Analysing banks’ intermediation and operating efficiencies using the two-stage network DEA model: The case of India

The purpose of this paper is to present a holistic approach for measuring overall bank efficiency and its decomposition in intermediation and operating efficiencies.

Recently developed two-stage network data envelopment analysis model by Liang et al. (2008) has been used for obtaining intermediation and operational efficiencies along with overall bank efficiency. The bootstrapped truncated regression algorithm as proposed by Simar and Wilson (2007) has been employed to explore the influential determinants of intermediation and operating efficiencies.

The empirical results reveal that the operating inefficiency is the dominant source of overall bank inefficiency in Indian banking sector. Another interesting finding is that public sector banks are more efficient than private banks in the intermediation stage of production process, while private banks are more efficient in the operating stage of production process. Finally, the results of bootstrapped truncated regression show that variations in intermediation efficiency are explained by bank size, liquidity position, directed lending and intermediation cost, while inter-bank differences in operating efficiency are influenced by profitability and income diversification.

The most significant practical implication that has been derived from the research findings is that at the industry level, overall efficiency enhancement needs improvement both in terms of resource-utilization and income-generating abilities of the banks. However, the relatively easy way to achieve higher bank efficiency is to improve the efficiency of banks in generating incomes from interest and fee-based sources.

This paper is the first to provide a comprehensive assessment of performance of Indian banks by examining the efficiency of individual banks considering both the intermediation and operating approaches simultaneously.