International Research Journal of Finance and Economics

ISSN 1450-2887 Issue 47 (2010)

© EuroJournals Publishing, Inc. 2010
http://www.eurojournals.com/finance.htm

Determinants of Profitability and Efficiency of Old Private

Sector Banks in India with Focus on Banks in Kerala State:
An Econometric Study

Manoj P K
Faculty (Techno-Management), Dept. of Applied Economics
Cochin University Science and Technology Kochi, Kerala – 682 022 (INDIA)
E-mail: manoj_p_k2004@yahoo.co.in

Abstract

Enhanced profitability and operational efficiency have become vital for banks in
India for survival and growth in the ongoing era of globalization. Ever since the initiation
of the financial sector reforms in the early1990s, the competition in the Indian banking
industry has been constantly on the rise, making the plight of Old Private sector Banks
(OPBs) growingly vulnerable. Focusing on the OPBs based at Kerala state (KOPBs, in
short) in the Indian union, this paper seeks to identify the determinants of profitability and
operational efficiency of KOPBs, using an econometric methodology. For the sake of
comparison of KOPBs, the general case of OPBs and New generation Private sector Banks
(NPBs) in India have also been analyzed.

Keyterms: Profitability, Operational Efficiency, Priority Sector Advances, NIM.

1. Introduction
Financial sector reforms initiated in India in the early 1990s, as part of economic deregulation
measures of the Government, have brought about fierce competition in the banking industry. Enhanced
profitability and operational efficiency have become essential for survival and growth of any bank,
including the Government-owned Public Sector Banks (PSBs)I. The case of Old Private sector Banks
(OPBs)II has been particularly vulnerable. The entry of a few New generation Private sector Banks
(NPBs)III in the mid-1990s, which are equipped with the latest technology on par with the Foreign
Banks (FBs)IV operating in India, has given another dimension to the industry competition. Many
OPBs have already succumbed to the pressures of competition. Besides, market share of OPBs (and of
PSBs) has been constantly falling while that of NPBs has been gradually on the rise. In India, Kerala
has got an enviable track record of private sector banking, right from the eighteenth century. However,
there has been a gradual decline in the number of private banks in Kerala over the years, as a result of a
series of failures, mergers and consolidations. As of March 2010, there are just four OPBs functioning
in the state of Kerala (KOPBsV, in short) as against eight private banks in 1985. During 2000s itself,
two KOPBs have vanished because of their inability to withstand competition. In the above context, it
is meaningful to identify the determinants of profitability and operational efficiency of OPBs with
focus on KOPBs, because such specialized studies with reference to OPBs are virtually nil, in the
recent times. Besides, the influence of priority sector advances, intensity of rural branches etc. on
profitability and operational efficiency is sought to be studied. Likewise, the impact of non-interest
income on profitability and operational efficiency is also sought to be studied. For the sake of
8 International Research Journal of Finance and Economics - Issue 47 (2010)

comparison, the general case of OPBs and New generation Private sector Banks (NPBs) in India have
also been studied, along with the four individual KOPBs.

Part I. Research Methodolgy

In this section, the objectives of the research, hypotheses set, methodology used including the
specification of the model (econometric methodology) etc. are covered.

2. Review of Relevant Literature and Research Gap

A brief review a few major studies relating to analysis of profitability and efficiency of banks in India
is presented below in the chronological order.
Varde (1979)[9] has made a distinction between effectiveness, efficiency and productivity of
banks and has pointed out that efficiency of a bank could be classified into four categories viz. (i)
manpower efficiency; (ii) operational efficiency; (iii) commercial efficiency; and (iv) efficiency of
ancillary business. Efficiency of each of these four categories can be measured separately, and this
efficiency in turn has got a positive influence on the productivity of the respective category. Amandeep
(1983) [1] has studied the various factors that affect the profitability of commercial banks with the help
of multiple regression analysis. The author has tried to determine the relative influence of each such
factor on the profitability of commercial banks, using trend analysis, ratio analysis, and multiple
regression analysis. Angadi and Devraj, (1983)[2], have studied the factors that determine profitability
and productivity of public sector banks (PSBs) in India and have observed that though PSBs have
discharged their social responsibilities, their deficiencies in respect of effective mobilization of funds at
lower costs, attracting retail banking business, augmenting earnings from other sources, effective cash
and portfolio management etc. have resulted in their lower productivity and profitability.
Chakrabarthy, (1986)[4] has made an empirical study of the relative performance of different groups of
banks (public, private and foreign) based on three basic parameters viz.(i) profit, (ii) earnings, and (iii)
expenses. The author has computed Herfindahl's index to measure the inequality in the sharing of
profits, earnings and expenses by each group of banks. The author has suggested that scheduled
commercial banks should take up some exercise to evaluate the relative performance of each of their
offices for more effective profit planning. Shah (1986)[7] has attempted an empirical study of the
relationship between costs of banks at branch level. He has highlighted the factors responsible for
declining profitability and increasing operational costs at the branch level. Sarkar and Das (1997)[6]
have compared the performance of public, private and foreign banks for the year 1994-95 by using
measures of profitability, productivity and financial management. They have found that PSBs
compared poorly with the other two categories. But, they have admitted that no firm inference can be
derived from a comparison done for a single year. Das (1999)[5] has compared performance among
public sector banks (PSBs) for three years in the post-reform period, viz. FY 1992, FY 1995 and FY
1998. He has observed that there has been convergence in the performance of different banks. He has
pointed that while there has been added thrust to generation of non-interest income, banks have
exhibited ‘risk-averse behavior’ by opting risk-free investments rather than advances which are
relatively more risky. Swamy (2001)[8] has studied the comparative performance of different bank-
groups for the period FY 1996 to 2000. During the study period there has been notable increase in the
technology initiatives of banks and also growing industry competition, both being primarily emanating
from the ongoing deregulation measures. The author has studied three major issues: (i) What has been
the impact of financial sector reforms on the structure of the Indian banking system?; (ii) What are the
advantages reaped by some of the new Indian private and foreign banks vis-a-vis PSBs?, and (iii)
Whether new competition has enhanced the overall efficiency of the banking system?. The author has
concluded that in many respects NPBs perform much better than PSBs, and even better than foreign
banks functioning in India. Arora, S. and Kaur, S (2008)[3] have studied the internal determinants of
diversification moves by banks taking two dependent variables, (i) net interest margin, and (ii) non-
International Research Journal of Finance and Economics - Issue 47 (2010) 9

interest margin. It has been observed that all the four explanatory variables viz. (i) risk, (ii)
technological change, (iii) cost of production, and (iv) regulatory cost have got significant influence on
the variations in the structure of income of the banks.
From the above review, it is noted that studies focusing on OPBs are quite rare, unlike PSBs.
Only some bank-group level studies are available wherein private sector banks in general are taken, not
OPBs in particular. Specific studies on KOPBs are nil. This paper seeks to bridge this research gap by
making a general study of OPBs and NPBs, and a bank-specific study of KOPBs.

3. Objectives of the Study

(i) To study the determinants of profitability (defined in terms of Operating Profit Ratio, OPR, ie.
the ratio of operating profit to total assets) of private sector banks in India, with focus on the
KOPBs.
(ii) To study the determinants of operational efficiency (defined in terms of Net Interest Margin,
NIM, ie. the ratio of net interest income to total assets) of private sector banks in India, with
focus on the KOPBs.

4. Hypotheses of the Study

(iii) Non-interest income is a significant determinant of profitability of KOPBs measured in terms
of OPR.
(iv) Non-interest income is a significant determinant of operational efficiency of KOPBs measured
in terms of NIM.
(v) Share of priority sector advances in the total advances adversely affects the profitability of
KOPBs measured in terms of OPR.
(vi) Share of priority sector advances in the total advances adversely affects the operational
efficiency of KOPBs measured in terms of NIM.
(vii) Share of rural (and semi-urban) branches in the total branch network adversely affects the
profitability of KOPBs measured in terms of OPR.
(viii) Share of rural (and semi-urban) branches in the total branch network adversely affects the
operational efficiency of KOPBs measured in terms of NIM.

5. Model Specification (Including the Economic Rationale)

One of the major objectives of this research is to analyse the profitability and efficiency of OPBs in
India, with focus on the KPOBs. For identifying the determinants of profitability, the popularly used
profitability measure for banks viz.OPR is used. Similarly, for operational efficiency, the commonly
used efficiency parameter for banks viz. NIM is used. (See, the objectives of the study, as given
above). Thus, OPR and NIM are the dependent variables in the econometric model. What might be the
major factors influencing OPR and NIM?, What is the underlying economic rationale?, What might be
the appropriate econometric model that can be used?, The above aspects are dealt in the following
paragraphs.
It is well recognized in finance and banking literature that the quantum of assets is a significant
determinant of a bank’s profitability and efficiency. The higher the value of assets, the greater is the
capability of a bank to earn more (profitability) as size factor is often critical in availing economies of
scale. Similarly, larger value of assets may also help to become more efficient by earnings more from a
given quantity of assets. Thus, Assets (ASST) is taken as one of the explanatory variables.
In the Indian scenario, the share of priority sector advances in the total advances of a bank is a
significant determinant of profitability and efficiency of a bank. This is because of the fact that priority
sector advances are extended as part of the directive credit policy of the Government, that seeks to
provide banking services to the hitherto excluded sections of the society, as part of the social
10 International Research Journal of Finance and Economics - Issue 47 (2010)

obligations of the Government. These advances carry differential (lower) rate of interest. The incidence
of defaults is higher. Obviously, a higher share of such advances in the total advances portfolio may
have a negative impact on profitability and efficiency. Thus, PRIOR (share of priority sector advances
in the total advances) is taken as another explanatory variable.
Investments in government securities expressed as a ratio of total assets (GSEC) is selected as
another explanatory variable influencing OPR and NIM. Because, banks have a tendency to earn
relatively risk-free income from investments in government securities if they have surplus funds. Such
investments ensure guaranteed, but lower rates of return compared to returns from quality assets
created out of lending activities (advances). Thus, to consider such investments, GSEC is taken as
another explanatory variable, for both the dependent variables viz. OPR and NIM.
Non-interest income is another important factor that influences the profitability and efficiency
of banks. Non-interest income augments the interest income of banks. Various fee-based activities that
banks undertake bring in such income. In the ongoing era of globalization, non-interest income is
increasingly becoming the driver of profitability and efficiency of banks. As such, NOM (ratio of non-
interest income to total assets) is taken as another explanatory variable influencing dependent
variables, viz. OPR and NIM.
In the peculiar case of India, rural branches of banks signify the commitment of the bank to the
rural populace. These branches are intended to support the rural population with credit facilities and
hence promote development of the rural economy. Just like priority sector advances, rural branches
have been encouraged by the Government as part of its social obligations, especially during the ‘social
banking’ thrust period of Bank NationalizationVI in India. The loans given are often of lower amounts
and are larger in number. Thus, the administrative costs are higher. Because of the above reasons, it is
rational to consider RURAL (ratio of rural and semi-urban branches urban and metropolitan branches)
as another explanatory variable.
Thus the econometric models for OPR and NIM can be expressed as follows:
OPR = SST) +PRIOR) + GSEC) + NOM) + RURAL) + 
NIM = SST) +  PRIOR) +  GSEC) + NOM) +  RURAL) + 
Here, is the estimated coefficients (is the intercept term, a constant) and is the error term.
Likewise, is the estimated coefficients and is the error term.

Part II. Analysis and Interpretation

The data for the ten years (FY 2000-2009) in respect of the four KOPBs as well as the two relevant
bank-groups as a whole (viz. OPBs and NPBs in India) are analysed using SPSS package to study the
relationship between the two depended variables (OPR and NIM) and the five independent variables.
From Tables (1&2), it follows that for CSB (Catholic Syrian Bank) there is no significant
association between OPR and any of the other explanatory variables. But, it may be noted that
maximum association of OPR is with non-interest income (NOM) and that this positive relationship is
reasonably strong as is evidenced by a significance level that is near to 10% LOS (0.132), even if not
strictly significant at 10% LOS. Moreover, this positive association of OPR and NOM is as expected as
per the underlying economic rationale. From Tables (3&4), it is observed that for CSB there is
statistically significant (5% LOS) and positive association between NIM and intensity of rural branches
(RURAL). Significant (5% LOS) and negative association between NIM and investment in
government securities (GSEC) is also indicated for CSB. Both these relationships are in conformity
with the underlying theory. There is an indication of a positive relation between NIM and NOM also,
though not statistically significant.
From Tables (5&6), it follows that for Dhanalakshmi Bank (DB) there is a significant (5%
LOS) association between OPR and NOM. It may be noted here that the positive association as above
between of OPR and NOM is as expected as per the underlying theory. From Tables (7&8), it is
observed for DB that there is strong, statistically significant (5% LOS) and positive association of NIM
International Research Journal of Finance and Economics - Issue 47 (2010) 11

with ASST and RURAL. Likewise, strong, significant (5% LOS) and positive relationship of NIM
with GSEC is also indicated. All these relationships are as expected and are in conformity with the
underlying.
From Tables (9&10), it follows that for Federal Bank (FB) there is a strong, significant (5%
LOS) and positive relation between OPR and NOM. Significant (10% LOS) and negative relation is
indicated between OPR and investment in government securities (GSEC). Besides, there is a
reasonably high level of negative association between OPR and intensity of priority sector advances
(PRIOR) as is evident from the significance level of 0.107 which is near 10% LOS, even if not strictly
statistically significant at 10% LOS. From Tables (11&12), it is observed that for FB there is a strong,
statistically significant (5% LOS) and positive association of NIM with NOM. Likewise, there is
strong, significant (5% LOS) and negative relationship between NIM and investments in government
securities (GSEC). Both these findings are as expected and are in conformity with the underlying
economic rationale.
From Tables (13&14), it follows that for South Indian Bank (SIB) there is a strong, positive and
significant (5% LOS) association of OPR with NOM. This positive association is as expected, and is in
conformity with the underlying economic rationale. From Tables (15&16), it is observed that there is a
strong, statistically significant (5% LOS) and positive association of NIM of SIB with intensity of rural
branches (RURAL). This positive relationship of NIM and RURAL is as expected and is in conformity
with the underlying economic rationale.
From Tables (17&18), it follows that there is strong, statistically significant (5% LOS) and
positive association of OPR of OPBs with NOM for OPBs in India, in general. This positive
relationship in turn is as expected and is in conformity with the underlying economic rationale. From
Tables (19&20), it is observed that for OPBs in general there is a strong, positive and significant
association of NIM with RURAL (5% LOS); and with quantum of asset (ASST) and NOM both at
10% LOS. With GSEC also there is significant (10% LOS) negative association. These relationships
are as expected and are in conformity with the economic rationale.
From Tables (21&22), it follows that there is a strong, significant (5% LOS) and positive
association of OPR and non-interest income (NOM), for NPBs in general. This finding is as expected
as per the underlying economic rationale. From Tables (23&24), it is observed that for NPBs there is a
strong, statistically significant (5% LOS) and positive association of NOM with intensity of rural
branches (RURAL). This result is also as expected and is in conformity with the underlying economic
rationale.

Tables 1: Results of Regression Analysis (Dependent Variable: OPR) for CSB

Model Standardized
Un-standardized Coefficients
Variables Coefficients T Sig.
B Std. Error Beta
(Constant) 15.163 24.821
ASST -1.882 4.361 -.288 -.432 .688
RURAL -1.407 1.205 -.747 -1.168 .308
PRIOR -.054 .081 -.378 -.664 .543
GSEC .213 6.871 .015 .031 .977
NOM .813 .431 .933 1.887 .132
Dependent Variable: OPR
12 International Research Journal of Finance and Economics - Issue 47 (2010)
Tables 2: Results of Regression Analysis (Dependent Variable: OPR) for CSB

Standard
Variables Mean R R Square Durbin – Watson
Deviation
OPR 1.795405 .8536322
ASST 5.634084 .1305811
RURAL 1.885302 .4536254
0.955 0.911 2.595
PRIOR 30.47096 6.0084549
GSEC .280854 .0584277
NOM 1.801099 .9796308

Tables 3: Results of Regression Analysis (Dependent Variable: NIM) for CSB.

Model Un-standardized Coefficients Standardized

Variables Coefficients t Sig.
B Std. Error Beta
(Constant) .457 13.122
ASST 1.398 2.306 .150 .606 .577
RURAL 2.891 .637 1.076 4.540 .010 *
PRIOR -.034 .043 -.168 -.795 .471
GSEC -14.915 3.633 -.715 -4.106 .015 *
NOM .393 .228 .316 1.727 .159
Dependent Variable: NIM
(* Significant at 5% LOS)

Tables 4: Results of Regression Analysis (Dependent Variable: NIM) for CSB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
NIM 9.2654 1.2193
ASST 5.6341 0.1306
RURAL 1.8850 0.4536
0.99 0.98 2.815
PRIOR 3.0471 6.0085
GSEC 0.2809 0.0584
NOM 1.8011 0.9796

Tables 5: Results of Regression Analysis (Dependent Variable: OPR) for DB.

Model Un-standardized Coefficients Standardized

Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -3.117 6.901 -.452 .675
ASST .142 1.255 .027 .113 .916
RURAL -.149 .470 -.079 -.318 .767
PRIOR .017 .033 .101 .515 .634
GSEC 9.439 5.078 .267 1.859 .137
NOM .852 .156 .948 5.475 .005 *
Dependent Variable: OPR
(* Significant at 5% LOS)
International Research Journal of Finance and Economics - Issue 47 (2010) 13
Tables 6: Results of Regression Analysis (Dependent Variable: OPR) for DB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
OPR 1.7799 0.9219
ASST 5.4191 0.1746
RURAL 1.6439 0.4862
0.97 0.95 2.53
PRIOR 32.1576 5.5208
GSEC 0.24670 0.0261
NOM 1.7673 1.0262

Tables 7: Results of Regression Analysis (Dependent Variable: NIM) for DB.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -7.466 2.574 -2.901 .044
ASST 2.469 .468 .336 5.274 .006 *
RURAL 3.593 .175 1.360 20.497 .000 *
PRIOR .004 .012 .015 .290 .786
GSEC -11.645 1.894 -.236 -6.149 .004 *
NOM -.060 .058 -.048 -1.027 .362
Dependent Variable: NIM ( * Significant at 5% LOS)

Tables 8: Results of Regression Analysis (Dependent Variable: NIM) for DB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
NIM 8.9540 1.2841
ASST 5.4191 0.1746
RURAL 1.6439 0.4862
0.99 0.98 2.50
PRIOR 3.2158 5.5208
GSEC 0.2467 0.0261
NOM 1.7673 1.0262

Tables 9: Results of Regression Analysis (Dependent Variable: OPR) for FB.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -1.943 7.035
ASST 1.617 .969 .717 1.669 .171
RURAL -.700 .513 -.554 -1.364 .244
PRIOR -.112 .054 -.527 -2.068 .107
GSEC -8.021 3.627 -.476 -2.211 .091 **
NOM 1.094 .199 .845 5.511 .005 *
Dependent Variable: OPR ( * Significant at 5% LOS) (Significant at 10% LOS)
14 International Research Journal of Finance and Economics - Issue 47 (2010)
Tables 10: Results of Regression Analysis (Dependent Variable: OPR) for FB.

Standard Durbin –
Variables Mean R RSquare
Deviation Watson
OPR 2.745967 .5408273
ASST 6.213996 .2399264
RURAL 1.841819 .4280802
0.97 0.95 2.88
PRIOR 34.03265 2.5446520
GSEC .255440 .0321281
NOM 1.636322 .4176910

Tables 11: Results of Regression Analysis (Dependent Variable: NIM) for FB.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) 34.598 16.521
ASST -3.017 2.276 -.496 -1.326 .256
RURAL -.022 1.205 -.006 -.018 .986
PRIOR -.026 .127 -.046 -.207 .846
GSEC -32.372 8.518 -.713 -3.801 .019 *
NOM 1.637 .466 .468 3.509 .025 *
Dependent Variable: NIM ( * Significant at 5% LOS)

Tables 12: Results of Regression Analysis (Dependent Variable: NIM) for FB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
NIM 9.3217 1.4595
ASST 6.214 0.2399
RURAL 1.8418 0.4281
0.98 0.97 2.88
PRIOR 34.0326 2.5446
GSEC 0.2554 0.0321
NOM 1.6363 0.4177

Tables 13: Results of Regression Analysis (Dependent Variable: OPR) for SIB.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) 3.228 9.167 .352 0.742
ASST .066 1.261 .026 .053 0.961
RURAL -.186 .600 -.166 -.310 0.772
PRIOR -.045 .053 -.257 -.858 0.439
GSEC -2.813 3.072 -.335 -.916 0.412
NOM .770 .273 1.124 2.823 0.048 *
Dependent Variable: OPR
(* Significant at 5% LOS)
International Research Journal of Finance and Economics - Issue 47 (2010) 15
Tables 14: Results of Regression Analysis (Dependent Variable: OPR) for SIB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
OPR 2.2191 0.5395
ASST 5.9719 0.2146
RURAL 1.9130 0.4822
0.95 0.91 2.73
PRIOR 32.1421 3.0601
GSEC 0.2801 0.0643
NOM 1.5519 0.7873

Tables 15: Results of Regression Analysis (Dependent Variable: NIM) for SIB.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -14.809 17.824 -.831 .453
ASST 3.246 2.453 .460 1.324 .256
RURAL 5.351 1.166 1.703 4.587 .010 *
PRIOR -.059 .103 -.119 -.573 .597
GSEC -10.657 5.973 -.452 -1.784 .149
NOM -.531 .531 -.276 -1.000 .374
Dependent Variable: NIM
( * Significant at 5% LOS)

Tables 16: Results of Regression Analysis (Dependent Variable: NIM) for SIB.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
NIM 9.1089 1.5149
ASST 5.9719 0.2146
RURAL 1.9129 0.4822
0.97 0.95 2.60
PRIOR 32.1421 3.0601
GSEC 0.2801 0.0643
NOM 1.5519 0.7873

Tables 17: Results of Regression Analysis (Dependent Variable: OPR) for OPBs.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -5.364 4.164 -1.288 .267
ASST 1.093 .778 .439 1.405 .233
RURAL .009 .441 .005 .019 .986
PRIOR -.021 .045 -.102 -.469 .663
GSEC 4.528 3.090 .292 1.465 .217
NOM .642 .146 .850 4.407 .012 *
Dependent Variable: OPR (* Significant at 5% LOS)
16 International Research Journal of Finance and Economics - Issue 47 (2010)
Tables 18: Results of Regression Analysis (Dependent Variable: OPR) for OPBs.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
OPR 2.2761 0.4602
ASST 5.6832 0.1848
RURAL 1.2665 0.2697
0.98 0.97 2.61
PRIOR 33.6250 2.2288
GSEC 0.2453 0.0297
NOM 1.5813 0.6096

Tables 19: Results of Regression Analysis (Dependent Variable: NIM) for OPBs.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) -14.924 9.145 -1.632 .178
ASST 4.273 1.709 .644 2.501 .067 **
RURAL 6.033 .968 1.327 6.230 .003 *
PRIOR -.141 .098 -.257 -1.437 .224
GSEC -17.990 6.787 -.435 -2.651 .057 **
NOM .695 .320 .345 2.172 .096 **
Dependent Variable: NIM
(* Significant at 5% LOS)

Tables 20: Results of Regression Analysis (Dependent Variable: NIM) for OPBs.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
NIM 8.9314 1.2265
ASST 5.6832 0.1848
RURAL 1.2665 0.2697
0.99 0.98 2.54
PRIOR 33.6250 2.2289
GSEC 0.2453 0.0297
NOM 1.5813 0.6097

Tables 21: Results of Regression Analysis (Dependent Variable: OPR) for NPBs.

Model Un-standardized Coefficients Standardized

Variables Coefficients t Sig.
B Std. Error Beta
(Constant) 1.774 4.439 .400 .710
ASST -.273 .598 -.377 -.457 .671
RURAL .026 .807 .008 .032 .976
PRIOR .005 .026 .157 .208 .845
GSEC 3.405 6.917 .162 .492 .648
NOM .799 .275 .851 2.902 .044 *
Dependent Variable: OPR
(* Significant at 5% LOS)
International Research Journal of Finance and Economics - Issue 47 (2010) 17
Tables 22: Results of Regression Analysis (Dependent Variable: OPR) for NPBs.

Standard Durbin –
Variables Mean R R Square
Deviation Watson
OPR 2.3878 0.2760
ASST 6.6041 0.3803
RURAL 0.3945 0.0863
0.91 0.82 2.05
PRIOR 22.9565 7.9598
GSEC 0.2249 0.0131
NOM 1.9008 0.2941

Tables 23: Results of Regression Analysis (Dependent Variable: NIM) for NPBs.

Model Standardized
Un-standardized Coefficients
Variables Coefficients t Sig.
B Std. Error Beta
(Constant) 14.557 10.346 1.407 .232
ASST -1.397 1.393 -.620 -1.003 .373
RURAL 10.064 1.882 1.012 5.349 .006 *
PRIOR .095 .061 .883 1.558 .194
GSEC -16.866 16.122 -.258 -1.046 .355
NOM .133 .642 .046 .208 .846
Dependent Variable: NIM
(* Significant at 5% LOS)

Tables 24: Results of Regression Analysis (Dependent Variable: NIM) for NPBs.

Standard Durbin –
Variables Mean R RSquare
Deviation Watson
NIM 7.9437 .8575548
ASST 6.6041 .3803431
RURAL 0.3945 .0862538
0.95 0.90 2.89
PRIOR 22.9565 7.9598082
GSEC 0.2249 .0131343
NOM 1.9008 .2940723

Table 25: Overall Results of Regression Analysis

Dependent Variable: OPR

Model
Variables CSB DB FB SIB All OPBs All NPBs
ASST
RURAL
PRIOR NS-N
GSEC S-P-10%
NOM NS-P S-P-5% S-P-5% S-P-5% S-P-5% S-P-5%
Dependent Variable: NIM
ASST S-P-5% S-P-10%
RURAL S-P-5% S-P-5% S-P-5% S-P-5% S-P-5%
PRIOR
GSEC S-N-5% S-N-5% S-N-5% NS-N S-N-10% N
NOM S-P-5% S-P-10%
18 International Research Journal of Finance and Economics - Issue 47 (2010)
Legends:
S-P-5% : Statistically Significant at 5% LOS, Positive association
S-N-5% : Statistically Significant at 5% LOS, Negative association
S-P-10% : Statistically Significant at 10% LOS, Positive association
S-N-10% : Statistically Significant at 10% LOS, Negative association
NS-P : Not Statistically Significant, still high significance near to 10% LOS, Positive
NS-N : Not Statistically Significant, still high significance near to 10% LOS, Negative
N : Not Significant, but Negative association

Part III. Overall Findings and Testing of Hypotheses

The major findings of the study are given in Table (25). It may be stated that there is a clear and
significant positive relationship between OPR and non-interest income (NOM) suggesting that
operating profits of banks are driven significantly by non-interest income. NOM of all the banks under
study except CSB and also that of both the bank groups (viz. OPBs and NPBs) have strong, positive,
significant (5% LOS) association with their respective OPR. In the case of CSB also, there is
reasonably high positive association which is near 10% LOS. Another notable finding is that there is
strong, negative association of net interest margin (NIM) of banks with investment in government
securities (GSEC), suggesting that higher GSEC may reduce NIM of banks. This negative relationship
is significant at 5% LOS for all the banks and bank groups, except SIB where the significance is near
10% LOS and in the case of NPBs where it is negative but not significant. Yet another notable finding
is the strong, significant (5% LOS) and positive association of NIM of banks with intensity of rural
branches, suggesting rural branches are positively contributing to net interest margin. But, FB is an
exception to this trend, where there is no significant relationship observed.
Hypothesis – 1: Non-interest income is a significant determinant of profitability of
KOPBs measured in terms of Operating Profit Ratio (OPR).
The first hypothesis as mentioned above is sought to be tested here. From Table 25, it is quite
clear that non-interest income (represented by NOM, the non-interest margin) has got a strong and
positive association with Operating Profit Ratio (OPR) at 5% LOS. This association is equally strong
in respect of the general case of all OPBs and all NPBs. However, for Catholic Syrian Bank (CSB)
though the relationship is obvious, it is not statistically significant even at 10% LOS. For CSB it is
significant at ‘near 10% LOS’. Thus, the first hypothesis stands accepted.
Hypothesis – 2: Non-interest income is a significant determinant of operational
efficiency of KOPBs measured in terms of Net Interest Margin (NIM).
The second hypothesis as mentioned above is sought to be tested here. From Table 25, it is
quite clear that non-interest income (represented by NOM, the non-interest margin) has got a strong
and positive association with NIM at 5% LOS only in respect of one bank viz. Federal Bank (FB). The
case of all OPBs in India also supports this relationship, but only at 10% LOS. In respect of any of the
other three KOPBs and also the case of all NPBs in India, there is no significant relation between
NOM and NIM. Thus, the hypothesis as above cannot be generalized. Thus, the second hypothesis
stands rejected.
Hypothesis–3: Share of priority sector advances in the total advances adversely affects
the profitability of KOPBs measured in terms of OPR.
The third hypothesis as mentioned above is sought to be tested here. From Table 25, it is quite
clear that share of priority sector advances in the total advances portfolio (denoted by PRIOR) has got
no significant relationship with the profitability measured in terms of Operating Profit Ratio (OPR).
Only, in respect of Federal Bank (FB) such a negative association is found, but it is not significant even
at 10% LOS. Thus, it may be concluded that PRIOR does not affect OPR, in general. Accordingly, the
third hypothesis stands rejected.
Hypothesis–4: Share of priority sector advances in the total advances adversely affects
the operational efficiency of KOPBs measured in terms of NIM.
International Research Journal of Finance and Economics - Issue 47 (2010) 19

The fourth hypothesis as mentioned above is sought to be tested here. From Table 25, it is quite
clear that share of priority sector advances in the total advances portfolio (denoted by PRIOR) has got
no significant relationship with the operational efficiency measured in terms of Net Interest Margin
(NIM). None of the KOPBs under study or the general cases of OPBs and NPBs, has any such
significant relationship. Thus, the sixth hypothesis stands rejected.
Hypothesis–5: Share of rural (and semi-urban) branches in the total branch network
adversely affects the profitability of KOPBs measured in terms of OPR.
The fifth hypothesis as mentioned above is sought to be tested here. From Table 25, it is quite
clear that share of rural (including semi-urban) branches in the total branch network (denoted by
RURAL) has got no significant relationship with the profitability measured in terms of Operating
Profit Ratio (OPR). This is applicable in respect of all KOPBs and also the general case of OPBs and
NPBs in India. Thus, fifth hypothesis stands rejected.
Hypothesis–6: Share of rural (and semi-urban) branches in the total branch network
adversely affects the operational efficiency of KOPBs measured in terms
of NIM.
The sixth hypothesis as mentioned above is sought to be tested here. From Table 25, it is quite
clear that share of rural (including semi-urban) branches in the total branch network (denoted by
RURAL) has got a strong and positive relationship with the operational efficiency measured in terms
of Net Interest Margin (NIM) and is applicable even in the general case of OPBs and NPBs in India.
However, the case of Federal Bank does not support the above relationship. Thus, the sixth hypothesis
is rejected, because the fact is just the reverse.

Concluding Remarks
In view of the foregoing, it may be meaningful to suggest the following strategies for OPBs in general
and KOPBs in particular, for enhancing operational efficiency and risk management capability,
particularly credit risk management:
Firstly, added thrust is required for enhancing the non-interest income. This can significantly
improve their profitability. Non-interest income can be improved through undertaking more of fee
based activities, besides the traditional fund-based activities like providing credit (advances). In this
regard, it may be pointed out that higher investments in technology would help to improve the non-
interest income of banks.
Secondly, as a policy banks may focus on income generation from lending and allied activities
(fee-based income) rather than investing more in government securities. This is because, as such
government investments goes up, the risk management capability particularly credit risk management
(in terms of NIM) may come down as per the empirical evidence. In short, more of lending and allied
activities and less of investments in government securities is the advisable policy for better risk
management capability of banks.
Thirdly, as a policy rural focus in respect of branches is good for better management of risks,
especially credit risk. Rural branches may act as promoters of low volume and large number loans
which may effectively diversify the credit risk, though such branches might not contribute towards
profitability per se. Another important fact in this regard is priority sector advances are do not affect
either profitability or risk management adversely, as against the popular belief in this regard. In short,
rural focus is quite desirable, and priority sector advances need not be discouraged also.
The strategies as above have got special significance in respect of OPBs in general and KOPBs
in particular in the ongoing globalized regime of fierce industry competition; because higher
profitability, and strong risk management capability are vital for these banks for survival and growth.
20 International Research Journal of Finance and Economics - Issue 47 (2010)

References
[1] Amandeep, (1983), Profits and Profitability in Commercial Banks, Deep and Deep Publications
Pvt. Ltd., Rajouri Gardens, New Delhi – 110 027.
[2] Angadi and Devraj, (1983), “Profitability and Productivity of Banks in India”, Economic and
Political Weekly, Vol. 18 (Nov. 26).
[3] Arora, S and Kaur, S (2008), “Diversification by Banks in India: What are the Internal
Determinants?”, The Indian Banker, Vol. III, No.7, July 2008, pp. 37-41.
[4] Chakrabarty, T.K. (1986), 'Profitability of Banks: An empirical attempt for identification of
variable of income and expenditure of scheduled commercial banks for Profit Planning,'
Proceedings of the Bank Economists Conference (BECON 1986), pp 3.17 to 3.61.
[5] Das, A. (1999), 'Profitability of Public Sector Banks: A Decomposition Model', Occasional
Papers 20, Reserve Bank of India, Mumbai.
[6] Sarker, P.C. and Das, A. (1997), 'Development of Composite Index of Banking Efficiency: The
Indian Case', Occasional Papers 18, Reserve Bank of India, Central Office, Mumbai.Shah, V.
D. (1986), 'Empirical Relationship between Size and Cost and Branch level,' Prajanan, Vol.
XV, No. 318, Jan. – Mar. 1986, pp. 29-48.Swamy, B.N.A. (2001), 'New Competition,
Deregulation and Emerging Changes in Indian Banking: An Analysis of Different Bank -
Groups', The Journal of Indian Institute of Bankers, Vol. 72, No.3, July- Sept. 2001, pp 13-22.
[7] Varde, (1988), 'Effectiveness, Efficiency and Customer Service in Banks', RBI Bulletin, April
1988, Reserve Bank of India, Central Office, Bombay.

End Notes
I. PSBs refer to the Public Sector Banks in India. PSBs is a group of commercial banks wherein
the Government of India has got controlling stake, ie. 51 percent or more equity. These include
8 State Bank group (SB group) banks comprising of State Bank of India and its 7 associate
(subsidiary) banks, and another 19 nationalised banks (NBs) which were once private sector
banks but were subsequently acquired by the Government of India, in two phases of
nationalization, in 1969 and in 1980.
II. OPBs refer to the set of all Old Private Sector Banks functioning in India. For the purpose of
this paper, those OPBs which have been functioning throughout the ten years’ period (FY 2000
to FY 2009) under study alone are considered. Thus, banks which have undergone
consolidation during the study period have not been considered for this purpose for the sake of
consistency. For instance, Bank of Punjab Ltd., an erstwhile OPB has since become Centurion
Bank of Punjab Limited after merger with a new generation private sector bank viz. Centurion
Bank. Though Centurion Bank of Punjab is still categorised as an OPB, the same has not been
considered. As per the above criterion, 15 OPBs have been functioning throughout the period
under study and accordingly these have been considered for analysis. These 15 OPBs include
the four Kerala-based OPBs (KOPBs) that are under focused study viz. (i) Catholic Syrian
Bank (CSB), (ii) Dhanalakshmi Bank (DB), (iii) Federal Bank (FB), and (iv) South Indian
Bank (SIB). The remaining 11OPBs are based in other states in India and include: (i) Bank of
Rajasthan, (ii) City Union Bank, (iii) Jammu & Kashmir Bank, (iv) Karnataka Bank, (v) Karur
Vysya Bank, (vi) Lakshmi Vilas Bank, (vii) Nainital Bank, (viii) Ratnakar Bank, (ix) SBI
Commercial and International Bank, (x) Tamil Nadu Mercantile Bank, and (xi) ING Vysya
Bank. The average values of performance parameters of the above 15 OPBs have been
considered as the representative figures for ‘OPBs’ category and are taken for analysis.
III. NPBs refer to the set of all New Generation Private Sector Banks in India. For the purpose of
this study only those NPBs that have been functioning throughout the ten years’ period (FY
2000 to FY 2009) under study have been considered. NPBs were given registration only since
the mid-1990s (FY 1995 and afterwards) by the Reserve Bank of India. These banks being
International Research Journal of Finance and Economics - Issue 47 (2010) 21

governed by the regulatory policies of the Government of India pertaining to the ongoing era of
financial sector deregulation (post 1991 scenario), their commitment towards priority sector and
such other directed credit policies of the Government are much lesser than those of Public
Sector Banks (PSBs) and Old Private Sector Banks (OPBs). Besides, these new banks are
equipped with latest technological platforms. In short, NPBs are more or less comparable with
foreign banks (FBs) operating in India, rather than PSBs or OPBs. As already mentioned above,
only the NPBs that have been functioning throughout the ten years’ period under study (FY
2000 to FY 2009) are considered for analysis, and as such the newer NPBs (like, Kotak
Mahindra Bank, Yes Bank etc.) have not been considered. As per the above criterion, four
NPBs viz. (i) Axis Bank (formerly, UTI Bank), (ii) HDFC Bank, (iii) ICICI Bank, and (iv)
Indusind Bank have been considered. The average values of the relevant parameters for each
year, for the 10 years’ period under study are taken as representative ‘NPB’ group in the study.
IV. FBs refer to the foreign banks functioning in India. FBs have lower commitment towards
priority sector and other directed credit schemes of the Government. FBs are equipped with
most advanced technology.
V. KOPBs refer to OPBs which are of Kerala origin, viz. registered in the state of Kerala. As of
March 2010, there are only four KOPBs viz. CSB, DB, FB, and SIB. (See Note–II above for
full details).
VI. Nationalization of banks (acquiring private banks by Government of India and making them
Government-controlled banks) took place in India in two phases; first in 1969, (14 banks) and
then in 1980 (6 banks). Of these 20 nationalized banks (NBs), one bank (viz. New Bank of
India) was merged with Punjab National Bank subsequently. Thus, there are 19 NBs in India as
of 2010.