The impact of regulatory reforms on cost structure, ownership and competition in Indian banking

Despite the fact that processes of deregulation and concomitant prudential re-regulation have recently been a dominant feature in financial markets of both developed and developing countries, relatively little empirical work has been done on their impact on bank competition and performance. This paper examines the impact of financial sector reforms on the cost structure characteristics and on the ownership-cost efficiency relationship in Indian banking. Following Battese and Coelli (1995) we employ a stochastic cost frontier approach on a balanced panel dataset which includes public sector, domestic private and foreign banks continuously operating in India throughout the period 1992-2004. We also examine the impact of reforms on the dynamics of competition in the lending market by estimating the persistence of the overcharge (the price-marginal cost ratio) through a partial adjustment model. Results suggest that Indian commercial banks have responded to the new regulatory environment by changing both the input mix and the output composition. The relationship between bank ownership and cost efficiency appears also to be affected. There is evidence of increased competition in the lending market in the latest stages of the reform process, at the time of the tightening of prudential norms. The coexistence of deregulation and prudential re-regulation seems to promote competition and consequently cost technology progress.