Economies of scale, technical change and persistent and time-varying cost efficiency in Indian banking: do ownership, regulation and heterogeneity matter?

Banks with different ownership types adjust differently to changes in regulatory environments. Although this topic has been widely studied, all the previous studies fail to control for bank-heterogeneity (bank-specific effects) in estimating cost structure and efficiency. We propose a model where we control for bank-heterogeneity, and introduce persistent and time-varying inefficiency. Additionally we incorporate determinants of both persistent and time-varying inefficiency as well as production risks. Furthermore, our model allows estimation of different technologies for different ownership types jointly. We use this model to analyze the effect of regulation in Indian banking. We find that private banks have not exhausted their economies of scale, foreign banks are operating under diseconomies of scale, especially after the reforms, and scale economies of state owned banks are unaffected by regulation. Banks of all ownership types have enjoyed technical progress; however, foreign banks have benefited the most, followed by state owned banks. Only state banks were able to improve their cost efficiency, while private banks, and especially foreign banks, were lagging behind their cost frontiers.