Recognizing nonmonotonicity of exogenous determinants in a stochastic profit efficiency framework: have banks overinvested in IT capital?

Abstract

PurposeThe purpose of this study is to explore and evaluate potential nonmonotonicity in the determinants of profit efficiency, specifically IT and R&D investments in the Indian commercial banking sector.Design/methodology/approachThe study employs an alternative stochastic profit efficiency framework and introduces nonmonotonic effects by parameterizing the location and scale parameters of the inefficiency component on an unbalanced panel data set of 72 commercial banks in the 2008–2019 period. Marginal effects across quartiles are calculated using a bias-corrected and accelerated bootstrap procedure of 500 simulations. The study disaggregates across ownership and size for gauging the impact of structure on the associations between determinants of profit efficiency.FindingsThe study partially rejects the productivity paradox as it discovers a negative association of IT and R&D with profit inefficiency. However, the observed nonmonotonicity of IT is of significance for bank managers, as the study concludes that overinvestment in IT is detrimental to a bank’s profit-maximizing interests. Further, bank size, loan default and credit risk depict a nonmonotonic relationship across the sample with large banks, high NPAs and high credit risk associated with reducing profit efficiency. In addition, higher margins and greater diversification are related positively to efficiency, and banks with cost-heavy structures or having high liquidity risk associated negatively with efficiency.Originality/valueTo the best knowledge of the authors, the study is perhaps the first to acknowledge and incorporate nonmonotonic associations of IT investments amidst other exogenous determinants under a stochastic profit efficiency framework.