Abstract
During the 1990s various economic, financial and political events, including the implementation of a number of economic and financial liberalisation measures took place in India. Therefore one would expect financial liberalisation and possibly other economic and social factors to have an important influence on the Indian banking performance. This thesis attempts to explore, empirically, theconditions that are likely to be associated with the growth, competition and profitability of Indian commercial banks. The empirical part of this thesis is divided into three parts. The first part examines the growth characteristics of banks - testing the Law of Proportionate Effect (LPE). The second section
examines the determinants of profitability of Indian commercial banks, and the final part investigates the impact of competition and how it has changed in the Indian banking system over time.
The first model tests Gibrat's (1931) Law of Proportionate Effect (LPE) using a sample of Indian commercial banks over the period 1997-2003. Gibrat's Law postulates that the growth of banks is a random process. This paper therefore considers whether the growth of Indian commercial banks is constant across bank size or whether growth is systematically related to bank factors such as the size of banks. In other words, does the growth of Indian commercial banks match the assumptions behind the LPE? This thesis finds that Gibral's (1931)) law held for the years 1999, 2001, and 2003 because the size of a bank in the previous year does not guarantee its growth in the subsequent year. However in 2000 and 2002 the law does not hold, evidenced by the fact that none of the predictors had sufficient influence on the response variables over the study period.
The second model examines the effects of bank-specific, industry-specific and macroeconomic determinants of bank profitability, using an empirical framework which incorporates the traditional Structure-Conduct-Performance (SCP) hypothesis. We found that all bank-specific variables have a significant influence on the profitability of Indian commercial banks. A strong negative dependence between profitability and the credit risk proxy suggest risk-aversion type behaviour of bank managers. Also staff expenses have a negative influence on profitability. It is worth mentioning that bank size does not appear to influence profitability. When macroeconomic and industry-specific variables were excluded from the model, the results show that apart from in 2004 (in this year results appeared to be insignificant), the relationship between profitability and credit risk and expense proxies revealed the same scenario, and bank size was insignificant. When industry-specific variables were taken into account ownership did not appear to be an important predictor, however, market concentration showed a negative and statistically significant effect on banks profit. This finding does not provide support for the traditional SCP hypothesis. Macro-economic variables are found to have relatively strong influence on bank profitability; interest rates are found to have a negative influence on profitability whereas the business cycle seems to influence banks profits in a pro cyclical manner.
The final model examines competitive conditions in Indian commercial banking. It is widely perceived that competition in the Indian banking sector has increased since the inception of financial sector reforms in the l990s. Using annual data on commercial banks over the period 1997- 2004, this paper evaluates the validity of this hypothesis in the context of the Indian commercial banking sector. The empirical evidence reveals that monopolistic competition existed in the Indian commercial banking market in 1997, 1998, 1999, and 2000. Conversely, in 2001, 2002 and 2004 the market was closer to perfect competition. Overall we tentatively suggest that competition in the Indian commercial banking sector has improved over the period of study and this is likely to be consequence of the ongoing liberalisation programme as well as rapid economic development.
| Date of Award | May 2009 |
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| Original language | English |
| Awarding Institution |
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| Supervisor | Philip Molyneux (Supervisor) |