Financial Sector Reforms and Bank Efficiency in Developing Countries : Lessons from India

In 1991, decades of government stranglehold on the economy gave way to liberalization and reforms in India. Financial sector reforms played a major part in this push towards a more market oriented economy. Based on the recommendations of the first Narasimham Committee, the Reserve Bank of India sought to create a more efficient and reliable banking system by implementing a three pronged strategy that involved (a) deregulation (b) competition and (c) reliability. The primary focus of this paper therefore is to study the extent to which the quot;three pillarsquot; that support the financial reforms have affected bank performance. Specifically, we address two questions: have banks become more efficient and productive after the reforms, and which strategies have had the greatest impact? We find evidence that the liberalization process has had a significant impact on some bank performance measures. Preliminary results suggest: (a) the increase in competition after deregulation has had a positive impact on most measures of performance and productivity, (b) public sector banks have gained as much as private banks though there is no difference between the two sectors if we include the dominant State Banks of India, (c) improved private sector profitability has taken the form of new banks expanding output as opposed to established banks reducing costs, and (d) non performing loans have a consistently significant and negative impact on profitability