Financial Performance Measures, Efficiency and Indian Banking

Abstract

Globalization forces are linking banking operations to worldwide markets making them vulnerable to global stress. This fundamental change compels banks to be more robust in terms of sound financial performance. Bankers worldwide compute a large number of financial measures using ratios to gauge bank performance. This paper calculates efficiency, an important indicator of financial performance of banks in India using Data Envelopment Analysis (DEA) for the period 2006-07. Following Jackson (1972), the paper investigates commonality that might exist among financial performance measures computed by banks in India and the estimated bank efficiency scores. Results of Factor Analysis uncovered fewer significant factors and interestingly show that efficiency scores do not cluster with other measures of bank performance despite emerging as one of the significant factor. The present paper argues that bankers and policy makers should not feel contented by looking at the standard performance measures alone. Rather, they should also try to examine bank performance vis-à-vis efficiency based on multiple inputs and outputs to capture the complete picture. A paradigm shift towards measurement of efficiency using sophisticated modeling techniques is recommended for better performance evaluation in banking.