Efficiency Of Indian Banks – Private Versus Public Sector Banks: A Two-Stage Analysis

www.yra.ijaar.co.in ISSN – 2277-7911 Impact Factor – 5.077 Oct-Nov -Dec 2022 Vol. 11 No. 4 99 Efficiency Of Indian Banks – Private Versus Public Sector Banks: A Two-Stage Analysis Dr. Rabindra Kumar Faculty of Commerce. Magadh University Bodh Gaya. Bihar. India. Abstract: This paper estimates and compares various efficiencies, namely, business, profit, and Z-Score efficiencies for private and publicly owned Indian banks. It uses the data envelopment analysis (DEA) following variable returns to scale, under input and output orientation, for measuring efficiency. Further, the Tobit regression model is used in the second stage to check the significant determinants from a list of bank-specific factors for various efficiencies. The study finds that the average efficiency scores of public sector banks (PSBs) are higher than private banks. The Z-score indicates that both PSBs and private banks are facing stability risks. Tobit regression model results confirm that return on assets and capital levels are significantly related to all types of efficiencies for private banks. On the other hand, the efficiency of PSBs is mainly affected by the level of nonperforming assets, market share, size of the bank, return on assets, and capital level. It is inferred that the prompt corrective action (PCA) framework of RBI (2014) and the merger and consolidation of PSBs by the government (2019) favorably impacted the efficiencies of PSBs. Additionally, it identifies the stability risk of Indian banks and suggests banks should build up adequate capital for stressful situations. Keywords: Xport Diversification, Financial Development, ARDL, Ethiopia. Introduction: Ali et al. (Citation1991) defined export diversification as the change in the composition of commodity exports. Export diversification is twofold, i.e. horizontal and vertical. The first deals with the number or volume of primary export commodities, but the latter is concerned with changes in the structure and commodities from primary to secondary and tertiary goods (Herzer & Nowak-Lehnmann, Citation2006). The exports of most developing countries in Africa are heavily dependent on very few primary commodities. The exports of primary commodities are extremely vulnerable to external shocks (Fonchamnyo & Akame, Citation2017). Sub-Saharan Africa’s export earnings largely depend on coffee, gold, oilseed, vegetables, hide, and skin, representing 80% of total export (World Bank, 2006). For more export entrepreneurs, financial development reduces liquidity constraints and encourages diversification of exports Corresponding Author: Dr. Rabindra Kumar DOI - 10.5281/zenodo.17579403 Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 100 (Chaney, Citation2016; Hausmann & Rodrik, Citation2003). Prebisch’s (Citation1962) theory also argues that the export of primary products reduces the terms of trade and further increases the instability of income. Furthermore, to improve falling terms of trade, a country needs to diversify its export composition (Dogruel & Tekce, Citation 2011); (Massell, Citation 1964); (WILSON, Citation 1984). They indicate that diversification of developing country exports should become a common economic policy objective (Brainard & Cooper, Citation 1968; Dogruel & Tekce, Citation 2011). Moreover, in the contemporary literature, opposite to the division of labour and specialization idea of Adam Smith, countries appear to diversify their production and exports as they grow (Hesse, Citation 2009: Krugman, Citation 1980). Like other developing countries, the main objective of the Ethiopian government has been to achieve rapid and sustainable economic growth. Foreign trade is an area which has been emphasized in the various programs of the Ministry of Finance and Economic Development for the year 2002/03. External trade is the most important sector to generate foreign exchange needed to finance imports of essential goods and services for the economy and to promote the economic performance of the country (EEA, 2013). However, Ethiopian export heavily depends on very few primary products; which constitutes above 90% of the total export earnings. As stated in the World Bank Journal (2016), the prices of these primary products fluctuate from time to time and led to lower and unstable export revenues earning. Unless the countries diversify their export earnings, it is hard to achieve sustainable economic growth and reduces external debts. One factor among different hindrances of export diversification is lower financial development. There are many measures of financial development, but the most frequently used measure is a credit to the private sector. Compared to low-income subSaharan African, Ethiopia’s financial sector development is low. The number of banks operating in Ethiopia remained at 18, of which 16 were private and the remaining 2 are publicly owned banks. These banks opened 4,625 branches, of which 68.2 percent were private bank branches. According to the central statistical agency estimation, the total population is 96,503,000. It indicates on average one branch serves 20,865.5 people. Among the total branches 34.4 percent resided in Addis Ababa in Addis Ababa there are only around four million residents. In Ethiopia 17 insurance companies are operating with 4.7-billion-birr total capital from 17 insurance companies; 16 were privately owned, with a 74.6 percent share of total insurance capital. There are 518 Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 101 branches, of which 53.90 percent were located at Addis Ababa. In addition to banks and insurance companies were 35 microfinance institutions (MFIs) with 28.4 billion birr saving deposit (NBE, 2017/2018 quarterly report). This causes a lower level of credit to the private sector. For instance, most funds by banks (two-thirds) have gone to the public sector. In 2011–2012 the share of credit going to the private sector was as high as 36 percent of total credit, but in June 2018 it declines to 32 percent. Still, the scale of such directed credit schemes to the public sector has been to such an extent that Ethiopia’s financial development now stands at just 11 percent of GDP, which is half of 20 largest African economies estimated 22 percent of GDP average. Therefore, Ethiopia’s financial sector is in need of much improvement if a more private sector–driven economy is to take hold in the coming years. Beyond the comparatively limited credit made available to the private sector, the specific forms and features of lending offered have not matched the needs and demands of most private sectors (CEPHEUS, 2019). Hence this study intends to examine the relationship between credit to the private sector, a proxy for financial development and export diversification in Ethiopia. The remainder of the paper is presented as follows. Section 2 provides an overview of previous theoretical and empirical literature. Section 3 presents methodologies and data. The remaining sections 4 and 5 present the result and discussion and conclusion and recommendations, respectively. Literature Review: Export diversification is important for economic growth in that diversification of export reduces export earning instability caused by fluctuations in world commodity prices. According to WILSON (Citation1984), if a country relies on a few exportable products, one export commodity, and its foreign exchange position is highly insecure. Contrary to this, Cline (Citation1982) argued, export-led growth may break down if a large majority of developing countries seek to pursue it at the same time. Because the resulting outpouring of manufactured exports might be more than western markets could absorb. Generally, inadequate finance is a major constraint to a firm’s production, at least as perceived by the firms themselves. Theoretically, this perception is likely to be based on the liquidity constraint hypothesis, that is, the need to finance particularly physical capital but also other production inputs with significant fixed costs. Since such outlays entail lagged returns, sufficient liquidity through credit is required to keep the firm afloat until future returns are realized. Also, as diversification often involves investment projects with long gestation periods, compared to primary Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 102 production, greater liquidity would be required. Where such liquidity is lacking, firms are likely to resort to shorter-term, probably less productive, investment projects rather than to projects involving longer gestation periods, usually required by export diversification. Such liquidity constraint is similar to that relating to a debt constraint, where longer-term projects are less attractive to investors and the government in the presence of a debt constraint (Fosu & Abass, Citation2019). In addition, domestic credit is expected to reduce liquidity constraints through the increase in the number of entrepreneurs in the export sector, and in turn it facilitates export diversification (Chaney, Citation2016). Moreover, Hausmann & Rodrik (Citation2003) pointed out that overcoming the liquidity constraint is critical in terms of expanding exports, especially relatively diversified exports that are likely to require longer-term and riskier investment projects. Such circumvention would in turn require readily available sources of funding. Recent theoretical and empirical studies emphasized the importance of export diversification instead of export specialization (Herzer & NowakLehmann, Citation2006). According to Parteka and Tamberi (Citation2011) export diversification can be emanated from the change in the structure of the economy, which requires a deep transformation of a country’s economy along different development paths. In addition, Kiendrebeogo (Citation2012) pointed out that having a developed financial sector creates a comparative advantage in the industrial sector, which in turn contributes to the diversification of export. Though diversified external trade generates ample foreign exchange and in turn promotes economic growth (EEA, 2013), export of Ethiopia heavily depends on very few primary products; which constitute above 90% of the total export earnings. Moreover, the price of those primary products varies frequently from time to time, which worsens the problem and causes lower and unstable revenue, and a huge negative trade balance (World Bank Journal (WBJ, 2016)). Unless the countries diversify their export earnings, it is hard to achieve sustainable economic growth and reduces external debts (Yokoyama et al., Citation2015). Among the factors causing low export diversifications in Ethiopia, underdeveloped financial sector is the major one. Financial sector development is measured in terms of credit to the private sector by all banks. Ethiopia’s financial sector is underdeveloped and unfairly distributed (Kassie, Citation2014). According to the Ministry of Finance and Economic Development (MoFED (Ministry of Finance and Economic Development), Federal Democratic Republic of Ethiopia, Citation2006) Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 103 since 2003 to achieve accelerated and sustainable growth the government of Ethiopia has emphasized external trade as a major tool. However, it is not as much as expected. Despite these previous researchers gave low attention to the effect of credit to the private sector on export diversification. For instance, Oliveira et al. (Citation2020), Fosu and Abass (Citation2019), Dogruel and Tekce (Citation2011), Nieminen (Citation2020), Liu and Zhang (Citation2015), and Long et al. (Citation2017) conducted a study on determinants of export diversification. However, most of the studies focused on the exchange rate, economic growth, trade openness (trade liberalization), and other macro variables as determinants of export diversification. Thus, most of the studies overlooked the effect of credit to the private sector on export diversification in the Ethiopian economy. Particularly in Ethiopia, hardly any evidence, there is no study conducted on the subject area. Therefore, this study intended to fill these gaps and examine the effect of financial development, which is the factors policies, and institutions that lead to effective financial intermediation and markets, and deep and broad access to capital and financial services” (Financial Development Index, 2008) on export diversification of Ethiopia. From the literature reviewed there is no adequate empirical and theoretical literature on the relationship between export diversification and credit to the private sector in Ethiopia. Some of the researchers did not consider the effect of financial development on the trade balance, particularly in Ethiopia, some other studies are out of date, and the remaining research conducted are in developed countries. Hence, we can’t conclude the same result as in developed countries because the microand macro-economic performance of developed and developing countries is different. Thus, the reviewed literature shows there is no evidence providing the effect of financial development on export diversification in Ethiopia. Data and Methodology: This study employed a quantitative analytical research approach. Descriptive and inferential/empirical study designs were used. Time series data of 41 sample years from the period 1980 to 2020 drawn from secondary sources were used. The Auto Regressive Distributed Lag (ARDL) co-integration technique developed by Im et al. (Citation2003) and Pesaran et al. (Citation2001) was employed as an econometric analysis method to indicate the relationship between export diversification and financial development, and other control variables. ARDL is a dynamic unrestricted model in which the explained variable is expressed as a function of its lag and other explanatory Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 104 variables. According to Charemza and Deadman (Citation1997), the methodology of the ARDL model follows a general to a specific approach, which enables the researcher to solve econometrics problems. ARDL model has many advantages over the Johansen (Citation1988) co-integration approach in that the first avoids the problem of the order of integration, suitable for both large and small samples (Pesaran et al., Citation2001), and provides unbiased estimates even when some of the explanatory variables are endogenous (Harris & Tzavalis, Citation1999). Model Specification: Based on the theoretical and empirical literature reviewed in this study, five variables are identified as factors that affect export diversification (ED). When identifying these variables we adopt Lugeiyamu (Citation2016) and modify it based on our objective. These are financial development (FD) measured by credit to private sector as a percentage of GDP (CPS%GDP), an official exchange rate (OER), external debt (EDEBT), real gross domestic product (RGDP), and trade liberalization (TL). Checking the Existence of Long-Run Relationship: This is a stage where the longrun relationship existing between variables is assessed. The existence of such a relationship is tested by computing a bound test for cointegration (bound F-statistic) to establish long-run relationship among variables. ARDL is extremely useful because it allows us to describe the existence of an equilibrium/relationship in terms of long-run and short-run dynamics without losing long-run information. The ARDL involves estimating the following equation: The General ARDL (p, q) Model is Specified as: βi represents long-run cointegration/relationship and αi represents short-run dynamics of the model. The existence of long-run cointegration will be tested based on the null hypothesis of βi’s = 0 against the alternative hypothesis βi’s ≠ 0. To identify the presence of co-integration in the long run bound test has been conducted. The value of Fstatistics is used as identifying the existence of longrun relationship between dependent and independent variables. ARDL bound test is based on Null hypothesis (HO): no long-run relationship and alternative hypothesis (H1): there exists long-run relationship. The decision is to accept HO if F < critical value for I (0) independent variables or reject if F > critical value for I (1). Most time series data exhibit a non-stationary trend and estimating a regression model with non-stationary data will result in spurious relationship and, in turn, causes misleading and biased parameter estimates. Though it only reveals short-run dynamics, to Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 105 resolve such type of problem differencing variables is important. In this regard error correction model (ECM_1) will be included based on the existence of long-run co-integration or not. Methodology: Definition and Summary Statistics of Variables: HHI is 1 if the trade pattern is completely concentrated, and 1/n if all products have equal shares in the export of a commodity. However, its value is substantially affected by n. to avoid this problem we used the normalized Herfindahl-Hirschman index. Therefore, as can be seen from Table 1 and Figure 1, export is more diversified if HHIN is close to zero and vice versa. For the study sample, the mean value of export diversification is 0.41, with the highest diversification period in 2015 amounting to the normalized Herfindahl-Hirschman value of 0.209 and the highest concentration of Ethiopia’s export from 1980 to 2020 recorded in 1988 with a value of 0.694. Financial development is defined as all financial resources provided to the private sector by depository institutions through loans, purchases of non-equity securities, trade credits, and other accounts receivable. This measure of financial development is theoretically identified by King & Levine (Citation1993) and empirically investigated by Ahad (Citation2017). For the study sample, the mean value of financial development is 16.188 percent, with minimum and maximum of 6.11 and 34.537% respectively. Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 106 Table 1. Summary statistics of variables used in the study In addition to financial development economic growth was used as an independent variable. The real GDP growth rate used in the empirical analysis averaged 5.9786% between 1980 and 2020 ranging from negative −11.144% to positive 13.57%with a standard deviation statistics of 6.6245. This growth variation across time in the country may be because of occurrences in domestic and external factors such as continuous deterioration in terms of trade, falling commodity prices, global economic downturn, and financial crisis in the international economies. The effect of economic growth on export diversification is ambiguous in that the expected signs under the absorption and monetary approaches are negative and positive respectively. Higherincome levels stimulate increased import demand as well as increased domestic production of tradable, leaving the ultimate impact on the trade balance somewhat indeterminate. However, it is argued that the former effect dominates the latter. In this study trade liberalization (TL) is used as a dummy variable. In 1992/93 the current government of Ethiopia implemented (major policy reforms). These policy measures include the reduction of tariff and non-tariff barriers, harmonization and simplification of tariffs, like tariff dispersion and lines, and reduction and gradual elimination of all controls including on domestic price. Before 1992 it takes the value 0 and 1 for post 1992. External debt (Debt): External debt or borrowing refers to taking monetary aid from a foreign country or institution. It is expected that external debt has a negative relationship with export diversification. From 1980 to 2020 external debt as a percentage of GNI ranges from 10.5085 to 131.181% averaging 59.6873% with a standard deviation of 36.0638. This is an indication that countries in the region are heavily dependent on external financial source to fill their financial gaps or government budget deficit. Young Researcher Vol. 11 No. 4 OctNov - Dec 2022 Dr. Rabindra Kumar 107 Finally official exchange rate (OER): is an exchange rate at which the currency of one country can be exchanged for the currency of another country. During the study period, Ethiopia’s official exchange rate ranges from 2.07 to 28.323 with mean values and standard deviation of 9.293 birr/USD and 7.641 respectively. Depreciation in the domestic currency can cause the price of foreign goods to become relatively more expensive as compared to domestic goods. In effect, it may lead to the competitiveness of domestic exports and will cause a shift of resources from sectors that produce non-tradable to sectors producing tradable goods. This implies an increase in domestic export relative to imports, thereby improving export diversification. The Relationship between Dependent and Independent Variables: In Figure 2 graphical relationship between the dependent and independent variables is presented. For the purpose of drawing the graphical relationship, the dependent variable, export diversification, is changed in to growth value of Herfindahl-Hirschman index (GHHI) before normalization. On panel “A” one can understand that stock of external debt as a percentage of gross national income was continuously rising during the military government in Ethiopia. After the fall of the military government the stock of external debt as a percentage of RGDP started to very slowly decline, remaining at its high level until 1998 and then after it showed a radical decline to reach at its lowest level since ever in 2006. This was mainly due to debt cancellation made to the country from various creditors in 1999 and it was the reflection of the impact of HIPC relief assistance made to Ethiopia in 2006 proposed by IMF and IDA. There is a positive relationship with concentration, but it has negative relationship with export diversification.