LITERATURE REVIEW

The term efficiency and profitability are interrelated that means higher the efficiency; greater
is the earning capacity of the banks and vice-versa. The high efficiency in banks reflects
soundness and safety and more likely to survive. The efficiency in the banking sector has
given prime importance due to change in banking sector reforms as well as due to increase
competition, greater use of technology, greater customer demands and varieties of financial
products and services. The bank today has to improve their efficiency because improved
efficiency results into improved profitability and productivity. The bank can improve its
efficiency by reducing its operating expenditure and cost of intermediation. The Indian
banking sector has been the backbone of the Indian economy over the past few decades,
helping it survive various national and worldwide economic shocks and meltdowns. It is one
of the healthiest performers in the world banking industry seeing tremendous
competitiveness, growth, efficiency, profitability and soundness, especially in the recent
years.
The measurement of efficiency of banking institutions serves to important purposes. it helps
to benchmark the relative efficiency of and individuals banks against the best practice
banks and secondly it helps to evaluate the impact of various policy measures on the
efficiency and performance these institutions .because banks provide transaction services and
payment systems, and efficient banking system has significant positive externalities , which
increases the efficiency of economic transactions in general. In the Indian context we have
seen the unfolding of slew of financial sector reforms measures since the early 1999s. An
important objective of these measures is to increase the operational efficiency of the banking
sector as whole, as well as of individual institutions. In fact, policy makers have cleanly
recognized that inefficiency is an important factor contributing to the high cost of banking
services in India.

The literature on the efficiency of financial institution is by now quite large despite its
relatively recent origin. Numerous attempts have been made to study the efficiency of banks
in developed countries. By contrast, studies analyzing the efficiency of banks in developing
countries, are especially in India, and are far fewer. Every firm is most concerned with its
profitability. One of the most frequently used tools of financial ratio analysis is profitability
ratios which are used to determine the company's bottom line and its return to its investors
.Profitability ratios are typically based on net earnings, but variations will occasionally use
cash flow or operating earnings . Profitability is a measure of efficiency and control.
Profitability ratios are employed by management in order to assess how efficiently they carry
on business operation. Profitability is the main base for liquidity as well as solvency.
Creditors, banks and financial institutions are interested in profitability ratios since they
indicate liquidity or capacity of the business to meet interest obligations, and regular and
improved profit to enhance the long term solvency position of the business.
(Chaudhary, June 2011) performed comparative analysis of services of public sector banks
and private sector banks and stated that the increased competition and information
technologies reduce processing costs, the erosion of product and geographic boundaries, and
less restrictive governmental regulations have all played a major role for public sector banks
in India to forcefully compete with private and foreign banks.

(Jha, 2011) analyzed the performance of seven public sector and private sector banks for the
year 2009-10. They used three sets of ratios, operating performance ratios, financial ratios,
and efficiency ratios. In all eleven ratios were used. They found that Axis Bank took the first
position, followed ICICI Bank, BOI, PNB, SBI, IDBI, and HDFC, in that order.
In Indian banks, amongst few studies conducted on efficiency (Das, 1999) has investigated
the Relationship between the efficiency and size. Using regression analysis he concludes
negative correlation between size and efficiency estimates. Thus, it may be observed that
there have been mixed results of impact of larger sizes on the efficiency levels of the banks.
The initiative to consolidate might have different consequences in different countries. Das
had also concluded through his research that Non-performing assets, poor management and
congestion of labor are the main causes of poor performance in PSBs.

In the study of Gunjan M. Sanjeev he concludes that the efficiency estimates are determined for
public sector banks for the period 1997-2001 using the DEA model. It has been observed that
there is generally a decline in the efficiency levels of the PSBs. Corporaton bank and state Bank
of Bikaner & jaipur have emerged as the most efficient banks throughout the study period. The
variability amongst PSB decreasing, thus suggesting that the banking industry is becoming
more competitive as a consequence of deregulation. No conclusive relationship can be
established between size and efficiency. Thus, it cannot be said with certainty that increase in
size as a result of consolidation will surely help the Indian banks in achieving higher efficacy.
Thus, the review of the studies pertaining to Indian banking industry also yield the mixed
results. In all 33 studies that have been reviewed, of which 25 studies concluded that
deregulation has improved the efficiency of Indian banks. However, only 8 studies have
provided an evidence of insignificant or adverse effect of deregulation on the efficiency of the
banks. All in all, the empirical evidence about the impact of deregulation on efficiency of
Indian banks has been mixed in the literature, 165 but the majority of studies have shown a
positive impact of deregulation and liberalization on the efficiency performance of banks.
(Bhattacharya, 1997) studied the impact of the limited liberalization initiated before the

deregulation of the nineties on the performance of the different categories of banks, using
DEA(Data envelopment analysis).Their study covered 70 banks in the period 1986-91. They
constructed one grand frontier for the entire period and measured technical efficiency of the
banks under study. The authors use advances, investments and deposits as outputs and interest
expense and operating expense as inputs. They found public sector banks had the highest
efficiency among the three categories, with foreign and private banks having much lower
efficiencies. However, public sector banks stated showing a decline in efficiency after 1987,
private banks showed no change and foreign banks showed a sharp rise in efficiency. The main
results accord with the general perception that in the nationalized era, public sector banks were
successful in achieving deposit and loan expansion. It should be noted, however, that the use of
one grand frontier for the entire period implies that technical change is not separately accounted
for.

(Das, 1997) Analyses overall efficiency- technical, allocative and scale- at PSBs. In the period
1990-96, the study found a decline in overall efficiency. This occurred because there was a
decline in technical efficiency, both pure and scale, which was not offset by an improvement in
allocative efficiency. The study, however, pointed out that the deterioration in technical
efficiency was mainly on account of four nationalized banks.
(Murty, 1996) Analyzed various factors, which can be helpful to improve the profitability of

public sector banks. The study examine the impact of monetary policy and market interest rates
on the bank profitability and also suggest various measures to improve the profitability of the
public sector banks in India.

(M.Sanjeev, 2006)In the study he conclude that the efficiency estimates are determined for
public sector banks for the period 1997-2001 using the DEA model. It has been observed that
there is generally a decline in the efficiency levels of the PSBs. Corporaton bank and state Bank
of Bikaner & jaipur have emerged as the most efficient banks throughout the study period. The
variability amongst PSB decreasing, thus suggesting that the banking industry is becoming
more competitive as a consequence of deregulation. No conclusive relationship can be
established between size and efficiency. Thus, it cannot be said with certainty that increase in
size as a result of consolidation will surely help the Indian banks in achieving higher efficacy.

(Manoj, 2010) assess the determinant of profitability of old private sector banks especially in
Kerala state found that while non interest income is important determinant of profitability of new
generation private sector banks, the old generation private sector Banks remained dependent in
rural areas for their profitability. The study also stresses the crucial linkage between Govt.
Securities (G-sec) and Net Interest Margin (NIM).

(Das, A. and Ghosh,S., 2009) Conducted a study on financial deregulation and profit efficiency
of Indian banks for a time period of 1992 to 2004. Using Non-Parametric DEA Methodology and

Univariate analysis and determinants of efficiency, the study indicate high level of efficiency in
costs and lower levels in profits, reflecting the importance of inefficiencies on the revenue side
of banking activity. The proximate determinants of profit efficiency appear to suggest that big
state owned banks performed reasonably well and more likely to operate at higher levels of profit
efficiency. A close relationship is observed between efficiency and soundness as determined by
banks capital adequacy ratio.
In analyzing the functions performed by commercial banks, (Bergendhal.G., 1998) mentions
five fundamental goals of efficient bank management: profit maximization, risk management,
service provision, intermediation and utility provision. To keep it simple, five fundamental goals
of efficient bank management: profit maximization, risk management, service provision,
intermediation and utility provision. To keep it simple, one can redefine the five goals in to two
by pooling the five goals, i.e., profit maximization (combining features of Bergendhals profit
maximization and risk management) and interest spreads (combining service provision,
intermediation and utility provision). As by reducing interest spread one can maximize utility of
bank customers i.e., reduce intermediation cost in providing services to both depositors and
borrowers.
A study by (Asli, 1998) while studying bank performance that taken interest spread and bank
profitability as dependent variables and bank specific variables (size, leverage, type of business,
foreign ownership), country specific variables (macro-economic, legal and institutional
environment) as explanatory variables concluded that foreign banks are better in terms of net
profits with high interest spread and low NPAs. The study found that higher interest spread could
indicate greater banking efficiency under segmented or imperfectly competitive markets.
(Saleem, 1995)He is of the opinion that Indian financial system is characterized by
predominance of public sector units and high degree of regulations, motivated mainly by socioeconomic considerations, as a result of liberalization, the existing institutional arrangement of
banking sector has become deficient in various ways the major issues related to international
competitiveness consists of financial soundness, operational efficiency, viability, profitability.
Mainly Indian banking system by two major factors, they are external and internal. Internal
factors including lack of proper supervision, low productivity and performance of employees etc.
whereas the external having bearing on the profitability have centered on pre-emption in the
form SLR, CRR, and the administered structure of interest rates.