Impact of Financial Crisis on Indian Banks

This blog attempt to investigates the impact of the 2007-2009 global financial crisis on the profitability of Indian banks. Here's a breakdown of the key points:

Context:

• Sound and well-regulated financial systems are crucial for economic stability.
• Banking crises can lead to economic slumps.
• The global financial crisis impacted many economies, but India seemed less affected initially.

Methodology:

• Banks are divided into public, private, and foreign ownership groups.
• The study period is 2003/04 to 2012/13.

The analysis presented in the study delves into the intricacies of profit efficiency across various ownership groups within the Indian banking sector, particularly focusing on the impact of ownership, technological advancements, and external factors such as the global financial crisis. Here's a comprehensive breakdown of the key findings:

Profit Efficiency Across Ownership Groups and Technology Gap Ratios:

• The study compares profit efficiency scores across different ownership groups, including public sector banks, old private banks, new private banks, and foreign banks.
• Foreign banks exhibit higher profit efficiency compared to domestic banks, with a significant margin over new and old private banks and a slight edge over public sector banks.
• Statistical tests confirm significant differences in efficiency distributions among ownership groups, supporting the global advantage hypothesis favoring foreign banks.
• During the global financial crisis, new private banks suffered the most in terms of profit efficiency, failing to recover post-crisis, while foreign banks remained relatively resilient.

Technology Gap Ratios and Innovation Leadership:

• Foreign banks demonstrate superior technology adoption, operating closer to the metafrontier, indicating advanced production technologies.
• Old private banks are identified as employing inferior production technology compared to other groups, with a larger gap from the metafrontier.
• Foreign banks emerge as technology leaders throughout the study period, although public sector banks exhibit increasing technological prowess in recent years.

Top and Worst Performers During the Crisis: 

• A substantial proportion of banks, particularly public sector banks, experienced significant declines in profit efficiency during the crisis, with foreign banks exhibiting more resilience.
• Axis Bank, HDFC Bank, and Bank of India were among the worst performers during the crisis, while Kotak Mahindra Bank and Yes Bank emerged as top performers.

Decomposition of Profit Inefficiency:

• Profit inefficiency is decomposed into profit gap inefficiency (PGIE) and relative inefficiency (RIE).
• Old and new private banks primarily suffer from profit inefficiency due to technology gaps, whereas public sector banks exhibit a more balanced contribution from both PGIE and RIE.
• Foreign banks' profit inefficiency is predominantly driven by relative inefficiency, highlighting managerial inefficiencies rather than technological gaps.

Implications of Foreignness Hypothesis:

• The study suggests that foreign banks face challenges related to the liability of foreignness in India, impacting their resource utilization and revenue generation processes.
• Operational constraints, such as operating as branches rather than wholly-owned subsidiaries and restrictions on raising funds from the capital market, contribute to their relative inefficiency compared to domestic banks.