Financial Liberalization and Banking Sector Efficiency in India:A Fourier Flexible functional form and Stochastic Frontier Approach

Abstract

The Indian financial sector has undergone a significant structural transformation since the initiation of financial liberalization during 1990’s. It brought significant changes in the financial sector in general and banking in particular. While there have been significant changes in the financial structure, India remains a bank dominated financial system. One of the major objectives of financial liberalization was to make the financial institutions more efficient and competent. Against this backdrop, the present paper intends to analyze the cost efficiency of the Indian banking sector applying the stochastic frontier approach. Using the Fourier Flexible functional form and stochastic cost frontier methodologies, the study finds, the public sector banks are the most efficient banks followed by the domestic private sector and foreign banks. The finding of the study is quite contrary to the international evidence. There could be several potential expiations to this unconventional finding. First, the natural monopoly argument - the public sector banks got the advantage of the first mover and also the economies of scale. Second, the time period of the study is the period of consolidation for the foreign banks and the new private banks. It is because, several banking specific reforms as a part of financial sector reform went on till late 1990’s.Key words: Financial Liberalization; Banking Sector; Cost Efficiency & Stochastic Frontier Approach