This document presents a quantitative analysis of the performance and efficiency of Indian banks using panel regression, focusing on 18 public and 14 private sector banks from March 2002 to March 2011. It examines various internal factors affecting banks' profitability, with return on net worth as the dependent variable, while exploring the impact of ownership structure on performance. The findings contribute to understanding the effects of economic reforms and competitive pressures within the Indian banking sector.

1. A Quantitative Analysis of Indian Banks’
Performance and Efficiency-A Panel
Regression Approach
Submitted to:
Dr. VIGHNESWARA SWAMY

2. Page | 1
Abstract
The importance of banks which constitutes the main structure of the financial system
increased with globalization on the both sides of country and firm. Factors that affect banks‟
performance can be macroeconomic or internal factors relevant with banks. In this study,
different internal factors that can have an impact on banks‟ profitability are examined with
panel data analysis. The dataset includes 18 public sector banks and 14 private sector banks.
The time frame considered for the analysis is from March‟02 to March‟11. Return on Net
Worth is taken as the dependent variable as a proxy for the profitability of a bank.
Table of Contents
Abstract......................................................................................................................................1
Table of Figures .........................................................................................................................2
Table of Tables ..........................................................................................................................3
1. Introduction........................................................................................................................4
2. Literature Review...............................................................................................................4
3. Indian Banking Sector........................................................................................................5
3.1 Performance and Trends of Indian Banks...................................................................6
4. Empirical Analysis.............................................................................................................9
4.1 Data Analysis ..............................................................................................................9
4.1.1 Dependent Variables............................................................................................9
4.1.2 Control or Independent Variables......................................................................10
4.1.3 Data Sample.......................................................................................................11
4.2 Model Estimation (Methodology).............................................................................12
4.2.1 Panel Unit Root Test..........................................................................................13
4.2.2 Results for the whole sample (Public and Private Banks) .................................14
4.2.3 Results for only Public Sector Bank Sample .....................................................18
4.2.4 Results for only Private Sector Banks Sample ..................................................19
4.3 Summary of the Results and Conclusion ..................................................................21
5. Limitations.......................................................................................................................22
6. Annexures ........................................................................................................................23
7. References........................................................................................................................25

3. Page | 2
Table of Figures
Figure 3-1 Growth in Aggregate Deposits of SCBs ..................................................................6
Figure 3-2 Demand Deposits Figure 3-3 Term Deposits.................................................7
Figure 3-4 Share in Deposits-Ownership Wise .........................................................................7
Figure 3-5 Growth in Gross Bank Credit...................................................................................8
Figure 3-6 Share in Bank Credit-Group Wise ...........................................................................8
Figure 3-7 NIM Trend-Group Wise...........................................................................................9

4. Page | 3
Table of Tables
Table 3-1 Major Achievements since Nationalisation...............................................................6
Table 3-2 Movement in Bank BPLR-Group Wise ....................................................................8
Table 4-1: List of Public Sector Banks (PSB) .........................................................................11
Table 4-2: List of Private Sector Banks...................................................................................11
Table 4-3: Model 1-Fixed One Way (Banks) Effect ...............................................................14
Table 4-4: Model 2-Fixed 2-Way Effect .................................................................................15
Table 4-5: Model 3-Random 2 Way Effect Model..................................................................15
Table 4-6: Model 4-Fixed 2-Way Effect for Efficiency..........................................................16
Table 4-7: Model 5-Random 2 Way Effect for Efficiency......................................................17
Table 4-8: Model 6- Random 2-Way Effect Regression on RONW of PSB...........................18
Table 4-9: Model 7-Random 2-Way Effect Regression on NIM of PSB................................18
Table 4-10: Model 8- Random 2-Way Effect Regression on RONW of PrSB .......................19
Table 4-11: Model 9-Random 2-Way Effect Regression on NIM of PrSB.............................20
Table 4-12: Summary of Results for Regression on RONW...................................................21
Table 4-13: Summary of Results for Regression on NIM .......................................................22
Table 6-1: LLC Panel Unit Root Test......................................................................................24

5. Page | 4
1. Introduction
The Indian financial sector underwent a radical change during the nineties. From the
relatively closed and regulated environment in which agents had to operate earlier, the sector
was opened up as part of the efficiency enhancing structural policies to bring about high
sustainable long-term growth of the economy. The banking sector was also not an exception
to this rule. New measures were undertaken to induce efficiency and competition into the
system. Accounting and provisioning norms, capital adequacy rules, proper risk management
measures, etc. were brought in place and entry regulations were also relaxed. The
environment was made friendlier for domestic private sector and foreign banks. So, as a
result, many new private players entered the banking sector giving rise to the heightened
competitive pressure.
In this report, an attempt has been made to analyze the effects of various internal factors and
the effect of ownership structure on the profitability of a bank. The methodology used for the
analysis is that of Panel Regression which becomes relevant when there are data for a period
of time for each of the units being considered and thus, becomes readily applicable to the
present case because for the banks that have been considered in this paper, the data on the
relevant variables are available for several years. In order to make full use of the available
data, this technique assumes relevance. Besides making full use of the data, this technique
also has some very important specific advantages. In an analysis of this kind, there might be
several bank-specific and time specific influences that are unobservable and hence not
captured by the variables used in the regression. For checking the effect of ownership, pooled
estimation technique has been used in place of Fixed and Random effect estimation
techniques.
2. Literature Review
Berger (1995) found a strong positive relationship between return on equity (ROE) and
Equity/Total Assets, using banks‟ performance variables as ROE, return on assets (ROA) and
net interest margin. Naceur and Goaied (2001) determined that good performer banks‟ labor
and capital efficiencies are higher, deposit accounts‟ volume is higher relative to income
earning assets and they increase their equity or enhanced equity with undistributed profit.
Türker (2002) researched Turkish banking sector profitability determinants using panel data
including the periods 1997-2000. Two-step approaches are applied to measure the relative
importance of the micro and the macro elements to determine the profitability. Within the
micro determinants: capital, liquidity, personnel expenditures, deposits and market share are
found to have significant influences on net interest margins. Among the macro variables,
inflation and budget deficits have significant effect on net interest margins. At the end of the
analysis results concluded that capital, liquidity, personnel expenditures, loans, non-
performing loans and deposits are the micro determinants of return on assets (ROA). The
findings of her study also revealed that, the most important contributors of return on equity
(ROE) are capital, securities portfolio, liquidity, personnel expenditures, loans, deposits and
market share.

6. Page | 5
The most extensive research about this subject belongs to Demirgüç and Huizingha (1998).
These two researchers tried to explain the interest spread and profitability components using
80 countries data during the period of 1988-1995. In their study, macro-economic variables,
taxing, banking regulations, financial structure and legal criterion are used as variables. They
found that when bank assets/GDP ratio increases and bank concentration rate decreases,
banks interest spread and profitability declined. In developing countries foreign banks are
more profitable than national banks whereas in developed countries that relationship reverses.
The relationship between bank ownership and performance has not been analyzed extensively
and only a few references in this regard include the papers by Sabi (1991), Davies and
Brucato (1987) and Sarkar, et. al. (1998). La Porta, et. al. (2000) identifies the
“development” view and “political” view of the government ownership of banks.
In the literature, there has been extensive analysis on the issue of ownership and performance
of firms. The broad lines of thought in this regard are the property rights approach (as
exemplified by the writings of Alchian, 1965 and de Alessi, 1980) and the public choice
approach (as represented by the writings of Nickskamen, 1971 and Levy, 1987).
It must be remembered that most of the evidence on the ownership-performance relationship
is centered on developed countries and a similar line of reasoning might not work for
developing countries because of the absence of a well-defined market for corporate control.
This is so because in many developing countries, there is a lack of free flow of information,
lack of transparency and the presence of incomplete markets, which are prerequisites for
defining property rights. The ownership-performance effects noticed in the context of
developed countries might not be working in these cases. India, thus, provides an interesting
example in this regard because the country has come out from the regulated environment and
is moving to a more market-oriented scenario. In this sense of the term, India is an emerging
economy and the period chosen for the analysis is the one when one can comfortably say that
both-public and the private sector banks have equal opportunities in terms of growth and
competition.
3. Indian Banking Sector
The Indian banking sector consists of the Reserve Bank of India (RBI), which is the central
bank, commercial banks and co-operative banks. Commercial banks are of two types-
scheduled, which are subject to statutory requirements and non-scheduled, which are not.
Scheduled banks can be further classified into public sector banks [comprising of the State
bank of India, its seven associates, other Nationalized banks and the Regional Rural Banks
(RRBs)] and private sector banks, which can be either domestic or foreign.
The primary objective of bank nationalization in 1969 was to provide assistance at
concessional rates of interest to relatively backward areas. Pursuant to the nationalisation, the
banking sector became dominated by a plethora of rules and regulations. Nationalisation
increased the scale of banking operations substantially (as depicted in Table 3-1, which
illustrates the major achievements since nationalisation) but, at the cost of profitability and
efficiency of the banking system; in many instances, this led to a piling of Non-Performing
Assets (NPAs) with the banks, causing major concern. As part of the reform process initiated
after the balance of payments crisis in 1991, large- scale reforms were brought about in the

7. Page | 6
financial sector in general and the banking sector in particular. As the architect of these
reforms, M. Narasimham (1998) had pointed out, the reforms in the banking sector can be
classified into two phases: The first phase consisted of the curative measures, which were
brought about for making the banking sector more oriented to the market and impart
competition to the environment. The second phase consisted of the preventive measures,
which were brought about to ensure smooth functioning of the banking sector in the long run.
Business Indicators June 1969 March 1991 March 2000
Total Number Of
Offices
8,262 60,220 67,339
Population Per Office
(000’s)
65 14 15
Total Deposits (Rs.
billion)
137.8 1101.2 8452
Deposits Per Office
(Rs. lakhs)
56 334 1255
Total Credit (Rs.
Billion)
106.8 667 4822
Credit Per Office (Rs.
lakhs)
44 202 716
Table 3-1 Major Achievements since Nationalisation1
3.1 Performance and Trends of Indian Banks2
a) Deposits:
Figure 3-1 Growth in Aggregate Deposits of SCBs3
1
Source: Sen and Vaidya (1997) and Statistical Tables Relating to Banks In India: 1999-2000
2
Source: RBI and Dun & Bradstreet Reports on Indian BFSI Sector

8. Page | 7
Figure 3-2 Demand Deposits Figure 3-3 Term Deposits
Figure 3-4 Share in Deposits-Ownership Wise
3
Scheduled Commercial Banks

9. Page | 8
b) Credit4
:
Figure 3-5 Growth in Gross Bank Credit
Figure 3-6 Share in Bank Credit-Group Wise
Table 3-2 Movement in Bank BPLR-Group Wise
4
Source: Annual Report, RBI, Various Issues

10. Page | 9
c) Net Interest Margin:
Figure 3-7 NIM Trend-Group Wise
4. Empirical Analysis
The effect of various control variables on banking performance can be analysed by estimating
an empirical model that would test the hypothesis of any significant effect of these variables
on performance. In this section, a model to test this hypothesis is estimated.
4.1 Data Analysis
Performance of a bank can be judged through various angles but in this report, the
profitability and the efficiency are being considered as the proxy for the performance
measurement. The proxy for the profitability that has been used in this report is Return on
Net worth (RONW) and that for the efficiency, Net Interest Margin (NIM) has been
considered. All the data that has been considered in this project is Secondary in nature.
4.1.1 Dependent Variables
Return on Net Worth or Return on Equity is the amount of income as a percentage of
shareholder‟s equity. Return on equity measures a bank's profitability by revealing how
much profit a bank generates with the money shareholders have invested.
Return on Equity = (Net Income/Stockholder Equity)
The measure of efficiency used here, the Net Interest Margin (NIM) is defined as the
difference between interest earned and interest expended as a proportion of average total
assets. Here, a bit modified version of this ratio has been taken into consideration. It is a ratio
between Net Interest Ratio and Total Fund of a bank instead of average total assets.
Net Interest Margin = Net Interest income/ Average Earning Assets

11. Page | 10
4.1.2 Control or Independent Variables
a) Non-Interest Income Ratio (NIIR): This factor has been brought into the picture to
capture the effect of diversification of a bank. Non-interest income tells about the income
earned by the bank through commission, brokerage, service charge, exchange and other
fee-based services which can play a pivotal role in the profits of any bank. The variable
taken into the consideration is the ratio between the Non-interest income and total fund of
a bank.
b) Interest Expended/Interest Earned (IntExpIntEar): This ratio represents the expenses
over the earnings. The interest expenditure represents the cost of fund of a bank. It
consists of interest paid on deposits and borrowings.
c) Investment/Deposit Ratio (InvesR): Investments include total investment including
investment in non-approved government securities. A major percentage of a bank‟s
investment is on Government approved securities. But now the banks are also shifting
their investments to other fields because of limited returns on Government securities (but
these are safer).
d) Total Loans/Total Assets (LINTNSTY): This ratio is also known as the Loan Intensity
of a bank. The loan to assets ratio measures the total loans outstanding as a percentage of
total assets. The higher this ratio indicates a bank is loaned up and its liquidity is low. The
higher the ratio, the more risky a bank may be to higher defaults.
e) C-D ratio (CDRATIO): Credit-Deposit ratio is one of the main indicators of banks
investment activities and also states the credit deployment for the resources raised in the
form of the deposits. It also a measure of liquidity of any bank. CD ratio is an index of the
health of banking system in terms of demand for credit in proportion to total deposit
growth in the banking sector. A declining CD ratio implies that banking sector was flush
with funds without any corresponding demand for credit affecting the bank's profitability
in the long run as they have to pay interest to depositors without corresponding income
from the credit outflow. RBI has indicated the banks that their average C-D ratio should
not exceed 70% mark.
f) Operating Expenses/Total Income (OperExpIncomeR): The operating expense ratio
shows the percentage of a bank's income that is being used to pay maintenance and
operational expenses. Operating Expenses equals the non-interest expenses. It is useful to
measure how costs are changing compared to income - for example, if a bank's interest
income is rising but costs are rising at a higher rate looking at changes in this ratio will
highlight the fact. It is also an efficiency measure.
g) Relative Deposit Market Share (RDS): It is defined as the amount of deposit at a
particular bank divided by the total amount on deposit at all banks. The deposit market
share is a way of measuring the size and performance of a bank.
h) Ownership Structure (Ownership): Here, a dummy variable OwS has been taken to
analyse the effect of type of ownership on the bank‟s performance. Only the Public (PSB)
and the Private (PrSB) category of ownership have been considered in this paper. Foreign
banks have been excluded from the analysis. The Ownership dummy will take the value
„1‟ if it is a public sector bank and „0‟ if it is a private sector bank.

12. Page | 11
Note: For the estimation purpose, all the variables have been transformed into their
natural logarithm.
All the measures of profitability and efficiency used in this paper are based on accounting
information and as such, are accounting measures. As such, they do not capture the
underlying determinants of shareholder value [See for example, Padhye and Sharma (2002)].
As has been pointed out by Padhye and Sharma (2002) and Mor and Sharma (2002) in this
context, Economic Value Added (EVA) or Shareholder Value Added (SVA) might be better
measures of performance of banks. The main reason for using the accounting measures in
spite of their inherent imperfections is that the balance sheets of banks are highly opaque and
the cash flow statements required for the calculation of these measures are extremely difficult
to obtain. For the calculation of SVA for example, one needs to have a forecast of future cash
flows for the bank in question. This job would have been next to impossible for our sample of
banks belonging to different categories and concentrated in different regions. The need was
thus felt to continue using the accounting measures and as has been pointed out earlier, these
measures had also been used in earlier studies.
4.1.3 Data Sample
The data sample consists of 18 public sector banks (PSB) and 14 private sector banks (PrSB).
The time frame considered for the panel regression is of 10 years from March, 2002 to
March, 2011. In total the sample size is of 32 banks and time frame of 10 years. Thus, the
panel dimension is 32*10=320 (excluding the time-series and cross-sectional ids). The list of
the banks taken into the sample is shown as below:
i. Allahabad Bank
ii. Andhra BANK
iii. Bank of Baroda
iv. Bank of India
v. Bank of Maharashtra
vi. Canara Bank
vii. Central Bank of India
viii. Corporation Bank
ix. Dena Bank
x. IDBI Bank
xi. Indian Bank
xii. Indian Overseas Bank
xiii. Oriental Bank of Commerce
xiv. Punjab National Bank
xv. State Bank of Bikaner & Jaipur
xvi. State Bank of India
xvii. Syndicate Bank
xviii. Union Bank of India
Table 4-1: List of Public Sector Banks (PSB)
i. Axis Bank
ii. City Union Bank
iii. Dhanlakshmi Bank
iv. Federal Bank
v. HDFC Bank
vi. ICICI Bank
vii. IndusInd Bank
viii. ING Vysya Bank Ltd
ix. Jammu and Kashmir Bank
x. Karnataka Bank
xi. Kotak Mahindra Bank
xii. Lakshmi Vilas Bank
xiii. South Indian Bank
xiv. Karur Vysya Bank
Table 4-2: List of Private Sector Banks
 The data for all the variables have been collected and calculated from the Capitaline Plus
Database, RBI and Indian Bank‟s Association.

13. Page | 12
 The panel data that will be used for the modeling is a balanced panel data. A balanced
panel is one which has same number of time-series observations for each cross-sectional
unit.
 For some of the variables, natural log transformation has been done just to normalize the
data for all the variables. It helps in increasing the normality of data if there is lot of non-
normality amongst the variables.
All the data used in this project is of secondary in nature and taken from public domain
sources mentioned above.
4.2 Model Estimation (Methodology)
The technique that will be used for modeling is a bit complicated regression technique known as
panel regression technique. A panel of data will embody information across both time and space.
For generating and the testing of the model, advanced econometric software EVIEWS v7.0 has
been used extensively.
The model that is being used to check the performance of the bank is shown as below:
Here, (Performance)it is the performance measure for the ith
bank during the tth
period, D is a
vector of dummy variables that characterize ownership, Xit is a vector of other control
variables that might affect performance and vit is a random error term. δ and β are the column
vectors of the coefficients to be estimated. The elements of β characterize the effect of
various control or independent variables on the performance of a bank.
In the analysis, both the estimation techniques of Panel Regression have been considered. But
the main focus will be on the Random effect model5
. The reason for choosing a random
effects model over a fixed effect one is primarily driven by data. In a fixed effects model, in
this case, the presence of the ownership dummy which takes the same value for the same
bank across all time-periods gives rise to a matrix of explanatory variables which is singular,
that is, the value of the determinant of that matrix becomes zero and as such, it cannot be
inverted. This happens because a linear combination of the vectors of ownership dummies
gives rise to the intercept vector. As the explanatory variable matrix cannot be inverted
because of the collinearity of the regressors, the coefficients cannot be estimated. It is also
termed as the dummy variable trap.
In random effects models, the estimation framework considers that the constant term or the
intercepts for each cross-sectional unit (i.e., individual stocks) are assumed to occur from
common intercept term i.e., α plus a random variable εi that varies cross-sectionally but is
constant over time in case of one-way random effect estimation. εi measures the random
5
For Details please see Baltagi (2005), Chris Brook (2008, pp.498) and Kennedy (2003, pp.315)

14. Page | 13
fluctuations of each entity„s intercept term from the global intercept term α. random effects
panel model can be written as:
Yit = α + βXit + ωit , ωit = εi + vit
The main required assumption of this framework is that the error term (here only cross-
sectional error term) εi has zero mean and is independent of the cross-sectional error term
(vit). Also, the variance σ2
ε is constant and error-term is independent of the explanatory
variables (Xit).
In random-effect models, a generalized least squares (GLS) method is usually used for the
estimation. The transformation used in this GLS estimation procedure is to subtract a
weighted mean of the Yit over time (i.e. part of the mean rather than the whole mean). Then,
define the „quasi-demeaned‟ data as Yit
∗ = Yit – θYi
’
and Xit
∗ = Xit – θXi
’
, where Yi
’
and Xi
’
are
the means over time of the observations on Yit and Xit respectively. θ will be the function of
the variance of the entity-specific error term, σ2
v , and of the variance of the entity-specific
error term, σ2
ε
This transformation ensures that there are no cross-correlations in the error terms, but
fortunately it will be automatically implemented by the Eviews.
4.2.1 Panel Unit Root Test
It is very important for any time-series data to pass this test. A unit root test tests whether a
time-series variable is non-stationary. Recent literature suggests that the panel-based unit root
tests have higher power than those based on individual time series. For the testing of the unit
root in a panel data, Levin, Lin and Chu (LLC6
) Test will be used using the EVIEWS v7.0.
The null hypothesis is that each individual time series contains a unit root against the
alternative that each time series is stationary.
LLC consider the following basic Augmented Dickey-Fuller (ADF) specification:
Δyit = αyit-1+ΣPj=1 βijΔyit-j+Xit’δ+εit
Where the assumption is that α=ρ-1 (ρ are the autoregressive coefficients). So, the null hypothesis
of the test is written as:
H0: α = 0
H1: α < 0
6
For details, please see Baltagi, Econometric Analysis of Panel Data 3e,Willey & Sons, 2005, pp. 240

15. Page | 14
The LLC test is performed for each of the 9 variables (both dependent and independent). The
results of LLC Panel Unit Root Test are shown in the Annexures. The Table for the unit root
test tells that No Unit Root is present in any of the variable. It means that the data for all the 9
variables are stationary and hence we can proceed for our estimation procedure.
4.2.2 Results for the whole sample (Public and Private Banks)
4.2.2.1 Profitability Measure (RONW) for Whole Sample
4.2.2.1.1 Model 1-Fixed One Way Effect for Profitability (Cross-Sectional/Banks
Effects Only)
Table 4-3: Model 1-Fixed One Way (Banks) Effect
On examining the above model, it is evident that the Non-interest Income Ratio (NIIR),
Interest Expended/Interest Earned Ratio and the Operating Expense to Income Ratio are the
only three variables that are affecting the profitability i.e. Return on Net-Worth (RONW). All
these are showing very high significant effect on the profitability of the banks. NII ratio is
showing a strong positive correlation with RONW while the other 2 are showing the strong
negative correlation with RONW. The direction of these effects is in line with the previous
researches.
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OPEREXPINCOMER
-2.355922
0.063802
-0.263787
0.374752
-0.181924
-0.218084
-1.131066
-0.908618
0.435621
0.053667
0.235028
0.048915
0.119903
0.123696
0.176452
0.097522
-5.408191
1.188843
-1.122363
7.661236
-1.517260
-1.763066
-6.410048
-9.317051
0.0000
0.2355
0.2627
0.0000
0.1303
0.0790
0.0000
0.0000
R-squared 0.715247
Adjusted R-square 0.676739
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 1.834630

16. Page | 15
4.2.2.1.2 Model 2-Fixed Two Way Effect for Profitability
Table 4-4: Model 2-Fixed 2-Way Effect
The results and the interpretation are pretty much similar to the previous model. But by
introducing the time effect, Investment/Total Deposit ratio is also showing significant effect
on RONW. The correlation between this and RONW is negative.
4.2.2.1.3 Model 3- Random 2-Way Effect Model for Profitability
Table 4-5: Model 3-Random 2 Way Effect Model
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OPEREXPINCOMER
-2.316522
-0.013453
-0.033949
0.373783
-0.056786
-0.494459
-1.151982
-0.646782
0.773557
0.064431
0.351306
0.147598
0.212188
0.243019
0.373691
0.232007
-2.994637
-0.208795
-0.096638
2.532429
-0.267622
-2.034651
-3.082710
-2.787773
0.0030
0.8348
0.9231
0.0119
0.7892
0.0429
0.0023
0.0057
R-squared 0.432848
Adjusted R-square 0.334848
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 1.831936
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OPEREXPINCOMER
OWNERSHIP
-1.776610
0.047185
-0.473256
0.374793
0.085547
-0.534993
-0.871891
-0.332721
0.160887
0.708863
0.045497
0.532804
0.098045
0.247103
0.259092
0.284856
0.089351
0.111641
-2.506281
1.037098
-0.888237
3.822656
0.346198
-2.064875
-3.060819
-3.723748
1.441108
0.0127
0.3005
0.3751
0.0002
0.7294
0.0398
0.0024
0.0002
0.1506
R-squared 0.153394
Adjusted R-square 0.131617
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 1.367928

17. Page | 16
The Random 2 way effect model estimation shows that the factors NIIR, INVESR,
INTEXPINTEAR and OPEREXPINCOMER are significantly affecting the RONW of the
banks. Ownership doesn‟t seem to have any significant effect on the banks‟ profitability i.e.
RONW. NIIR is positively correlated to the RONW while the rest are negatively affecting
RONW or the profitability of the banks.
4.2.2.2 Efficiency (NIM) Measure for Whole Sample
For efficiency factor, the variable Operating Cost to Income ratio (OPEREXPINCOMER)
has been excluded because that is itself a direct measure of the efficiency of any bank.
4.2.2.2.1 Model 4: Fixed Two Way Effect for Efficiency
Table 4-6: Model 4-Fixed 2-Way Effect for Efficiency
As shown in the above table, only 2 factors are significantly affecting the efficiency of the
banks. These are loan intensity of the banks and the Interest Expended to Interest Earned
Ratio. Both of these are negatively correlated. It shows that if banks are giving more loans
relative to the size of their assets then it has a negative effect on the NIM or the efficiency of
the banks. Similar is the case with the Interest Expended to Interest Earned ratio. Only
problem in this model is that Durbin-Watson Statistic is more than 2 which shows that there
might be some negative serial correlation amongst the error terms. But it is not that higher so
we can ignore it.
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
-3.943912
0.028500
-0.864065
0.096115
0.337336
0.134659
-1.338791
0.620390
0.088879
0.392746
0.083271
0.186957
0.211506
0.270163
-6.357147
0.320656
-2.200062
1.154236
1.804351
0.636664
-4.955498
0.0000
0.7487
0.0286
0.2494
0.0723
0.5249
0.0000
R-squared 0.504946
Adjusted R-square 0.421530
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 2.472216

18. Page | 17
4.2.2.2.2 Model 5: Random 2-Way Effect for Efficiency
Table 4-7: Model 5-Random 2 Way Effect for Efficiency
If we compare our results from the previous model (model 4), then we can see that two more
variables are showing significant effect on NIM. These are Relative Deposit Share (RDS) and
Ownership. The result shows that the RDS is having negative correlation with NIM. It means
that the banks which have large deposits (relatively) are less efficient than the banks with
lower deposits. Ownership dummy is positively correlated with the efficiency of Banks. It
means that the Public sector banks (code is 1) are more efficient than the private sector banks
(code is 0). This is in contrast to the view that the privatization or the private banks are more
efficient than the public sector banks.
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OWNERSHIP
-5.218617
-0.067844
-0.853572
0.039816
0.241950
-0.267077
-1.763927
0.111146
0.401450
0.019504
0.324347
0.054359
0.147073
0.150831
0.134503
0.046350
-12.99942
-3.478526
-2.631659
0.732471
1.645098
-1.770700
-13.11443
2.397984
0.0000
0.0006
0.0089
0.4644
0.1010
0.0776
0.0000
0.0171
R-squared 0.404907
Adjusted R-square 0.391555
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 2.239094

19. Page | 18
4.2.3 Results for only Public Sector Bank Sample
4.2.3.1 Profitability Measure for Public Sector Banks (PSB)
Table 4-8: Model 6- Random 2-Way Effect Regression on RONW of PSB
The results shown in the above table are same as shown in table 4.5. Only problem in this
model is that Durbin-Watson Statistic is less than 1 which means that there is some positive
serial correlation between the error terms.
4.2.3.2 Efficiency Measure for Public Sector Banks
Table 4-9: Model 7-Random 2-Way Effect Regression on NIM of PSB
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OPEREXPINCOMER
-1.566017
0.063465
-1.082809
0.480145
0.570280
-1.007887
-0.981144
-0.213477
1.030672
0.069314
0.738198
0.149099
0.331177
0.351455
0.360794
0.085386
-1.519414
0.915618
-1.466827
3.220316
1.721981
-2.867758
-2.719398
-2.500127
0.1305
0.3611
0.1442
0.0015
0.0869
0.0047
0.0072
0.0134
R-squared 0.199450
Adjusted R-square 0.166870
Probability (F-Statistic) {Chow-Test} 0.000002
Durbin-Watson stat 0.866417
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
-6.241409
-0.069081
-2.102312
0.019099
0.697052
-0.686699
-1.916391
0.828704
0.041548
0.642118
0.118402
0.284719
0.296975
0.287264
-7.531533
-1.662685
-3.274028
0.161308
2.448211
-2.312316
-6.671191
0.0000
0.0982
0.0013
0.8720
0.0154
0.0219
0.0000
R-squared 0.310228
Adjusted R-square 0.286305
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 2.361995

20. Page | 19
If we compare the results shown by the above model with the model 5 shown in Table 4.7,
then we can say that the results are bit different in this case. Here, the significant variables are
Loan-Intensity, CDRATIO, Investment Ratio and Interest Expended to Interest Earned Ratio.
Except from CDRATIO all the remaining 3 are negatively correlated with the NIM. This
shows that in case of Public Sector banks CDRATIO plays a significant role in their
efficiency. Also, RDS has no significant effect on NIM in the case of Public Sector Banks.
4.2.4 Results for only Private Sector Banks Sample
4.2.4.1 Profitability Measure for Private Sector Banks (PrSB)
Table 4-10: Model 8- Random 2-Way Effect Regression on RONW of PrSB
All the results are consistent with the previous model 3 shown in Table 4.6. Only difference
is that in the case of private sector banks Investment Ratio does not have any significant
effect on RONW.
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
OPEREXPINCOMER
-2.618381
0.022764
-0.296664
0.389714
-0.428801
-0.138149
-1.412150
-0.862477
0.978910
0.047114
0.745894
0.128399
0.385505
0.356173
0.410849
0.201979
-2.674793
0.483163
-0.397729
3.035173
-1.112310
-0.387871
-3.437150
-4.270129
0.0084
0.6298
0.6915
0.0029
0.2680
0.6987
0.0008
0.0000
R-squared 0.239410
Adjusted R-square 0.199076
Probability (F-Statistic) {Chow-Test} 0.000005
Durbin-Watson stat 2.245964

21. Page | 20
4.2.4.2 Efficiency Measure of PrSB
Table 4-11: Model 9-Random 2-Way Effect Regression on NIM of PrSB
It is only for this model that NII ratio is also significantly affecting the NIM. Loan Intensity
does not have any significant effect on the efficiency of Private Sector Banks. Rests of the
results are similar to the Model 5.
Variables Coefficients Standard
Error
t-Statistic Probability
C
RDS
LINTNSTY
NIIR
CDRATIO
INVESR
INTEXPINTEAR
-4.281945
-0.046824
0.144608
0.097330
-0.091292
-0.121039
-1.821875
0.224716
0.012434
0.188298
0.032947
0.098050
0.091071
0.092036
-19.05491
-3.765717
0.767974
2.954137
-0.931077
-1.329070
-19.79516
0.0000
0.0002
0.4439
0.0037
0.3535
0.1861
0.0000
R-squared 0.774331
Adjusted R-square 0.764150
Probability (F-Statistic) {Chow-Test} 0.000000
Durbin-Watson stat 1.092265

22. Page | 21
4.3 Summary of the Results and Conclusion
a. Summary for Profitability Measure:
Most of the results shown by all the models are more or less consistent with each other
which is a positive sign. Following table shows the consolidated results of all the
regression models related to the RONW:
Sample Model RDS LINTNSTY NIIR CDRATIO INVESR IntExpIntEar OperExpIncomeR OWNERSHIP
All
Banks
Fixed
1-Way
NE NE +ve NE NE NE -ve NE
Fixed
2-Way
NE NE +ve NE NE NE -ve NE
Random
2-way
NE NE +ve NE NE -ve -ve NE
PSB
Random
2-Way
NE NE +ve NE -ve -ve -ve NE
PrSB
Random
2-Way
NE NE +ve NE NE -ve -ve NE
Table 4-12: Summary of Results for Regression on RONW
NE: No Significant Effect on RONW
+ve: Positive Significant Correlation with RONW
-ve: Negative Significant Correlation with RONW
From the above table, it is pretty much clear that Non-interest income ratio which has been
taken as the proxy for the diversification is having a very high significant and positive effect
on the Return on net worth of the banks. The time frame that has been considered in this
paper is one when the banks started to focus on non-fund based activities or fee-based
activities. This is when the banks tried to diverse their portfolio and come out with different
and innovative services like advisory services, investment services etc. From the results, we
can confidently say that this diversification from the traditional fund based activities has
significantly affected the profitability of the banks in the positive manner.
Operating Expense ratio and Interest Expended to Interest Earned Ratio show a significant
negative effect on the profitability of the banks which is quite true in practice also.
Ownership structure does not show any significant effect on the profitability of the banks and
thus the analysis done in this paper poses a question on the myth that the Private Sector banks
are more profitable than the Public Sector banks.
One interesting result shown by the regression model run for the PSB only is that Investment
to deposit ratio is negatively correlated with the RONW. The possible interpretation for this
result is that the Public Sector banks are more conservative in nature and the major
percentage (30-40%) of their investment is on the Government approved securities which are
less profitable (though more safer). On the other hand private sector banks invest in different
avenues which are bit riskier but provide better returns.

23. Page | 22
b. Summary for Efficiency (NIM) Measure:
The consolidated results for all the regression model run on the NIM is shown in the
following table:
Sample Model RDS LINTNSTY NIIR CDRATIO INVESR IntExpIntEar OWNERSHIP
All
Banks
Fixed 2-
Way
NE -ve NE NE NE -ve NE
Random
2-way
-ve -ve NE NE NE -ve +ve
PSB
Random
2-Way
NE -ve NE +ve -ve -ve NE
PrSB
Random
2-Way
-ve NE +ve NE NE -ve NE
Table 4-13: Summary of Results for Regression on NIM
The results are not that consistent in this case. One important result shown by the model is
that Public Sector Banks are more efficient than the Private Sector banks. Interest Expended
to Interest Earned is significantly affecting the banks‟ efficiency in a negative manner. The
results for PSB and PrSB are bit different like RDS is negatively correlated with the NIM in
case of PrSB which shows that the private banks which are having larger deposits relatively
are less than those which are smaller in this aspect. Also in case of PrSB, NII is having a
positive significant effect on the NIM. This shows that the private sector banks try to improve
their efficiency by focusing more on fee-based activities. In case of PSBs, Investment ratio is
negatively correlated to the NIM which tells that the Investment strategies used in the Public
Sector banks are affecting the NIM in a negative manner. CDRATIO is positively correlated
with the NIM for the PSB.
5. Limitations
In this project only the listed banks have been considered. There are a considerable number of
other banks which are not listed. Also, foreign banks have not been included in the
considered sample.
In this project only the accounting variables have been considered which are internal to the
banks. There are many macroeconomic factors like GDP, Inflation, Interest Rates, CRR, and
SLR etc. which directly or indirectly affect the performance and efficiency of the banks.
Also, some other important factors like Capital Adequacy Ratio have not been taken into the
account.

24. Page | 23
6. Annexures
Panel Unit Root Test (LLC Test)
Null Hypothesis: Unit root (common unit root process)
Date: 10/02/11 Time: 10:30
Sample: 2002 2011
Exogenous variables: Individual effects
User-specified lags: 1
Newey-West automatic bandwidth selection and Bartlett kernel
Total (balanced) observations: 256
Cross-sections included: 32
Series: RONW
Method Statistic Prob.**
Levin, Lin & Chu t* -6.55633 0.0000
Series: RDS
Method Statistic Prob.**
Levin, Lin & Chu t* -12.6470 0.0000
Series: LINTNSTY
Method Statistic Prob.**
Levin, Lin & Chu t* -12.6367 0.0000
Series: NIIR
Method Statistic Prob.**
Levin, Lin & Chu t* -11.1109 0.0000
Series: CDRATIO
Method Statistic Prob.**
Levin, Lin & Chu t* -87.7283 0.0000
Series: INVESR
Method Statistic Prob.**
Levin, Lin & Chu t* -21.8001 0.0000
Series: INTEXPINTEAR
Method Statistic Prob.**
Levin, Lin & Chu t* -13.6823 0.0000

25. Page | 24
Series: OPEREXPINCOMER
Method Statistic Prob.**
Levin, Lin & Chu t* -10.6429 0.0000
Series: NIM
Method Statistic Prob.**
Levin, Lin & Chu t* -3.30728 0.0005
** Probabilities are computed assuming asymptotic normality
Table 6-1: LLC Panel Unit Root Test

26. Page | 25
7. References
 Ownership Effects On Bank Performance: A Panel Study Of Indian Banks, Bikram De,
ICICI Research Center Jan‟2003, Paper presented at the Fifth Annual Conference on
Money and Finance in the Indian Economy
 The Performance of Indian Banks During Financial Liberalisation, Petya Koeva, IMF
Working Paper, July‟2003
 Bank-specific, Industry-specific and Macroeconomic Determinants of Bank Efficiency :
Empirical Evidence from the Thai Banking Sector, Fadzlan Sufian and Muzafar Shah
Habibullah, The Journal of Applied Economic Research 2010 4: 427
 Examining Internal Factors That Affect Banks‟ Performance Through Panel Regression
Analysis, Journal of Modern Accounting and Auditing, ISSN1548-658, March 2011, Vol.
7, No. 3, 310-315
 Ownership Structure, Performance and Risk in Indian Commercial Banks, Siva Reddy
Kalluru, IUP journal for Applied Finance, ICFAI University Press
 The Relative Efficiency of Commercial Banks in Thailand: DEA Approach, International
Research Journal of Finance and Economics, ISSN 1450-2887 Issue 18 (2008)
 Baltagi H. Badi, 3rd
Edition, 2005.Econometric Analysis of Panel Data: John Willey and
Sons
 Wooldridge Jeffrey M., Econometric Analysis of Cross Section and Panel Data: London:
MIT Press, Cambridge, Massachusetts
 Brooks C., 2nd
Edition, 2008. Introductory Econometrics for Finance. New York:
Cambridge University Press
 Gujarati Damodar N., Sangeetha., 4th
Edition, 2007. Basic Econometrics: Tata McGraw-
Hill Publishing Co.Ltd.
 www.capitaline.com
 http://www.iba.org.in/
 http://www.rbi.org.in
 www.in.yahoo.finance.com
 http://papers.ssrn.com
 http://www.bseindia.com
 http://www.nseindia.com