An obvious question that emerges from the reforms is whether or not they were helpful for the Indian Banking system, and there exists a vast amount of literature that states that these reforms were helpful in improving the efficiency of the Indian banks. Bhattacharya (1997) conducted a study using 23 years of data from 1970-1992 and found that total factor productivity was increasing at a rate of 2%, but during the deregulation period the growth rate for total factor productivity was 7%, indicating that the reforms were effective in the early stages. Ram Mohan and Ray (2004) conducted a study where they used 8 years of data from 1992 – 2000 and concluded that there was a convergence in performance between public and private banks in the post reform era and that public sector banks performed significantly better than private sector banks in terms of revenue maximization efficiency. They allocate the superior performance of the public banks to higher technical efficiency. A study done by the Reserve Bank of India (2008) states that efficiency has improved across all bank groups over the period 1991-2007. The report performs a comprehensive study on “resource mobilization, management of risk and capital and lending and investment operation” of banks to come to this conclusion.
6
Developmental financial institutions is defined by the RBI as “an institution promoted or assisted by Government mainly to provide development finance to one or more sectors or sub-sectors of the economy” (RBI, May 2004)
26 The period from 1980 – 2010 has not been studied in the existing literature. This period is interesting because two sets of reforms were introduced in the span of this 30 year period. This period ensures enough time for the implementation and for the effects for these reforms to take place. However, this paper analyzes the effects of the reforms on the profitability of these banks over this period. The positive effect of these reforms on loans, savings, and other balance sheet items has been studied by many notable economists in India and worldwide. As mentioned above, economists have found positive effects from the reforms; however, very few studies have focused on profitability of the banking sector. The two main publications used to gather all the data were the Handbook of Statistics on the Indian Economy and Statistical Tables Relating to Banks of India. RBI published a compilation of bank data for the past 30 years on March 3rd, 2011. This was the main source of data for all the regressions and ratios in this chapter. GDP Growth Rate was downloaded from IMF‟s World Economic Outlook database. This section analyzes the profitability of the banks in the wake of the first and the second set of reforms using yearly data from 1980-2009.
Table 3.3 and 3.4 display the regression results for the profitability indicators on the public and private banks. Equation (1) in table 3.3 and 3.4 suggests that CRR has a negative relationship with return on assets (ROA) and is statistically significant. CRR affects private banks more than public banks, a one percentage point increase in CRR will lead to a 1.02
percentage point decrease in ROA for private banks holding everything else constant; however a one percentage point increase in CRR will decrease the ROA of public banks by only -0.3 percentage points, holding everything else constant.
27 Table 3.3: Regression Results for Public Banks
Dependent Variable ROA ROE Net Interest Margin to Assets
Independent Variable (1) (2) (3) CRR -0.30** -0.34** 0.06 (0.10) (0.09) (0.08) SLR -0.06 0.00 -0.06 (0.07) 0.00 (0.05) GdpGrowth -0.03 -0.03 0.01 (0.09) (0.09) (0.08) Minimum_Lending_Rate 0.35* 0.29 -0.05 (0.16) (0.15) (0.13) Constant -0.89 -21.08 4.92*** (1.84) (49.96) (1.36) Observations 20 20 20 Adj. R-Squared 0.51 0.51 -0.03
Standard errors in parentheses *** p<0.001, ** p<0.01, * p<0.05;
Table 3.4: Regression Results for Private Banks
Dependent Variable ROA ROE Net Interest Margin to Assets
Independent Variable (1) (2) (3) CRR -1.02** -0.08* -0.19* (0.31) (0.03) (0.09) SLR -0.15 -0.02 -0.03 (0.20) (0.02) (0.06) GdpGrowth 0.62* 0.06 0.15 (0.28) (0.03) (0.08) Minimum_Lending_Rate 0.9 0.09 0.21 (0.48) (0.05) (0.13) Constant 4.66 0.19 0.11 (4.96) (0.55) (1.38) Observations 20 20 20 Adj. R-Squared 0.51 0.51 -0.03
Standard errors in parentheses *** p<0.001, ** p<0.01, * p<0.05;
Equation (2) in table 3.3 and 3.4 outlines the relationship between ROE and CRR. Since the equity multiplier of the public banks is so high, the effect of CRR on ROE is greater on public banks than on private banks. ROE and CRR have a strong negative relationship,
28 statistically significant as well. If CRR decreases by one percentage point the ROE of public banks should increase by 0.34 percentage points, and the ROE of private banks should increase by 0.08 percentage points holding everything else constant. The ROA of public banks have a positive relationship with the minimum lending rate, statistically significant at the 90% level. If the minimum lending rate increases that will increase interest income for the banks and lead to a higher net income which would lead to a higher return on assets. Equation (1) of table 3.3 suggests that a one percentage point increase in the minimum lending rate should increase the ROA of public banks by 0.35 percentage points, holding everything else constant. Net Interest Margin to Assets has a negative relationship with CRR statistically significant at the 5% level, as stated by equation (3) in table 3.4. For a one percentage point increase in CRR the net interest margin to assets ratio will decrease by 0.19 percentage points holding everything else constant. The reforms in 1991 that helped decrease the CRR and the SLR were definitely profitable for the private and public banks, as they helped increase the profitability of the banking industry of India. 7