Banking & Research - XV : Impact of Deregulation

Over the last decade and a half, the banking and financial systems of the developed countries have been undergoing rapid changes—mostly driven by deregulation, innovations in information technology and the globalization of markets. Simultaneously, the pressure of competition compelled the banks to go all out for achieving economies of scale and scope and improving their efficiency. This has resulted in a wave of mergers and acquisitions in the banking and financial sectors. The consolidation process was essentially aimed at maximizing profitability, reducing cost inefficiency, increasing market power, and exploiting scale and scope economies, and improving managerial efficiency. However, there is very little literature supporting these assumptions. In fact, the extent of exploitable scale and scope economies are reported to be smaller than expected and often the increasing managerial efficiencies are considered doubtful in large financial institutions. Indeed, there is a concern that the larger the financial institutions, the lesser the customer orientation becomes. Mergers and acquisitions are also feared as a source of diversion of the attention of the businesses from small customers.

Thus, measurement of efficiency improvement derived from the consolidation process continues to be the most appealing field of research for the academia. Driven by it, the authors, Bernardo Maggi and Stefania P S Rossi have investigated the efficiency of European and US commercial banks and presented their findings in the article—“Does Banking Consolidation Lead to Efficiency Gains? Evidence from Large Commercial Banks in Europe and US”. The authors have derived the scale and scope economies indicators and measurement of X-efficiency from three cost functions, namely—Fourier flexible form, translog and Box-Cox, and thus ensured the stability and the robustness of the evidence across the different specifications. The findings revealed that overall the largest banks do not have higher efficiency scores. The authors opine that further enlargement of the production size does not necessarily lead to production gains. However, there is an interesting feature in their findings: The scale and scope economies are larger in the US than in the European banks, probably because of higher level of technology used by the US banks and perhaps the longer period for which the restructured process is on. The authors, based on their findings, have also opined that banks should focus more on cost efficiency than on enlarging the scale of production.

There is another interesting article—“An Analysis of Technical Progress and Efficiency in Malaysian Commercial Banks Before Mergers”—by Shazali Abu Mansor, Alias Radam and Muzafar Shah Habibullah, which studies the efficiency of 37 commercial banks in Malaysia. The authors have measured the Total Factor Productivity and its efficiency components for 37 commercial banks during the period of 1988-93 using a non-parametric Data Envelope Analysis. It was found that almost all the productivity growth came from efficiency change rather than improvement in technology, which means that efficiency gains and losses across the system were found to be mostly mutually offsetting and efficiency change did not have a significant impact on overall Total Factor Productivity.

Incidentally, these two articles have a relevance to the Indian banking system, which, having reformed itself, is on the move towards consolidation. As the authors of the second article—Shazali Abu Mansor, Alias Radam and Muzafar Shah Habibullah—opined, the findings of these two articles have many policy implications: Improving managerial performance by identifying ‘best practices’ and ‘worst practices’ associated with high and low measured efficiencies; assessing the effects of deregulation, merger and market structure on efficiency, etc.

In the next article—“Determinants of Liquidity and Interest Rates: Some Results for India during 1995-2005”—the authors, Ajay Pathak and Subhasis Ray, have attempted to find out the possible determinants of liquidity and interest rate behavior in the Indian market. The authors have first undertaken data requirement analysis followed by determination of analysis technique for understanding the relationship between liquidity and interest rates, if any, and the underlying determinants. The study revealed that liquidity can be explained by exchange rate, inflation, foreign exchange reserves, bank credit and government borrowing. But liquidity has failed to significantly explain variation in the interest rate. The simultaneous equation model revealed that exchange rate, inflation and foreign exchange reserves have a dominant effect on interest rate behavior. The authors also believe that non-quantifiable factors such as government policies, improvement in living standards of the people, monetary policy and market sentiment do have an impact both on the liquidity and interest rate behavior. This study thus throws open a wide scope for further research in verifying the influence of quantifiable and non-quantifiable factors on the interest rate behavior.

The Muhammad Yunus-led ‘micro finance’ is by now well established in Africa, Latin America, Asia, and Eastern Europe. Micro finance essentially involves granting loans under joint liability to individuals who have no wealth but formed into groups to pursue an economic activity. Such joint liability lending enables the lender to cut off all the members of a group from future credit if any one member in the group has not repaid the loan. It is expected that joint liability induces borrowers of similar nature and value system to form into a group and avail loans. Empirical studies reveal that these ‘wealth-less’ borrowers have achieved a fair degree of success in terms of repaying the loans and building up their financial sufficiency. In this context, the author, Alessandro Fedele, in his article—“Joint Liability Lending in Microcredit Markets with Adverse Selection: A Survey”—has found that due to peer selection mechanism, safe borrowers select the contract with higher joint liability and lower interest rates and as a consequence the welfare impact and repayment rate rise more under joint liability than under conventional individual liability.

In order to improve the scope for liquidity management in the Indian money market, the certificate of deposits was introduced in 1989 and commercial paper was introduced in 1990 and since then it has been the endeavor of the central bank to give a boost to the penetration and stabilization of these two products in the Indian money market. It is a well-known fact that CPs and CDs exhibit contrasting market behavior: CP market gets activated amidst ample liquidity while CD market gets a boost in periods of liquidity crunch. It thus raises a question: Is there any relationship between CD and CP either in terms of issuance or outstanding balances? The other question is: Are they cointegrated and move in the opposite direction? This is precisely what has been examined by the author Varadraj Bapat in his article— “A Study of CD and CP Market in India: Cointegration Analysis of their Volumes”. The author has conducted Augmented Dickey Fuller test to ascertain that the concerning series are non-stationary and then carried out Johansen and Johansen Juselius’s cointegration test and VAR model ‘order 2’ to know the nature and the degree of long-run relationship between the outstanding under CD and CP market and found that the series are non-stationary and they are not co-integrated.

With the advent of financial reforms, India has witnessed a tremendous change in the banking sector. New private sector banks have brought in severe competition to the public sector banks in terms of technology adopted and the resulting delivery of services and new products. A paradigm shift has been set in motion, as a result of which customer satisfaction has become the major driver of business growth. Against this background, the author, Nalini Prava Tripathy, analyzed the factors that are essential in influencing the decisions of the customers of Public Sector Banks to invest or not, in her article—“A Service Quality Model for Customers in Public Sector Banks”. The author has used Factor Analysis—an appropriate multivariate technique—to identify the groups of determinants of customer behavior. In this analysis, the author has used Principal Component Analysis and ranked the factors that represented the satisfaction level of the customers of the public sector banks: Core factor(5), technology factor(4), service behavior(3), price factor(2), environmental factor(2) and situation factor(1).

Courtesy - IUPJBM, Vol. V, No. 2 May 06