Local Area Banks
(Source: Indian Banking Year Book, Indian Banks Association, Mumbai, 2002)
Having noted the global changes and keeping in view several recommendations and policy
changes due to reforms in banking sector, the authors have also surveyed some papers on
banks during early stages (1986-1991) prior to liberalization. They used Data Envelopment
Analysis to calculate radial technical efficiency scores and Stochastic Frontier Analysis to
component, an ownership component, and a random noise component. They found that
publicly owned Indian banks to have been the most efficient, followed by foreign-owned
banks and privately owned Indian banks. It was an attempt to explain these patterns in
primary function of banking by lending to the constituents of economy, they stand a chance
By 2001, the Indian financial sector entered its 10th year of reforms, which have touched
upon almost every segment. Nevertheless, it experienced major reforms and has come far
9
away from the days of nationalization. The Narasimham Committee laid the foundation for
reforms in the Indian banking sector and paved way for enhancing its efficiency and
viability. With India becoming a member of WTO, it had to be opened up for international
players and to prepare the Indian banking industry for a vibrant global competition. As the
international standards became prevalent, banks had to unlearn their traditional operational
methods of directed credit, directed investments and administered interest rates. Moreover,
increase in the number of banks, transparency of banks' balance sheets through prudential
norms and increase in the role of the market forces due to deregulated interest rates have all
made by India in the WTO Financial Services Agreement in December 1997 had a
significant impact on the banking industry (M. Thenmozhi and R. Kishore Kumar, 2001).
Technology and competition have brought about notable changes in the Indian banking
today. From Internet Banking to Cash Management Services, technology has changed both
in retail and wholesale banking. Banks have been slow to adapt to the changing times
the state owned banks opposed to introduction of new technology. Moreover, with lines of
demarcation between banks and financial institutions blurring, the focus has shifted to
offering all assets (e.g. loans) and liabilities (e.g. deposits) products under one roof heading
The impact of reforms on banking sector varies from changing their constitution, cost of
operations, reporting norms and ultimately their profitability. The predominance analysis of
banks was undertaken. The reforms associate themselves with vision, vigour and vitality
and a mission to strengthen the Indian economy (AV. Aruna Kumari, 2002).
10
Globalization can lead to suspicion, protectionism, and policies that are ultimately self-
destructive. Such fears cannot be allowed to frustrate the great potential of a world. The
author believes that countries can face the challenges of globalization positively
Banking in the new millennium will be marked by high expectations of customers who are
well informed and possess technical knowledge. Computers are rapidly taking over the
functions and personalized service will continue to have relevance. The sum and substance
of banking activity in future will boil down to one simple prescription: Customer Delight
(K.Sivaloganathan, 2002).
Sathye (2003) measured the productive efficiency of banks in India. It was done using Data
Envelopment Analysis. The study shows that the mean efficiency score of Indian banks
compares well with the world mean efficiency score and the efficiency of private sector
commercial banks, as a group is paradoxically lower than that of public sector banks and
foreign banks in India. The existing policy of reducing Non-Performing Assets and
rationalization of staff and branches may be continued to obtain efficiency of Indian banks
internationally competitive.
To sum up, Indian Public Sector Banks as well as others have transformed from mere
collectors of deposits and purveyors of credit as per directions of the Government or RBI to
highly competitive financial outfits in course of the past 12 years ever since Financial
Sector Reforms were introduced. Various measures taken by the regulator were
(1) Prudential Norms and transparency of Balance Sheets (2) Capital Adequacy
requirements and 4-way classification of Assets (Loans and Investments) (3) Gradual
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reduction of SLR and CRR stipulations (4) Provisioning Norms (5) Deregulation of Interest
Rates (6) Creation of Debt Recovery Tribunals, BIFR, etc., (7) Enactment of new laws or
shifting or combining of loss making branches (13) Voluntary Retirement Scheme for
employees (14) Investment in Hardware, Software and training of staff (15) permission for
All these measures have definitely aided in reduction of costs, improving productivity and
profitability of banks, strengthening of capital and funds base of banks, reduction of multi-
tier decision making levels, speedier collection and transfer of funds, investor education
and information dissemination through use of Internet, offering innovative products and
services, spread of banking habits among all sections of society, competition with foreign
and new generation private sector banks, etc. Customer is now seriously considered as king
and all efforts are being made to suit his needs and meet the demands by tailoring various
Cocheo, Steve (1982) focused on the adaptability of bankers to economic conditions in the
Northeastern States, basis of state boundaries in the ranking of banks; Need for projecting a
percentage return on average foreign and domestic assets to perform at high levels, etc.
the United States for 1993, total assets; Tier one capital ratio; credit quality ratios,
12
profitability revenue mix, total revenues, ‘U.S. Bankers’ composite score were discussed in
U.S.Banker.
Thomas, Tony (1995) highlighted the results of KPMG’s 1995 ratings of Australian banks’
strength and efficiency; overall ranking of banks; Ratio of write-offs to loans; Capital
adequacy ratio; Return on net assets; Levels of derivatives; Interest margins and spreads.
Ozanian, Michel K. and Bradford, Stacey, L. (1996) focused on the stock performance of
top banks in the United States as of July 8, 1996. Total asset value of bank takeovers;
Trend towards increasing the percentage of non-interest income versus interest income;
List of top performing banks in the United States; Measures used in ranking the banks. In
1996, World of Banking dealt with ranks of the 20 biggest banks in Russia in respect of
share of gross assets and net assets ratio; Consequences of the country’s banking crisis;
Outflow of deposits from commercial banks and trust companies; Public’s wariness
States; what performance ranking of banks provides; Selection of the criteria used to
In 1998, American Banker presented statistical information on the rankings of banks, thrift
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Eisenbeis et al (1999) examined the properties of the X-inefficiencies in bank holding
companies in the Unites States derived from both stochastic and linear programming
ranking of banks’ efficiencies under the two methods; Relationship of the stochastic
Altunbas et al (2001) examined efficiency ranking of banks through Translog cost function
Implications of efficiencies and scale economies for the financial sector regulation
It also presents several charts depicting the rankings of banks based on financial
3. Ranking of Banks
Numbers count. But they never tell the full story. Traditionally, it was the norm to rank
companies and banks on the basis of their sales or assets with an assumption – the biggest
is the best. Today in the era of mega-mergers, there are still some who swear by this old-
fashioned thinking. Others have graduated a bit. Their idea of ranking is to involve a large
number of ratios and indicators, juggle with weightages and finally come up with relative
scores. There is something to be said for this approach. It is objective and eliminates
biases. But even if it still works for the manufacturing sector, it fails in any service
dollars. It is all about service. Convenience, Comprehensive Service and a Smiling Face
are things you cannot put numbers to. Besides, any number-crunching exercise always
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throws up some absurdities. There could be banks that score very high on, for instance,
Asset Quality. But their lack of Non Performing Assets (NPA) is not necessarily because
they are canny lenders, it is more because they do not lend at all. Can they be termed
banks at all if they are not involved in what should be one of their primary functions?
One side, State Bank of Patiala has recorded a net profit of Rs.161.10 crores for 2000-01
and ranked number 13 and SBI that has posted a net profit of Rs. 1604.25 crores for the
year ended March 31, 2001, got a rank of 27 (Bank Indices, 2001, Banking & Finance,
2002).
CAMELS stands for Capital Adequacy, Asset Quality, Management, Efficiency, Liquidity
and Systems with reference to reforms in Banking Sector. Business magazines, with the
help of private agencies, have been taking up ratings of banks for the last seven to eight
years. One agency’s survey is totally different from the others and peculiarly the same
agency is changing their parameters next year, making the public more confused about the
ranks. Such surveys every year on banks make Public Sector Banks to compete with
Private Sector Banks and Foreign Banks. This, some times, gives a feeling that asking a
physically challenged person to compete in a race along with a group of perfectly fit
persons. This made the authors to think in the direction of comparing Public Sector Banks
among themselves first in Closed Model and then comparing them with the Private Sector
4. Closed Model
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The authors have taken the cross-sectional data from the past survey results on banks
(Banking & Finance, 2002) and compared the 27 Public Sector Banks among themselves as
a closed model (Annexure-1). The four factors, based on the financial and business
indicators, have been considered are - Efficiency, Financial Strength, Profitability and Size
& Scale for these Public Sector Banks (Annexure-2). Each of the factors is given an equal
weightage of 25%. Each parameter within a Factor is ranked by giving equal weightage
Efficiency is a composite of (1) Cost of Funds (CF**), (2) Ratio of intermediation costs to
total assets (Total Expenses / Assets) (TE / A**), (3) Burden – total non-interest expenses
minus total non-interest income divided by total assets (B**), (4) Business per Branch
(BPB), and (5) Operating Profit per Employee (OPPE). The parameters marked as ** are
Financial Strength is a composite of (1) Capital Adequacy Ratio (CAR) – Tier I + Tier II,
(2) NPA level (net NPAs to net advances) (NPA to NA**), and (3) Leverage (total debt / net
worth) (L**). The parameters marked as ** are ranked in ascending order while other
Profitability is a composite of (1) Net Interest Spread (IS), (2) Operating Profit to Average
Working Funds (OP to AWF), (3) Return on Assets (RNP / AWF and (4) Return on Equity
(RE). The parameters marked as ** are ranked in ascending order while other parameters
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Size & Scale is a composite of (1) Aggregate Deposits (AD), (2) Average Working Funds
(AWF), (3) Operating Profits (OP), Net Profits (NP), and Credit + Investment Deposit
The authors have then carried out Cluster Analysis for these 27 Public Sector Banks. They
came out as 5 clusters based on each of the four factors (Annexure-3). The authors also
have done the overall ranking on four factors - Efficiency, Financial Strength, Size & Scale
and Profitability combined as Total and have done Cluster Analysis for these 27 banks and
5. Open Model
The authors have taken the cross-sectional data from the past survey results on banks
(Banking & Finance, 2002) and compared the Public Sector Banks with Private Sector
Banks and Foreign Banks as an open model (Annexure-4). Data was available for all 98
commercial banks in India for the first two years only. Subsequently, due to closures,
mergers & acquisitions, etc., data was available only for 87 banks. These were compared
under this open model. The four factors, based on the financial and business indicators,
have been considered are - Efficiency, Financial Strength, Profitability and Size & Scale for
all these Banks (Annexure-5). Each of the factors is given an equal weightage of 25%.
Each parameter within a Factor is ranked by giving equal weightage across all the banks.
Similar to earlier Closed Model exercise, Efficiency is a composite of (1) Cost of Funds
(CF**), (2) Ratio of intermediation costs to total assets (Total Expenses / Assets) (TE /
A**), (3) Burden – total non-interest expenses minus total non-interest income divided by
total assets (B**), (4) Business per Branch (BPB), and (5) Operating Profit per Employee
17
(OPPE). The parameters marked as ** are ranked in ascending order while other
Financial Strength is a composite of (1) CAR – Tier I + Tier II, (2) NPA level (net NPAs to
net advances) (NPA to NA**), and (3) Leverage (total debt / net worth) (L**). The
parameters marked as ** are ranked in ascending order while other parameters are in
descending order.
Profitability is a composite of (1) Net Interest Spread (IS), (2) Operating Profit to Average
Working Funds (OP to AWF), (3) Return on Assets (RNP/AWF) and (4) Return on Equity
(ROE). The parameters marked as ** are ranked in ascending order while other parameters
Size & Scale is a composite of (1) Aggregate Deposits (AD), Average Working Funds
(AWF), (3) Operating Funds (OP), (4) Net Profits (NP), and (5) Credit + Investment
The authors have done Cluster Analysis for all the banks and it came out as 5 clusters based
on each of the four factors (Annexure-6). The authors have also done the overall ranking
of the four factors - Efficiency, Financial Strength, Size & Scale and Profitability combined
as Total and have done a Cluster Analysis for these 87 banks and it came out as 5 clusters
based on Total.
6. Transitional Analysis
18
The authors have computed the mobility of the banks from one cluster to another over the
period of study in closed model (Annexure-7) and open model (Annexure-8), keeping in
mind the framework of Srinivasa Rao, K.S. and Srinivasa Rao, K. (1994).
After computing all the scores for the four parameters converted as total, the authors have
graded the banks into four categories. These are best (score less than 4), better (with score
4 – 6), good (with score 7 – 9) and moderate banks (with scores 10 and above).
In Closed Model, 8 out of 27 banks viz., Bank of Baroda, Corporation Bank, Oriental Bank
of Commerce, State Bank of India, Canara Bank, Punjab National Bank, State Bank of
Hyderabad and State Bank of Patiala were graded as best banks. In the remaining 19
banks, 3 were graded as better, 7 as good and 9 were graded as moderate banks.
In Open Model, 12 out of 98 banks were not continued throughout the period of study. Out
of 86 banks, 11 were graded as best banks viz., Bank of America, Citibank N.A., Deutsche
Bank AG, Corporation Bank, HDFC Bank, ABN-Amro Bank N.V., Global Trust Bank,
HSBC, ICICI, Oriental Bank of Commerce, Standard Chartered Bank. In the remaining
banks, 8 were graded as better, 39 as good and 26 were graded as moderate banks.
7. Conclusion
Indian Public Sector Banks have been operating in different economic and political
conditions for several decades – earlier as Private Sector Banks and now in Public Sector
subsequent to their nationalization. They have been functioning as commercial and profit
oriented establishments for long period but due to the developmental policies of the
Government of India, profit making was given a go-by. The transition in political and
19
economic conditions in the country took place in later years of eighties and simultaneously
technological and legal changes have also gained importance. Thanks to the Financial
Sector Reforms initiated during early nineties, the focus has shifted to productivity,
profitability, efficiency, transparency, etc in order to make them work on high standards
However, the story does not end here. Radical changes in accounting, deregulation of
interest rates, close follow up of non performing assets, introduction of prudential norms,
voluntary retirement of old generation staff, concern for total customer care, professional
managements, have made the managements (including the GOI) to turn to generate
surpluses and make these banks self-sufficient even by approaching the Capital Market.
banking system, Public Sector Banks will gear up and reach to their pinnacle in
performance and delivering the expected levels of service in about 4 –5 years from now.
The authors suggest that the managements of these 27 banks will give a thorough look into
all the aspects of study, diagnose the reasons for the outcomes, and assess their strengths
Acknowledgements
The authors highly acknowledge their gratitude to the Chairman, ICFAI International
Conference Committee and to the reviewers who have given a positive feedback on their
paper. The authors are very much thankful to Prof.D.Nagabrahmam, Director, TAPMI for
the encouragement and support.
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List of Abbreviations
23
11. Return on Assets (RNP / AWF)
24