Intermediation Cost Efficiency: A Tale of Two Bank Groups

This paper makes a comparative assessment of the public and private sector bank intermediation cost efficiency during the reform period. The years covered in the study are 1996-97 , 1998-99, 2000-01, 2002-03. The study concentrates on twenty public and ten Indian private sector banks. This paper makes use of two nonparametric methods— the Free Disposal Hull approach (FDH) and the Data Envelopment approach for construction of the cost frontier for efficiency measurement. In the FDH approach, we take segments of the cost frontier as the benchmark. In the DEA approach, the authors take a linear version of the entire frontier as the benchmark. As per the FDH results, observed public sector commercial banks exhibit higher mean efficiency scores (when the year-wise figures are averaged) than the observed private sector banks when net interest margin or non-interest income are taken as the output indicators. However, if loan is taken as the output indicator, the mean efficiency score of the observed private sector banks is higher than the observed public sector banks. In terms of DEA, the observed private sector commercial banks have higher mean cost, technical and cost efficiencies than the observed public sector commercial banks. In case of allocative efficiency, however, the results indicate fluctuations in efficiency scores across the commercial bank groups when loan is taken as the output indicator. Test of significance has been carried out to examine if the mean cost efficiencies of the two bank groups are significantly different across bank groups. The results are positive for both FDH and DEA.