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Privatization, Performance, and Efficiency: A Study of Indian Banks

Article  in  Vikalpa · January 2005

DOI: 10.1177/0256090920050102

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Milind Sathye
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R E S E A R C H Privatization, Performance, and
includes research articles that
focus on the analysis and Efficiency: A Study of Indian Banks
resolution of managerial and
academic issues based on
analytical and empirical or Milind Sathye
case research

Executive Enhancing efficiency and performance of public sector banks (PSBs) is a key objective of economic
reforms in many countries including India. It is believed that private ownership helps improve
Summary efficiency and performance. Accordingly, the Indian government started diluting its equity in PSBs
from early 1990s in a phased manner. Has the partial privatization of Indian banks really helped
improve their efficiency and performance? International evidence on impact of privatization is
mixed. Though the issue is important in the Indian context, no study to the author’s knowledge has
addressed it so far. The present study, thus, fills an important gap.
The data required for the study were obtained from Performance Highlights of Banks, a
publication of the Indian Banks’ Association. The author could readily obtain publications for five
years — 1998-2002; his analysis is, thus, restricted to these five years. The financial performance
of the banks was measured using the standard financial performance measures such as return on
assets. The efficiency of banks was measured using accounting ratios, e.g., deposits per employee.
Two main approaches are generally used to evaluate the impact of privatization on firm
performance:
¾ ‘Synchronic’ approach in which the performance of state-owned firms is compared with the
firms that were privatized or with the firms that were already in private ownership.
¾ ‘Historical’ approach, in which ex-ante and ex-post privatization performance of the same
enterprise is compared.
Given that the data are available for only five years, the author uses the synchronic approach.
Since the dataset is not large enough to allow the use of more robust multivariate statistical
procedures, he confines himself to the use of the difference of means test.
This study reveals the following:
¾ Financial performance of partially privatized banks (measured by return on assets) and their
efficiency (measured by three different ratios) were significantly higher than that of the fully
public banks.
¾ In the matter of quality of advances (measured by the ratio of non-performing assets to net
advances), significant difference was not found in these two groups. Of course, there is no
quick fix for this problem.
¾ Partially privatized banks also seem to be catching up fast with fully private banks as no
significant difference was found in financial performance and efficiency between them. On
comparing the strategies of privatization in India with the other countries, India was found
KEY WORDS
KEY WORDS to adopt the strategy of initial public offerings like Poland. This strategy failed in Poland but
Privatization seems to have succeeded in India.
Privatization
Indian Banking ¾ Gradual privatization and well-developed financial markets seem to have contributed to
Indian Banking Indian success.
Efficiency
Efficiency
Performance Note: This paper-mimeo was cited in the World Bank Conference on Bank Privatization held in October 2003.
Performance

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7
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T
his paper examines the effect of bank privatization operating expenses, spread, net profit, asset quality, and
on bank performance and efficiency. To achieve capital adequacy were compared but no statistical
these objectives, relevant banking data published analysis was done. Lastly, in several countries, post-
by the Indian Banks’ Association for five years — 1998- privatization outcomes were far from satisfactory;
2002 — are analysed using the difference of means test. however, India’s partial privatization, as shown by this
The partially privatized banks (PPBs) 1 show a significant study, appears to have resulted in positive outcomes.
positive difference in financial performance and efficiency Prior studies suggested that partial privatization fails
when compared to the fully public sector banks (FPBs). to produce any improvement in performance and that
Interestingly, the financial performance of banks already mixed state-private firms often do worse than fully state-
in the private sector is not significantly different from owned companies (e.g., Boardman and Vining, 1989).
those that are partially privatized. With partial The results of this study, like those of Frydman et al.
privatization of banks showing encouraging results, this (1997), contrast with these findings and could be of
study suggests that the current proposal of the interest to researchers.
Government of India to bring down its stake further to
33 per cent of the capital may further help in improving THE INDIAN BANKING SECTOR:
the performance and efficiency of these banks. This study
A SNAPSHOT
also compares India’s gradual privatization strategy with India is the largest country in South Asia with a huge
that of the other countries like Poland, Mexico, and financial system characterized by many and varied
Mozambique and highlights the lessons that could be financial institutions and instruments. The Indian
learnt. financial sector was well-developed even prior to the
A study such as this is important for many reasons. political independence of the country in 1947. The
Firstly, enhancing efficiency and performance of the vastness of the Indian banking system could be gauged
public sector banks (PSBs) has been the key objective from Figure 1.
of reforms in many countries, including India. Talwar At the top of the banking system is the RBI, which
(2001) states that “as a part of financial sector reforms is responsible for the prudential supervision of the banks
and with a view to giving the PSBs operational flexibility and the non-bank financial institutions and for
and functional autonomy, partial privatization has been performing the other central banking functions. India’s
authorized as a first step, enabling them to dilute the largest bank—the State Bank of India—and its seven
stake of the Indian government to 51 per cent.” Anderson associate banks were brought under social control in the
et al. (1997) consider a firm as privatized when more than mid-to late fifties. Thereafter, with two successive
a third of the shares stand transferred to the private nationalization of banks, another 19 banks (14 banks in
investors (thus, 66 % of shares remain in state ownership). 1969 and six in 1980s)2 were brought into the public
The Reserve Bank of India (2003) stated that “dilution sector. The PSBs occupy a predominant position in the
of government stake….could provide greater operational Indian financial system. The important banking indicators
freedom to banks which could have a positive impact of the commercial banks in India are presented in Table 1.
on their efficiency.” Accordingly, the Government of Table 1: Banking Indicators of Commercial Banks in India
India embarked upon the dilution of its stake in the PSBs (as on March 2002)
from the early 1990s. The policymakers, stakeholders, Banking Indicators Public Private Foreign
and researchers would be interested in knowing the Sector Sector Banks
Banks Banks
effect of such a dilution on performance and efficiency
Number of banks 27 30 40
of the banks that were partially privatized. Secondly,
Number of branches 46,384 5311 194
studies on bank privatization are largely confined to the Total deposits (Rs trillion) 9.88 1.69 0.645
East European, South American or African countries. Total loans and advances (Rs trillion) 4.81 1.16 0.486
Total assets (Rs trillion) 12.03 2.78 1.23
Studies on bank privatization in Asia and particularly Operating profit (Rs trillion) 0.217 0.05 0.04
on India are lacking. The RBI (2003) did present a Provision for NPAs (Rs trillion) 0.08 0.01 0.003
comparison of a sample of five PSBs which divested their Total staff (in nos.) 756,625 73,096 13,827
Average return on assets 0.76 1.18 -0.51
government holding with a sample of five wholly
Source: Indian Banks’ Association (2003). Performance Highlights of
government-owned banks. The financial parameters like Banks, Mumbai.

8 PRIVATIZATION, PERFORMANCE, AND EFFICIENCY

8
 Figure 1: Scheduled Banking Structure in India (as on March 31, 2002)*

Scheduled banks in India

Scheduled commercial Scheduled cooperative

banks banks

Public sector Private sector Foreign banks Regional rural

banks (27) banks (30) in India (40) banks (196)

Scheduled urban Scheduled state

cooperative banks cooperative banks
(52) (16)

State Bank of Old private

Nationalized India and its New private
banks (19) banks (22) banks (8)
associates (8)

* As included in the Second Schedule of the Reserve Bank of India Act., 1934.
Note: Figures in brackets indicate number of banks in each group.
Source: Report on Trend and Progress of Banking in India 2002, RBI, Mumbai.

As can be seen from Table 1, the PSBs control over 80
per cent of the banking assets. The banking system has
developed well over the years in terms of its geographical
coverage, deposit mobilization, and credit expansion.
With regard to technology, it is catching up with the
developed world. Some banks have started ATMs in the
metropolitan centres and are also offering transactional
internet banking services.
The PSBs were subjected to directed credit, pre-
scribed interest rates, and substantial pre-emption of
deposits. The banking services that were mostly confined
to the metropolitan areas were expanded to the rural
areas. Thus, while at the end of 1964, only 10 per cent
of the commercial banks were located in the rural areas,
the proportion stood at 40 per cent by 2002. The share
of advances in the priority sector3 increased substantially
after nationalization. The overall priority sector credit
target is presently 40 per cent of the net bank credit for
both the public sector and the private sector banks. For
the foreign banks, the target is 32 per cent.
Since the early 1990s, the Government of India has
implemented many banking sector reforms following
the recommendations of the government-appointed
Narasimhan Committee (I and II). These include lowering
the statutory liquidity ratio from the peak of 38.5 per
cent to 25 per cent, the cash reserve ratio at 4.75 percent
from its peak of 15 per cent, a gradual deregulation of
interest rates on deposits and lending, introduction of
prudential norms in line with the international standards
and the like. A system of flexible exchange rates on
current account has been adopted.
A major drag on the banking system in India is the
slow progress in the management of non-performing
assets (NPAs). In 2001, the ratio of NPAs to net advances
stood at about 15 per cent (Hanson and Kathuria, 2002).
A few banks have much higher levels of NPAs than
average and low capital. To support the weak public
sector banks, the government injected a substantial
amount of capital before the banks were allowed to tap
the capital market. Detailed recommendations for
restructuring of weak public sector banks (Indian Bank,
UCO bank, and United Bank) were given by the RBI-
appointed Verma Committee (RBI, 1999). In the early
1990s, the Government of India amended the relevant
legislation to provide for a reduction of its stake in the
public sector banks to 51 per cent.
LITERATURE REVIEW
The question that we address in this study is: what is
the impact of privatization of the banks on bank per-
formance and efficiency? Given that some Indian banks
were completely government-owned, for the purpose of
this study, a bank that has been allowed to tap capital
market to raise capital by diluting government equity
has been considered as privatized. Hence all the banks
in which dilution of government ownership has taken

VIKALPA • VOLUME 30 • NO 1 • JANUARY - MARCH 2005 9

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place are included in the set of privatized banks.
Performance refers to financial performance of banks
which is measured by relevant accounting ratios, for
example, the return on assets (ROA). Efficiency refers
to cost efficiency, that is, the ability to produce a given
level of output at the lowest cost.
To build the conceptual framework for this study,
we draw on the literature on the government’s
participation in the financial markets. Government
ownership of the banks as a part of the ‘commanding
heights’ approach was advocated by authors such as
Lewis (1950) and Gerschenkron (1962). The development
theories emphasize that government ownership helps
channelize savings for long-term projects of strategic
interest. The ‘political theorists’ oppose this view and
state that government ownership leads to misallocation
of resources and inefficiencies of government enterprises
and that there are political motives behind such public
ownership. It has long been argued that privatization
of firms makes them efficient and perform better. Galal
et al. (1994), World Bank (1995), and La Porta and Lopez-
de-Silanes (1997) support the view that privatization
helps improve performance.
However, recent studies in transition economies, for
example, by Carlin and Landesman (1997), Frydman et
al. (1998), and Jones and Mygind (1999) found that post-
privatization performance of the firms was poor. The
RBI (2003) stated that “as regards the linkage between
ownership and performance, international evidence
suggests that ownership has limited impact on economic
efficiency.” Studies that support this position include
those of Tulkens (1993), Altunbus, Evans and Molynenx,
(2000) and Denizer, Tarimcilar and Dinc (2000).
Against this background, the Indian banking sector
provides a particularly interesting setting to examine the
impact of privatization on the banking firms. The banking
sector in India comprises of domestic banks (privately-
owned, partially privatized banks, fully public sector
banks) as well as foreign banks. As already stated, in
India, the economic reforms started in the early 1990s
and the approach of the Government of India towards
privatization of banks has been gradual. To begin with,
it was proposed to reduce the government stake in the
PSBs to 51 per cent. Accordingly, 12 out of the 27 PSBs
have issued capital reducing the government stake,
though it still continues to be 66 per cent at the minimum.
The government is now considering a legislation that
allows its stake to be reduced to 33 per cent. The proposal
10
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is, however, facing opposition from the bank staff who
are questioning the impact on performance and efficiency
of the PSBs that raised capital (an argument advanced
by the government prior to privatization) before a further
reduction of the stake is allowed. The policy makers too
are interested in knowing the impact of partial
privatization of banks so far. As stated above, the RBI
(2003) did present a comparative position of the
performance and efficiency ratios of five government-
owned PSBs, five partially privatized government-owned
banks (divested PSBs), and those banks that were already
in the private sector. However, statistical significance
was not tested. Interestingly, no other published study
exists, to our knowledge, which has examined this issue
in the Indian context. This study, thus, fills an important
gap.
DATA AND METHODOLOGY
The data required for this study were obtained from
Performance Highlights of Banks, a publication of the Indian
Banks’ Association, where financial performance and
efficiency ratios for each of the banks in India are available.
We could readily obtain publications for five years, from
1998 to 2002; our analysis is, thus, restricted to these five
years.
The financial performance of the banks was
measured using standard measures like ROA, spread to
working funds ratio (Spread/WF), establishment ex-
penses to total expenses ratio (EE/TE), loan out ratio
(Loans/Deposits) and non-performing assets to net
advances ratio (NPA/Net Adv). Efficiency of the banks
was measured using accounting ratios such as deposits
per employee (depo/staff), advances per employee
(loans/staff), and net profit per employee (NP/Staff).
These performance and efficiency measures, among
others, are used in the literature (for example, Perevalov,
Gimadii and Dobrodie, 2000) and also by the Indian
Banks’ Association and RBI. The KPMG Financial
Institutions Performance Survey in Australia also uses,
among others, these measures. In recent years, some
studies (for example, Bhattacharya et al., 1997 and Sathye,
2003) have measured efficiency of the banks using the
mathematical programming technique of Data Enve-
lopment Analysis (DEA). In this study, we confine our
analysis to the traditional financial ratios to measure
performance and efficiency mainly because of ready
availability of data thereon.
Two main approaches are generally used to evaluate
PRIVATIZATION, PERFORMANCE, AND EFFICIENCY
the impact of privatization on firm performance: the consisting of banks that had issued capital and the other
‘synchronic’ approach and the ‘historical’ approach that had not. We analysed the ratios indicated earlier
(Frydman et al., 1997). In the synchronic approach, the for each of the banks using the difference of means test.
performance of the state-owned firms is compared with The results of this analysis are presented in Table 2 (a).
the firms that were privatized or with those firms that Thereafter, we compared the PPBs with the banks that
were already in private ownership. Some notable studies were always in the private sector (PVBs) again using the
in this area include those of Boardman and Vining (1989), difference of means test. The results of this analysis are
Commander, Fan and Schaffer (1996) and La Porta and presented in Table 2 (b).
Lopez-de-Silanes (1997). In the historical approach, ex Next we analysed the data by classifying the PSBs
ante and ex post privatization performance of the same into two distinct groups of banks—the nationalized banks
enterprise is compared. Notable studies that followed group and the State Bank group. The nationalized banks
this approach include those by Megginson, Nash and group consists of 19 banks. After nationalization, the
Randenborgh (1994), Earle and Estrin (1997), and Government of India held their entire capital directly.
Dewenter and Malatesta (1998). Given that the data are The State Bank group consists of the State Bank of India
available for only five years, we use the synchronic (which was brought under public ownership in 1955 by
approach, that is, we compare the fully state-owned an Act of Parliament) and its seven associate banks. The
banks with those that are partially privatized. Our data capital of the State Bank of India was held largely by
set is not large enough (there are only 27 public sector the Reserve Bank of India and the government-owned
banks of which 12 are partially privatized) to allow the financial institutions like insurance companies and not
use of more robust multivariate statistical procedures, by the government directly. The entire capital of the
hence we confine ourselves to the use of the difference associate banks was held by the State Bank of India.
of means test. Traditionally, the State Bank group enjoyed certain
privileges. For example, banks in this group work on
Analysing Financial Performance
behalf of the RBI where the latter does not have offices.
For the purpose of data analysis, we first divided all the In addition, the government business is mostly routed
27 public sector banks into two groups—one group Table 2(b): Financial Performance (comparison with banks
already in private sector)
Table 2(a): Financial Performance (all public sector banks)
Performance Measures 1998 1999 2000 2001 2002
Performance Measures 1998 1999 2000 2001 2002 n 42 40 41 42 42
n 27 27 27 27 27 No of PPBs 8 8 9 12 12
No of PPBs 8 8 9 12 12 ROA
ROA PPBs NA 0.86 0.82 0.69 0.85
All PSB-PPB NA 0.86 0.82 0.69 0.85 PVBs NA 0.98 1.25 0.77 1.17
All PSB-FPB NA 0.5 0.55 0.4 0.69 Sig.
Sig. ** * ** * EE/TE
EE/TE PPBs 17.44 17.07 17.46 20.08 16.80
All PSB-PPB 17.44 17.07 17.46 20.08 16.8 PVBs 11.22 11.06 11.27 10.23 10.37
All PSB-FPB 21.42 21.25 20.02 21.69 18.67 Sig. ** ** *** *** ***
Sig. *** *** * Spread/WF
Spread/WF PPBs 3.2 2.79 2.70 2.95 2.81
All PSB-PPB 3.20 2.79 2.7 2.95 2.8 PVBs 2.56 2.21 2.27 2.42 2.13
All PSB-FPB 2.96 2.89 2.81 2.94 2.8 Sig. ** ** * ** ***
Sig. NPA/Net Adv
NPA/Net Adv PPBs NA 7.85 7.00 6.61 5.78
All PSB-PPB NA 7.85 7.01 6.61 5.78 PVBs NA 8.26 7.14 7.3 8.22
All PSB-FPB NA 9.52 8.47 7.97 6.46 Sig.
Sig. Loan/Deposits
Loan/Deposits PPBs 52.27 49.70 50.11 49.69 51.71
All PSB-PPB 52.27 49.70 50.11 49.69 51.71 PVBs 49.96 49.27 49.46 50.37 53.27
All PSB-FPB 45.15 44.77 45.9 47.5 49.66 Sig.
Sig. ** * Notes: PPBs: partially privatized banks,.PVBs: banks already in private
Notes: All PSB-PPB: partially privatized out of all PSBs. sector.
FPB: fully public sector banks. *significant at 10%, **significant at 5% ***significant at 1%.

VIKALPA • VOLUME 30 • NO 1 • JANUARY - MARCH 2005 11

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through the State Bank group.4 When analysing the
performance of the public sector banks, the State Bank
group is often distinguished from the other nationalized
banks because of its early public ownership and special
privileges enjoyed by it. We not only analysed the
performance of all the public sector banks (which include
the State Bank group) but also separately that of the State
Bank group and the other public sector banks’ group to
provide further information to the readers. We analysed
these two groups separately again using the difference
of means test. The results are presented in Tables 2 (c)
and (d).
Analysing Efficiency
Analysis similar to the above was carried out to assess
the impact of partial privatization of the PSBs on
efficiency. The results are presented in Tables 3(a) to (d).
RESULTS AND DISCUSSION
As can be seen from Table 2 (a), the ROA of the PPBs
is significantly greater than that of the FPBs. Interestingly,
in respect of the other four financial performance
measures, there is no significant difference between these
two sets of banks in the recent years. The EE/TE (which
refers to salary and other benefits to staff) is not signi-
Table 2(c) : Financial Performance (nationalized banks
group)
ficantly different, possibly because even though these
banks introduced voluntary retirement scheme (VRS),
they still have to carry the burden of VRS-related
expenditure. The RBI (2003) states that “the operating
expenses …. of divested public sector banks witnessed
a sharp rise…..mainly due to large outgo on account of
VRS-related expenditure incurred by these banks.” Earle
and Esrin (1997) argue that “….many types of restruc-
turing may impose higher short-run costs.” This means
that better performance of the PPBs is possibly due to
an increase in the productivity of their existing staff. This
fact is also borne out by the efficiency ratios. All the three
efficiency ratios of the PPBs presented in Table 3 (a) are
significant and greater than that of the FPBs. The superior
efficiency and performance can be attributed to what
Frydman et al. (1997) call as the ‘marketization shock’
which seems to have geared the staff of the PPBs for
better productivity. A non-significant spread/WF ratio
between these two sets of banks could mean that these
banks are operating in identical or level-playing field
in terms of cost of financing and returns as compared
to the FPBs. Thus, the PPBs seem to be using improved
efficiency as a competitive weapon to better their financial
performance. In terms of quality of loans and advances,
though on an average, the ratio of NPAs/Net Adv was
lower in the PPBs as compared to the FPBs, no significant
Table 2(d): Financial Performance (State Bank group)

Performance Measures 1998 1999 2000 2001 2002 Performance Measures 1998 1999 2000 2001 2002
n 19 19 19 19 19 n 8 8 8 8 8
No of PPBs 5 5 6 9 9 No of PPBs 3 3 3 3 3
ROA ROA
NB-PPB NA 0.92 0.85 0.71 0.86 SB-PPB NA 0.72 0.78 0.64 0.83
NB-FPB NA 0.44 0.41 0.27 0.53 SB-FPB NA 0.62 0.89 0.63 1.02
Sig. ** ** ** ** Sig.
EE/TE EE/TE
NB-PPB 16.19 15.51 16.53 19.64 16.69 SB-PPB 19.53 NA 19.31 21.4 17.11
NB-FPB 21.47 21.22 20.21 22.12 19.84 SB-FPB 21.3 NA 19.53 20.83 16.33
Sig. *** *** *
Sig.
Spread/WF
Spread/WF
SB-PPB 3.21 2.98 2.64 2.89 2.78
NB-PPB 3.2 2.84 2.73 2.96 2.81
SB-FPB 3.74 3.38 3.36 3.32 3.13
NB-FPB 2.68 2.64 2.6 2.75 2.63 Sig. ** **
Sig. NPA/Net Adv
NPA/Net Adv SB-PPB NA 8.82 8.38 7.2 5.69
NB-PPB NA 6.88 6.32 6.41 5.81 SB-FPB NA 9.36 7.39 6.72 4.76
NB-FPB NA 9.69 8.89 8.6 7.31 Sig.
Sig. Loan/Deposits
Loan/Deposits SB-PPB 55.43 49.17 49.58 50.7 50.25
NB-PPB 50.38 50.02 50.37 49.35 52.19 SB-FPB 55.66 52.81 53.84 53.64 55.3
NB-FPB 41.4 41.64 42.85 44.44 46.84 Sig. *
Sig. *** *** ** * * Notes: SB-PPB:State Bank group, partially privatized.
Notes: NB-PPB: partially privatized nationalized banks. SB-FPB: fully public sector banks.
NB-FPB: fully public sector banks. *significant at 10%, **significant at 5%, ***significant at 1%.

12 PRIVATIZATION, PERFORMANCE, AND EFFICIENCY

12
Table 3(a): Accounting Efficiency (all public sector banks) Table 3(c): Accounting Efficiency (nationalized banks
group)
Efficiency Measures 1998 1999 2000 2001 2002
n 27 27 27 27 27 Efficiency Measures 1998 1999 2000 2001 2002
No of PPBs 8 8 9 12 12 n 19 19 19 19 19
NP/Staff No of PPBs 5 5 6 9 9
All PSB-PPB NA 0.93 1.08 0.93 1.43 NP/Staff
All PSB-FPB NA 0.5 0.64 0.48 0.98 NB-PPB NA 1.11 1.1 0.99 1.51
Sig. ** * ** * NB-FPB NA 0.35 0.39 0.32 0.74
Depo/Staff Sig. *** *** ** **
All PSB-PPB 71.41 89.05 97.13 118.22 139.26 Depo/Staff
All PSB-FPB 56.33 66.64 75.76 100.07 118.12 NB-PPB 83.2 100.09 108.31 125.93 149.27
Sig. *** *** ** * ** NB-FPB 57.78 68.56 81.74 102.5 121.52
Loans/Staff Sig. *** *** ** * **
All PSB-PPB 36.77 42.61 48.3 58.28 72.31 Adv/Staff
All PSB-FPB 25.36 29.65 36.22 47.34 58.58 NB-PPB 41.65 49.68 53.89 61.71 78.24
Sig. *** *** *** ** ** NB-FPB 24.06 28.56 35.08 45.62 57.22
Sig. *** *** *** ** **

Table 3(b): Accounting Efficiency (comparison with banks

already in private sector) Table 3(d): Accounting Efficiency (State Bank group)

Efficiency Measures 1998 1999 2000 2001 2002 Efficiency Measures 1998 1999 2000 2001 2002

n 42 40 41 42 42 n 8 8 8 8 8
No of PPBs 8 8 9 12 12 No of PPBs 3 3 3 3 3
NP/Staff NP/Staff
SB-PPB NA 0.79 1.03 0.77 1.17
PPBs NA 0.93 1.08 0.93 1.43
SB-FPB NA 0.82 1.25 0.76 1.47
PVBs NA 2.44 3.39 1.27 8.84
Sig.
Sig. Depo/Staff
Depo/Staff SB-PPB 51.77 61.44 74.78 95.09 109.26
PPBs 71.41 86.09 97.13 118.22 139.26 SB-FPB 52.29 61.94 60.22 95.22 111.33
PVBs 237.78 209.98 277.2 266.41 263.71 Sig.
Sig. * * Loans/Staff
Loans/Staff SB-PPB 28.66 30.17 37.14 48 54.52
PPBs 36.77 42.61 48.30 58.28 72.31 SB-FPB 29.01 32.62 39.23 50.76 61.3
PVBs 120.68 107.15 142.16 138.25 148.83 Sig.
Sig. *
*significant at 10%, **significant at 5%, ***significant at 1%.

difference is observed. The NPAs are a drag on the entire
banking system in India and this is mainly the legacy
of social control over the banks. There is no quick fix
for this. The RBI and the Government of India have
undertaken several measures to contain the NPA
problem, for example, changes in the legislative
framework (like the recently introduced Securitization
and Reconstruction of Financial Assets and Enforcement
of Security Interest Act 2002 and the establishment of
Asset Reconstruction Company), to provide impetus to
the recovery efforts by the banks. However, it may take
a while before such measures yield significant impro-
vement.
Table 2 (b) shows that the PVBs do not have a
significantly different ROA as compared to the PPBs.
This seems to suggest that the PPBs are fast catching up
with the private sector banks in terms of profitability.
The RBI (2003) notes that “..there has been a convergence
in the financial performance of the partially government-
owned PSBs with old private banks in recent years.”
However, the PPBs show a significantly higher ratio of
EE/TE. As already stated above, VRS-related expenses
could have contributed to this situation. A significant
positive difference in the Spread/WF ratio is indicative
of the ability of the PPBs to tap low cost funds through
their extensive branch network.5 According to RBI’s Report
on Currency and Finance (2003), “….as competition
intensified, spread tended to narrow……the decline in
spread took place across all categories of banks with the
decline being more pronounced in the case of new private
sector banks.” Similarly, no significant difference is
noticed between the three efficiency measures of the
PPBs and the PVBs as indicated in Table 3(b), except in
respect of Depo/Staff ratio in the recent years.
Tables 2 (c) and (d) further analyse the performance
of the PPBs. It could be seen that the PPBs in the

VIKALPA • VOLUME 30 • NO 1 • JANUARY - MARCH 2005 13

13
nationalized banks group show a significant positive
improvement in terms of ROA and loans/deposits ratio.
However, the PPBs in the State Bank group do not show
any significant difference in any of the parameters. The
non-effect of the ‘marketization shock’ in the State Bank
group need not come as a surprise. As already stated,
the capital of the State Bank of India is not directly held
by the Government of India and the group continues to
enjoy the privileges of government business being routed
through them. This scenario is different than that of the
nationalized banks where the Government of India held
the entire capital directly. As a result, ‘the marketization
shock’ seems to have worked well with the nationalized
bank cohort. This position is further confirmed by Tables
3 (c) and (d) where the efficiency ratios of the PPBs in
the nationalized banks group are significantly and
positively different while those in the State Bank group
do not show a significant difference.
Next we compare the Indian partial bank priva-
tization experiment with the privatization experiments
in the other countries of the world. Various strategies
have been used across the world for privatization of
banks. These include sale to a strategic investor, initial
public offerings (IPOs), voucher system, and sale to
employees. India followed the strategy of IPOs,6 which
was similar to that followed in the privatization of Bank
Slaski in Poland, where it did not succeed. In the case
of Bank Slaski, Dammert and Lasagabaster (2002) find
that some of the reasons for the failure of IPO strategy
were nascent capital market, inexperienced brokers, and
IPO price set at too low a level. India presents a contrast.
It already possessed a vibrant capital market and had
experienced brokerage houses that could efficiently
manage and appropriately price the issue. As stated by
Berry (1994), “Indian banking and finance were well
developed even in the colonial period……..there was a
significant presence of both foreign and domestic banks
and a well developed stock market.” The capital market
reforms that began in 1992 removed some of the
weaknesses in the system like limited information and
transparency, regulation on pricing of IPOs, costly tra-
ding, limited number of dealers, and accounting
standards not reflecting the international practice. The
equity market reform took four approaches: the
establishment of Securities and Exchange Board of India
which was given regulatory powers in 1992, the
establishment of the National Stock Exchange in 1992,
allowing new mutual fund operators in 1993-94, and the
14
14
development of a share depository. As stated by Hanson
and Kathuria (2002), these capital market reforms
‘contributed to a stock market boom.’ Further, as stated
by RBI (2003), the accompanying “progress of banking
sector reforms has been a major factor in enhancing the
attractiveness of banking sector stocks.”
The lessons that follow from India’s bank priva-
tization experiment are worth noting. In India, the
supporting infrastructure like well-developed financial
markets (as explained above), a suitable legislative
framework, and a sound prudential supervision system
(establishment of Banking Ombudsman, establishment
of debt recovery tribunals, establishment of an indepen-
dent Board for Financial Supervision, introduction of
CAMELS7 system, etc.) were brought in place alongside
bank privatization. Deolalkar (2000) states that “Changes
in banks’ reporting requirements, improvement in the
quality of on-site supervision, and the establishment of
credit information and loan grading and provisioning
requirements have all helped….….to lower systemic risk
across board.” This was not the case in countries like
Mexico, Chile, and Mozambique where a few years after
privatization, the institutions were experiencing financial
problems which quickly spread into a systemic crisis
(Dammert and Lasagabaster, 2002). Further, bank
privatization in India has been gradual. Even now 66
per cent of the capital is contributed by the government.
Over a period of eight years, during 1993-2001, only 12
out of the 27 public sector banks were partially privatized.
In contrast, privatization in Mexico was hasty (Dammert
and Lasagabaster, 2002). In 15 months, 18 commercial
banks were sold. The regulatory and supervisory reforms
like the adoption of international capital adequacy norms
and those indicated above were simultaneously initiated
in India. In countries like Mexico and Mozambique, re-
gulatory and supervisory weaknesses were at the root
of privatization failures (Dammert and Lasagabaster,
2002). In sum, there are useful lessons to be learnt from
India’s gradual privatization strategy which could be of
interest to policy makers and researchers in other
countries.
CONCLUSION
This study examines the impact of privatization on bank
performance and efficiency using data of banks in India
for the five-year period — 1998-2002. Statistical analysis
was performed using the difference of means test for
three groups of banks — partially privatized, fully state-
PRIVATIZATION, PERFORMANCE, AND EFFICIENCY
owned, and those already in the private sector. Partially
privatized banks have performed better as compared to
the fully public sector banks in respect of certain financial
performance and efficiency parameters. Partially priva-
tized banks also seem to be catching up with the banks
already in the private sector. No significant performance
or efficiency difference was seen in these two cohorts
of banks. Overall, going by the results of this study,
partially privatized banks have continued to show
improved performance and efficiency in the years after
privatization. In several countries, post-priva- tization
outcomes were far from satisfactory. However, India’s
partial privatization, as shown by this study, appears
to have resulted in positive outcomes. Prior studies
suggested that partial privatization fails to produce any
improvement in performance and that mixed state-
private firms often do worse than fully state-owned
companies (Boardman and Vining, 1989). The results of
ENDNOTES
1. The 12 partially privatized PSBs are the State Bank of
India, State Bank of Bikaner and Jaipur, Oriental Bank
of Commerce, Dena Bank, Bank of Baroda, Bank of
India, Corporation Bank, State Bank of Travancore,
Syndicate Bank, Vijaya Bank, Andhra Bank, and Indian
Overseas Bank (Report on Trend and Progress of Banking
in India, RBI, 2002).
2. One of the banks—New Bank of India—later merged
with Punjab National Bank (a nationalized bank).
3. Priority sector refers to the lending for agriculture and
other rural sector of the economy, poverty alleviation
programmes, exports, small-scale industries, and such
other purposes.
4. Out of 8,998 State Bank branches in India, about 7,000
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Milind Sathye is an adjunct Professor at Southern Cross
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worked as an Assistant Director with the Government of Aus-
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international journals. He has been on the panel of referees
of many international journals and is also on the editorial
board of some of these journals. Two of his books on banking
have been published by John Wiley and Sons, Australia and
his third book is in print.
e-mail: Milind.Sathye@canberra.edu.au
PRIVATIZATION, PERFORMANCE, AND EFFICIENCY