K C Chakrabarty: Productivity trends in Indian banking in the post reform
period - experience, issues and future challenges
Special address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at
the FIBAC 2013, organized by FICCI (Federation of Indian Chambers of Commerce &
Industry) and IBA (Indian Banks' Association), Mumbai, 13 August 2013.
* * *
Data used in the document in provisional and intended to capture the broad trends only. It may not tally with
actual figures.
Shri K.R. Kamath, Chairman, IBA and CMD, Punjab National Bank; Shri H.S.U. Kamath,
CMD, Vijaya Bank; Smt. V.R. Iyer, CMD, Bank of India; Shri R.K. Dubey, CMD, Canara
Bank; Shri M. Narendra, CMD, Indian Overseas Bank; Shri D. Sarkar, CMD Union Bank of
India; other senior colleagues from the banking industry; delegates to the conference;
members of the print and electronic media; ladies and gentlemen. It is, indeed, a great
pleasure and privilege for me to address this august gathering today and I thank FICCI and
the IBA for this opportunity. The conference, which is in its twelfth edition, has succeeded in
bringing together the best minds in the banking industry and has grown into a platform which
deliberates contemporary issues facing Indian banking. I am very glad to note the theme
chosen for this year's event, "Consistency, Quality and Resilience: The Next Frontier for
Productivity and Excellence". I strongly believe that productivity and efficiency in banking
services would be the bulwark for all round economic development in India. Considering the
challenges currently confronting the economy, there is little doubt that the time for the next
big productivity push in Indian banking is now. I therefore, congratulate FICCI and IBA for
their choice of theme for the conference and do hope that ideas emanating from the
conference deliberations bear fruition in the coming days.
2. I am happy to note that BCG has brought out a study report on the theme of the
conference, which, based on extensive field survey, has recommended several measures for
attaining productivity excellence in Indian banking. I congratulate BCG for their effort and do
hope that the banking industry gives serious thought to the study recommendations and
takes them forward in right earnest.
3. During my address today, I would be highlighting the trends in productivity in Indian
banking over the last two decades, including trends across bank groups. However, the thrust
of my address would be on the fact that improvements in productivity and efficiency of banks
has not had the desired beneficial impact on all segments of our economy and hence, there
is a need for the entire paradigm of banking productivity and efficiency to be reoriented to be
in alignment with our national priorities.
Productivity and efficiency
4. Investopedia defines productivity as an economic measure of output per unit of input. The
concept of productivity is more easily applied to industrial settings while it is more difficult to
define and measure in the context of services sector, including the banking industry. We
often have to rely upon proxies to gauge productivity of banks and there is no single measure
that has been universally accepted as representing banking productivity.
5. It is common to see the terms "productivity" and "efficiency" being used interchangeably in
literature. However, productivity is more a measure of performance of labour, which is one of
the factors of production. Efficiency, on the other hand, is a much broader term which
represents the performance of all factors of production. In case of banks, while productivity
measures the performance of their staff, efficiency represents the combined performance of
staff, capital and management. However, let me add that there are strong inter-linkages
between the performance of the three factors of production: high productivity of staff will
result in efficient utilization of capital, while an efficient management function would result in
superior performance by labour and capital. It would, therefore, be safe to conclude that
when all the key inputs are optimally deployed, the outcome will be an "efficient" bank.
Having said that, let me state upfront that I would also be using the terms "productivity" and
"efficiency" concurrently in my address today.
Productivity and efficiency of banks
6. Banks form the core of a nation's financial system, performing the vital function of financial
intermediation through liquidity, maturity and risk transformation. Finance is the lifeline of any
commercial activity and banks act as a link between the savers and the borrowers. The
productivity and efficiency of banks, thus, critically impacts the productivity and efficiency of
all economic activity and is a matter of concern for policy makers and economy watchers.
There are two aspects to banking efficiency which I would like to highlight:
(i) Allocational efficiency focuses on ensuring that the precious
Allocational Efficiency:
financial resources are allotted to the most productive activities as per development needs of
society. It seeks to ensure that the broad national priorities are furthered through the process
of resource allocation and that the interests of the most vulnerable sections are protected.
(ii) Operational Efficiency means banks seek to provide financial
Operational Efficiency:
services in a safe, secure, speedy and cost effective manner. The goal should be to ensure
that the transformation function generates least friction in terms of time and cost overlays.
7. The concepts of allocational and operational efficiencies have considerable inter-linkages
and the challenge for banks is to ensure optimal performance on both fronts. However, as I
would argue later in my address, the Indian banking system has not succeeded in balancing
these two parameters, with the result that progress on one has been at the cost of the other.
8. Those who would recollect my address at FIBAC 2012 may remember that I had sought to
deliberate on the concept of allocational efficiency through the Revised Priority Sector
Guidelines, which had been issued a few months earlier. The theme for this year's event
permits me to take my thoughts forward by focusing on the other element, viz. operational
efficiency and on the interplay between the two.
Importance of productivity in banking
9. As I mentioned earlier, banks perform the important function of financial intermediation
and the efficiency of their operations has an important bearing on overall economic health of
the country. Greater efficiency in banking operations ensures that the cost of financial
intermediation is minimized. At a time when the global and Indian economy are facing
challenges on multiple fronts, efficient financial intermediation would provide impetus to the
process of economic recovery by channelizing funds to the most productive sectors at the
lowest cost.
10. Improvement in productivity and efficiency, and the resultant decline in cost of providing
financial services will help in furthering financial inclusion (FI). More importantly, it will help in
converting the improved access to financial services into improved usage. This improved
usage will make the FI activities commercially viable both for the banks and for the BCs and
encourage them to scale up their FI initiatives, thereby helping in quickly bringing the
remaining unbanked villages into the fold of the formal financial system. Hence, banking
productivity and efficiency has a direct impact on improving financial access and financial
usage.
11. The recent decline in economic growth has presented significant challenges to banks
through rising impairment of assets, pressure on margins and volatility in non-interest
income. In this demanding business environment, improved operational efficiency will help
banks in standing up to the challenges and enable them to maintain their health and
profitability. I strongly believe that every time the financial system has been faced with a
crisis, a resolute push towards improved productivity and efficiency has invariably aided it in
seeing through the troubled times.
12. As banks form the core of the country's financial system, the health and profitability of
banks will help in ensuring stability and resilience of the entire financial system. Thus, from a
systemic stability perspective also, improved productivity and efficiency of the banking
system is a definite positive.
Productivity trends in Indian banking
13. The Indian banking industry has, over the years, taken significant strides in its quest for
greater productivity. Analysis of data (based on various parameters) indicates that Indian
banks, particularly the public sector banks, have shown significant progress on the
productivity and efficiency front. The efficiency of banks has been analyzed based on cost
based parameters and profitability linked parameters.
Cost based parameters
14. As can be seen from the table above, all three ratios have seen a significant
improvement during this period, indicating improved efficiency of the banking system. For
instance, the Ratio of Operating Expenses to Average Assets has seen a decline from 2.60%
to 1.75% during 1992-2013. A bank-group wise analysis indicates that Public Sector Banks
(PSBs) have seen much greater progress as compared to new private banks and foreign
banks (Tables in Annex). The Cost Income ratio across bank groups also indicates similar
pattern, with the ratio seeing a significant decline over the period 1995-2013. The main
drivers of this decline were the PSBs, which saw a perceptible decline in this ratio while new
private banks and foreign banks, in fact, saw a rise in this ratio over the period under review.
15. An analysis of the CAGR of various expense parameters indicates that operating
expenses grew at a CAGR of 14.65% between 1992 and 2013, whereas staff expenses grew
at a CAGR of 13.63% during this period. PSBs had the lowest CAGR for operating
expenses, staff expenses and other operating expenses (Table in Annex)
16. As indicated by Table 2 above, banking productivity in terms of staff costs has seen a
considerable improvement during 1992-2013. Interestingly, there has been a significant
convergence of these ratios across various bank groups (Tables in Annex). While the ratios
have increased over this period in case of foreign banks and new private banks, the ratios
have seen a considerable decline in case of PSBs.
Profitability/turnover based parameters
17. The NIMs of banks saw a decline from 3.30% in 1992 to 2.79% in 2013. Importantly, the
NIMs of Nationalized banks were considerably lower than that of other bank groups and
stood at 2.39% in 2013, while foreign banks and new private banks had NIMs of 3.89% and
3.32% respectively (Tables in Annex). The higher NIMs indicated greater intermediation
spread charged by banks and could be viewed as a cost. Banks need to develop the
capability to viably carry out their operations with lower NIMs as this would be essential in
providing low cost services to the excluded groups.
18. It is evident that improved productivity and efficiency has positively impacted the
profitability levels of the banking system. However, as I would be alluding to later, the same
has been due to structural changes in banks' balance sheet. The higher profitability
parameters also indicate that the benefits of improved efficiency have not been passed on to
the customers and have, instead, been retained by banks for higher profits and provisioning.
19. Thus, the key observations from the analysis of productivity trends in Indian banking are:
 On both cost and profitability based parameters, the productivity and efficiency of
banks has seen a definite improvement over the last two decades.
 At a bank group level, PSBs have performed better than new private banks and
foreign banks on various benchmarks.
 However, the progress has not been constant and continuous over this period.
There have been phases of rapid and slow growths.
Four phases of productivity growth
20. In order to better understand the productivity trends in the banking system, the post
reform time line in India may be divided into distinct phases based on various internal and
external developments which impacted the banking sector.
 This phase represents the period immediately after the
Phase 1 (Pre-1995):
economic reforms. Besides the challenges posed by the changes in business
environment due to the reforms, banks also had to adjust to changes in regulatory
norms.
 This was a period of stabilization post reforms and was
Phase 2 (1995-2001):
characterized by developments like computerization, formulation of strategies for
technology implementation, challenges of NPAs and banks approaching markets for
capital.
This was the growth phase when the impact of reforms was

Phase 3 (2001-2007):
fully felt. This period was characterized by technology upgradation by banks, benefit
of global liquidity and a period of growth. This was also the phase of build-up of risks
due to the irrational exuberance exhibited by market players.
 This last phase is dominated by the global financial crisis
Phase 4 (2007-2013):
and post crisis pains. The risks building up in the previous phase crystallized during
this period. The period is also characterized by reforms fatigue, lack of banking
penetration, absence of internal reforms and ineffective structure, systems and
people.
21. In view of the considerable inter-year variations in various productivity indicators, analysis
of the same has been done over the above four phases in order to identify trends. For this
purpose, averages of various parameters over the relevant period have been considered.
The key observations that emerge from the analysis of expenses across the four phases are:
 There is definite evidence of productivity and efficiency gains in Indian banking. This
productivity gain has led to strengthening of balance sheets of banks.
 The gap between PSBs and other bank groups on various productivity parameters
has considerably narrowed. Though there were initial concerns that PSBs will lose
out to competition from the new private banks and foreign banks, it is commendable
that PSBs have responded well to the challenge and have succeeded in raising their
efficiency levels. In case of new private banks, expense ratios remain high as they
are in an expansionary phase.
The pace of productivity gains has varied with the greatest progress being seen in

Phase 3 (2001-2007), while lower gains were witnessed in the initial two phases. It
is observed that the productivity gains started tapering off in the fourth phase.
 Within operating expenses, it is observed that staff expenses have improved faster
than other operating expenses. Currently, other operating expenses of PSBs
continue to remain considerably lower than new private banks and foreign banks.
This is largely due to the fact that they have not paid adequate attention to the
physical infrastructure and the ambience at branches. However, this ratio is also
expected to converge in the future.
 Interestingly, in phase 4, PSBs have emerged as the highest per employee staff
expenses among Indian bank groups. This clearly indicates that they have lost the
staff cost advantage of the past. However, they have saved on aggregate staff
expenses by curtailing staff deployment with the use of technology.
Global comparison
22. While we have made some progress on the productivity front, it is important to
benchmark the Indian banking system against global productivity standards in order to get a
better understanding of where we stand.
While there has been a tangible improvement in our relative productivity levels on various
parameters such as Operating Expenses Ratio, we still lag behind several of our peers from
Asia and the developed world. For instance, in case of Ratio of Operating Cost to Assets,
China (0.80%), Malaysia (1.27%) and Korea (1.05%) have much lower ratios as compared to
the Indian position of 1.65%. Considering the fact that we are pursuing the mission of
extending access to affordable banking services to the unbanked poor, we need to target a
level which is at par, if not better than many of these countries.
23. Our Net Interest Margin at 2.70% is also higher than that observed in many other
countries. While this would have helped in improved profitability of our banks, the higher
margins indicate an extent of inefficiency, which is being passed on to the ultimate
customers. On the Ratio of Net Profit to Assets, Indian banks are better than many other
jurisdictions. Considering the fact that our Operating expenses ratio are higher than many
countries, the ratio suggests that our banks have been passing on the cost of their
operational inefficiencies to their customers and are, thus, able to record greater profits at the
cost of their customers.
What has happened to allocational efficiency?
24. As was observed from the analysis presented previously, the Indian banking system has
seen a perceptible improvement in its efficiency levels over the last two decades. However,
the question that I would like to pose here today is that has the improved operational
efficiency resulted in attainment of desired outcomes for all sections of our population? I
would argue that the improved operational efficiency has not facilitated greater allocational
efficiency, but has, instead, been at the cost of allocational efficiency. Let me present some
data to buttress my argument:
The proportion of rural branches to total branches of scheduled commercial banks (SCBs)
has seen a sharp decline from 57.16% in 1994 to 37.18% in 2013. In fact, the number of
rural branches of SCBs saw a continuous decline between 1994-2006. This indicated a
complete neglect of the requirements of rural areas by banks during this period. It was only
after a determined regulatory push towards financial inclusion that the number of rural
branches saw a perceptible rise post 2009. The failure of banks to improve their allocational
efficiency is evident from the fact that resources, in terms of banking presence, was not
allotted to the most underbanked segments i.e. the rural areas. This was despite the fact that
improving operational efficiency and access to technology over this period had enhanced the
capability of banks to better serve rural habitations. Yet it appears that banks chose to ignore
the need for allocational efficiency.
The above data indicates that the number of credit accounts in rural areas increased at a
CAGR of 1.4% between 1994-2012, while the number of credit accounts in Metro areas
recorded a CAGR of 13.86%. The proportion of credit flowing to rural areas also declined
from 18% to 8%, while the proportion of deposits being sourced from rural areas declined
from 15.1% to 9.4% during this period. Both the above metrics highlight the declining focus of
banks on rural business and greater emphasis on business in metro areas.
The proportion of bank credit going to agriculture and SSI sectors has seen a steady decline
from 30.03% in 1994 to 17.95% in 2013. This was despite the fact that these sectors have
been receiving special attention from policy makers for some time now. As compared to this,
the proportion of credit to medium and large industries has marginally increased from its
levels in 1994, despite their contribution to GDP declining significantly over the years. This
again highlights inadequate allocational efficiency among banks and their preference for
catering to the needs of larger borrowers instead of smaller ones.
Another measure of inadequate allocational efficiency among banks is the concentration of
deposit/ credit indicated by the proportion held by top 10/100 cities as compared to total
deposit/ credit. Based on this measure, there has not been any improvement in concentration
of credit, which has remained largely unchanged over this period at around 60%, while
concentration of deposits saw a considerable deterioration from 39% to 49%. The
concentration indicated by the proportion of credit/ deposit to top 100 cities has also been
steadily increasing over this period. This clearly indicates that smaller towns/ cities and rural
areas were being deprived of credit/ deposit services by banks, adversely impacting
economic growth opportunities available to them.
The above occupation-wise analysis of deposits indicates that the percentage of deposit
accounts held by individuals declined from 96% to 86% between 1997 and 2012. During this
period, the proportionate amount of deposits held by individuals saw a steep decline from
77% to 51%. The declining share of individuals in deposits, both in terms of number and
amount reinforces the fact that banks have been losing their focus on smaller customers and
are increasingly moving towards servicing bigger clients.
Over the period 1994-2012, the number of very small credit accounts (limit upto ₹25000)
saw a decline from around 55 million to 44 million despite the total number of credit accounts
increasing by 119.4% over this period. The outstanding credit in these accounts as a
proportion of total credit also declined from 18.3% to a mere 1.6%. Similarly, proportion of
amount outstanding in small loans upto ₹0.2 million to total loans also declined from 30.5%
to 9.5% during this period. The decline in smaller loan accounts, which often cater to the
needs of the poor and marginalized sections of the society, again highlights the fact that
banks have largely focused on catering to the needs of the bigger borrowers, which is
against the principles of allocational efficiency. Predictably, the proportion of amount
outstanding in high value loans (limit > ₹1000 mn) increased from 10% to 31% during this
period.
25. A similar analysis in case of term deposit accounts reveals that the proportion of
accounts with deposit less than ₹0.1 mn declined from 93.6% to 73.7% between 2002-2012.
Importantly, the proportion of amount involved in such deposit accounts saw a sizeable
decline from 46.8% to 10.9% during this decade. Based on the above trends in credit and
deposit accounts, it is fair to conclude that banking in India has been increasingly oriented
towards wholesale business. It appears to be losing its focus on retail and small value
business. Here, I would like to remind our bankers that one of the lessons from the global
financial crisis was that small value and retail business proved to be a source of stability and
that banks focusing heavily on wholesale business were the most severely impacted in the
crisis.
What has not happened?
26. From the above data on various parameters, it is apparent that improving efficiencies in
the Indian banking system have not had the desired beneficial impact on all segments of the
population. This clearly implies that allocational efficiency has not kept pace with operational
efficiency and, in fact, I may say that operational efficiency has been achieved at the cost of
allocational efficiency. The gains from improving operational efficiency have not reached the
customers, particularly the small customers or the poor and marginalized groups. In terms of
geographical spread, these gains have not reached the rural areas and have largely
remained restricted to the metropolitan areas and larger cities. It is regrettable to note that
despite the improvements made in operational efficiency, the problems of disparities in
Indian banking and low penetration continue unabated.
27. While it was expected that greater competition and adoption of new technology would
result in all round efficiency improvement in the banking system, it is again apparent that
whatever limited competition that the banks have been exposed to and the technological
progress has not resulted in bringing down the costs of providing banking services. I would
like to pose the question that is a financial system with high operational efficiency but low
allocational efficiency sustainable in the long run?
Why has it not happened?
28. There are several reasons that can be attributed to this trend of declining allocational
efficiency against improving operational efficiency. Let me list a few:
 The basic reason for the declining allocational efficiency is the lack of banking
penetration in the country. This has resulted in the denial of basic banking services
such as provision of savings and credit facilities to large segments of our population.
 As was seen from the data analysis also, banks seem to be increasingly focusing on
wholesale business and have reduced their emphasis on individuals and segments
such as agriculture and small industries. This trend has adversely impacted
allocational efficiency as the same demands that the needs of the smaller customers
be prioritized while allocating banking resources.
 While new technology has been adopted by banks in India, including migration to
CBS, the beneficial impact of technological progress on the productivity of banks is
still low when compared with global standards. This can largely be attributed to the
fact that banks have not succeeded in leveraging technology to create products,
business models and delivery channels that maximize productivity and efficiency.
 Most importantly, technological progress has not been accompanied by internal
reforms in banks. Banks have not attempted to carry out comprehensive Business
Process and Structure Reengineering to ensure that internal processes are
realigned by leveraging technology with the goal of weeding out redundant
processes and simplifying/ automating others.
What have we done?
29. Ensuring greater levels of allocational efficiency in the economy has been one of the
important priorities for policy makers and regulators. In fact, it is difficult to envisage the long
term sustenance of a social or financial system where large scale disparities and inequalities
exist. Hence, allocational efficiency, focusing on the needs and expectations of the excluded
groups, has been receiving the attention of the Government and Reserve Bank. I would like
to highlight some of the steps taken to ensure greater allocational efficiency in banking
operations:
(i) Prescription of priority sector norms requiring banks to lend a certain part of their credit to
sectors of the economy which, in the absence of these norms, would not receive adequate
credit. With the revision in the priority sector norms in 2012, the same have been rationalized
and larger foreign banks have also been mandated to be at par with Indian banks on priority
sector lending, in a phased manner.
(ii) Pricing norms for the priority sector business have been freed and banks are permitted to
fix interest rates on their own. This will help banks to carry out FI initiatives in a viable and
self sustaining manner, which will facilitate its scaling up. We, however, do expect that the
pricing would be non-discriminatory and would not be exploitative.
(iii) There has been a policy shift with emphasis being on greater branch expansion in rural
areas. This is in recognition of the trend of declining rural branches and the importance of
brick and mortar structures in improving allocational efficiency through FI. Accordingly,
domestic SCBs have been mandated to allocate at least 25 per cent of the total number of
branches to be opened during a year in unbanked rural centres, with the incentive of
frontloading over the Financial Inclusion Plan (FIP) period.
(iv) Banks have been permitted to adopt Business Correspondents (BC) based delivery
models to effectively cover the last mile. A host of institutions have been permitted to
become BCs.
(v) A bank-led structured and planned push towards improving access and usage of the
formal financial system by the unbanked masses has been made by leveraging on
technology. Some of the FI initiatives taken in India include:
 Banks have been advised to prepare Board approved FIPs. First phase of FIP for
the period 2010-2013 has been completed. Banks are now preparing the second
phase of FIPs for the period 2013-2016.
 To address the issue of uneven spread of Bank branches, domestic SCBs have
been given the freedom to open branches in centres with population of less than
100,000 subject to reporting to RBI.
 A high level Financial Inclusion Advisory Committee (FIAC) has been set up to
provide strategic direction to FI initiatives across various stakeholders.
 In order to ensure operational efficiency and close monitoring of BC operations,
banks have been advised to open intermediate brick and mortar structures to
provide support to about 8-10 BC units at a reasonable distance of 3-4 kilometers.
 An integrated approach has been adopted for achieving FI through financial literacy.
Various measures have been taken for the spread of financial literacy. A National
Strategy for Financial Education has been finalized. Curriculum setting bodies are
being involved for disseminating financial literacy in schools.
What should happen?
30. The way forward for banks on the path towards greater productivity and efficiency has to
be two pronged. On the one hand, banks need to focus on further improvement in
operational efficiency so that they are at par with their global peers. Concomitantly, banks
also need to concentrate on improving allocational efficiency so that the benefits of improved
operational efficiency are enjoyed by all. The key challenge will be to ensure that the two
goals are synergized and allotted equal priority.
31. There are several other measures that Indian banks need to initiate in order to establish
the balance between allocational efficiency and operational efficiency:
 Banks need to initiate internal reforms in order to ensure that their systems and
processes are in a position to leverage technology to maximize productivity and
efficiency gains. For this purpose, banks need to look at large scale Business
Process and Structure Reengineering.
 Transaction costs need to be reduced by fully leveraging technology. This would
include creation of new cost effective products, business models and delivery
channels.
 Banks need to implement robust information systems and IT architecture and should
harness the power of the IT systems for business development. Besides, a strong IT
system will also aid in adoption of better risk management practices.
 Productivity improvement should benefit people at the bottom of the pyramid
through improved access to financial services and lower cost of financial access.
Every individual should have the opportunity to improve his/her financial position by
leveraging access to the financial system. Banks have to facilitate this.
 Banks have to reverse the tendency of focusing on wholesale business and should
ensure that agriculture, retail and SME business receive adequate attention. This is
important not just for improving financial access for the smaller and marginalized
groups, but also as a source of stability for banks.
 Banks should strive to improve their pricing ability, both for liability and asset
products, with the objective of ensuring that the pricing framework is transparent,
non-discriminatory and non-exploitative. The basic principle of pricing should be that
the poor and the vulnerable should not be subsidizing the provision of banking
services to the rich. Besides, an effective pricing framework can assist in building up
balance sheet strength by encouraging good business and shedding bad business.
However, for all this, banks need to develop the ability to identify risks and to build
them into their pricing frameworks.
 In order to improve productivity and efficiency, banks need to be given more
flexibility in operational matters, particularly in manpower practices. In fact, I strongly
believe that HR practices at banks, particularly PSBs, need to undergo significant
change in areas such as manpower planning, job description, performance
appraisal, promotion and placement policies, performance based compensation
practices, etc. Attaining greater productivity and efficiency requires not just the right
technology, systems and processes, but also the manpower with the right skills and
attitude, demonstrating the necessary flexibility and adaptability to be able to keep
pace with the changing times. Greater emphasis has also to be laid on productivity
in terms of per branch and per employee performance.
 Lastly, but most importantly, there is an urgent need for improved governance and
greater accountability across all levels of management and administration. The
change in corporate culture and the move towards true productivity and efficiency
needs to be led by managements in their respective organizations. The pace and
direction of thes