Market Response with Special Reference to Cash Reserve Ratio: An Event Market Response with Special Reference to Cash Reserve Ratio: An Event Study Analysis of S&P BSE BANKEXStudy Analysis of S&P BSE BANKEX

Market Response with Special Reference to Cash Reserve Ratio: An Event Market Response with Special Reference to Cash Reserve Ratio: An Event Study Analysis of S&P BSE BANKEXStudy Analysis of S&P BSE BANKEX

International Conference on Reinventing Thinking Beyond Boundaries to Excel 2013 (April 6, 2013 )

PLAN FOR DISCUSSION

Introduction

Objective of the Study

Literature Review

Methodology

Variable Specification and Model

Data and Sample

Results and Discussions

Conclusion

Monetary Police is the process by which monetary authority of a country, generally the Central Bank; controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. In India, the central monetary authority, Reserve bank of India (RBI), is designed to perpetuate the price stability in the economy.

The monetary policy is related to the control of some measures of the money supply or the level and structure of interest rates. It is the process by which the central bank or monetary authority of a country controls the supply of money, often targeting a rate of interest.

The monetary policy constitutes only one possible element of an economic policy. In this operating target goals that the Central Bank can influence better in the short period of

time. Although Central Banks cannot use monetary policy instruments directly to intermediate

targets, affect operating targets, such as reserve money and short-term interest rates, which influence movements in intermediate variables. Monetary neutrality implies that policy should not affect real stock prices in the long run.

Monetary policy actions might affect stock prices over shorter horizons, however, by altering the path of expected dividends, the discount rate, or the equity premium.

INTRODUCTIONINTRODUCTION

objectives of the monetary policy of India, as stated by RBI, are: Price Stability, Controlled Expansion of Bank Credit, Restriction of Inventories, Promotion of Exports and Food Procurement Operations, Desired Distribution of Credit, Equitable Distribution of Credit, To Promote Efficiency, Reducing the Rigidity. Cash Reserve Ratios (CRR) “Cash reserve ratio is the cash parked by the banks in their specified current

account maintained with RBI.” The cash reserve requirement is a bank regulation that sets the minimum reserves

each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands and would normally be in the form of fiat currency stored in a bank vault or with a central bank.

INTRODUCTIONINTRODUCTION

THE REASONS FOR A DECREASE IN A CASH RESERVE RATIO Regulations meant to govern the business environment exist in almost all economic

sectors. The banking sector has rules, such as a cash reserve ratio that has to be maintained with the Federal Reserve Bank. A cash reserve ratio is the amount of money banks are required to deposit with the Federal Reserve Bank. This amount depends on the amount of deposits held in each bank. This amount is used to control the amount of cash at the disposal of the bank.

Government Regulation Reduced Deposits Profitability Provide Employment Support Other Sectors Liquidity

INTRODUCTIONINTRODUCTION

The following are the objectives of the study.

To analyze the impact of cash reserve ratio on the share price return during the pre and post announcement period.

To test the returns performance of stock price during the pre and post announcement of cash reserve ratio.

OBJECTIVEOBJECTIVE

HYPOTHESISHYPOTHESIS

Literature Review

A good deal of literature has been exploring the issues of efficiency and performance of banking sector in a developed as well as developing economies considering the frontier analysis techniques (Miller and Noulas, 1996; Berger and Master, 1997; Mukharjee et al., 2001; Drake and Hall, 2003; Saha and Ravisankar, 2000; Sathye, 2003; Shanmugam and Das, 2005; Sufian, 2009).

Frontier analysis techniques in the performance assessment of banking sector gained huge popularity due to its advantageous nature over the traditional performance measures.

Traditionally financial or operational performance of any banking or financial units were used to be measured by the specific financial ratios. However, these financial ratios include a single aspect of performance and did not capture the long term performance of financial units.

Literature Review

Frontier techniques marked an edge over these traditional methodologies as frontier technique of estimation can handle multiple input-output variables and capture different aspects of the performance of any organization.

In the frontier techniques there are two main approaches one is econometric specification based parametric technique and the other is linear programming based non parametric specifications.

The non parametric approach has an advantage over the parametric approach as it does not require any functional specification, do not require complex assumption and reduce the biases in the estimation.

In the literature non parametric based Data Envelopment technique has been used widely to assess the efficiency and productivity of the banking sectors in the developed as well as developing economies (Berger and Humphrey, 1997).

Methodology

Data Envelopment Analysis DEA is a non parametric frontier technique to assess the relative efficiency and benchmark banks on the basis of efficiency scores. DEA is a linear programming based operational research technique to examine relative efficiency of any decision making unit (DMU) to other DMU’s in the sample. DEA was developed by Charnes, Cooper and Rhodes in 1978, for constant return of scale; later Banker et al. (1984) improved this model for the variable return of scale.

These scores range from 0 to1.

1 for the best practicing banks on the efficiency frontier whereas 0 for the worst, lying below the efficiency frontier.

We assess the efficiency and effectiveness of the banks and these efficiency scores are used as a proxy of performance of banks.

Variable specification and Model for the Study

Efficiency as an indicator of performance of any organization consider the input –output aspect and therefore any organization is said to be efficient when it produces maximum output using given level of inputs or uses minimum inputs to produce given level of output.

Therefore, the role of input-output specification is very crucial and vital in the study of efficiency of banking units.

Intermediation approach found to be the most value addition approach to assess technical efficiency of banking units following DEA models.

Variable (Input-Output Specification)

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Intermediation and Operating Approach (To estimate the technical efficiency and productivity changes)

Variables Definition

Inputs

Deposits (x1) Total funds collected on deposit mobilization.

Interest Expenses (x2) The amount paid as interest on all short and long-term liabilities like debentures, deposits.

Non-interest Expenses (x3) Expenses incurred other than interest expenses such as operating expenses, rent, depreciation, and insurance.

Personnel Expenses (x4) Total expenditures on bank employees such as salaries, employee benefits, and reserves for retirement pay.

Variable (Input-Output Specification)…

Variables Definition

Outputs

Loans and Advances (y1) Total loans provided by the bank.

Interest Income (y2) Income received as interest on the bank’s loan portfolio.

Non-interest Income (y3) Income received from sources other than banking activities, non-traditional banking activities like fee based income.

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Input-Output Framework

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Data and Sample

The sample size includes 65 scheduled commercial banks (26 public banks, 19 private banks and 20 foreign banks) operating throughout the study period (2000-2010).

Data Source

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Analysis of Efficiency of Indian Banking Sector: Major Findings

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The Indian banking sector exhibits a decline in the average technical efficiency estimates.

Indian public banks are leading the other ownership groups. The private banks are lagging behind their public counterparts. foreign banks exhibit a slow down and decline in the annual mean

efficiency scores.

Efficiency of Indian Banking Sector

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Indian banking sector is able to manage inputs to produce outputs and exemplify an upward trend during the period of the study.

The Indian public banks lead the other ownership groups in terms of average pure technical efficiency estimate.

Foreign banks seem unable to manage their costs to produce optimum outcomes and the impact of turbulent conditions of global meltdown evident in the downfall of their performance.

Efficiency of Indian Banking Sector

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The public banks are found to be the most scale efficient and set a benchmark to other ownership groups.

Private Banks are leading foreign banks in scale efficiency and therefore, the scale inefficiency is not a major concern for private players in India.

The foreign banks seem to be the major sufferer of scale inefficiency in the Indian banking system.

Influence of Ownership Structure on Efficiency of Banking Sector

This study test for any significant difference in efficiency estimates between Indian public & Indian private banks, Indian public & foreign banks, and Indian private & foreign banks.

The null hypothesis states that there is no significant difference in average efficiency estimates between two ownership groups in the Indian banking industry.

To test this hypothesis, this study applies non-parametric (Kolmomogorov-Smirnov, Kruskall-Wallis, and Mann-Whitney U) tests.

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Influence of Ownership Structure…

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rejects the null hypothesis framed in the case of public and foreign banks, and private and foreign banks and propose the significant difference in the efficiency estimates between public and foreign banks and private and foreign banks.

Hypothesis Test for Differences in Average Technical Efficiency Estimates across Ownership

Influence of Ownership Structure…

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Hypothesis Test for Differences in Average Scale Efficiency Estimates across Ownership

rejects the null hypothesis in all cases, exhibits significant difference in average scale efficiency estimates

across the different ownership.

Influence of Ownership Structure…

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Hypothesis Test for Differences in Average Scale Efficiency Estimates across Ownership

Do not reject the null hypothesis in all cases, Indian banking sector exhibits no significant differences in pure

technical efficiency estimates across different ownership groups.

Conclusion This study investigates the differential role of ownership in efficiency changes of

Indian banking sector and exhibit significant differential between public & foreign banks and private & foreign banks, These differences exhibit the significant influence of ownership structure on the performance of Indian banking sector.

The plausible reason behind these differences exist inside the regulatory regime of Reserve Bank of India and nature & operation of different ownership groups.

Foreign banks found to be significantly different in terms of efficiency scores from public and private banks because the operation of foreign banks is very much limited in India and they operate as a branch of their parents and not as a wholly owned subsidiary in India.

These regulatory changes varying to different ownership groups exhibit significant performance changes across the ownership groups in Indian banking sector.

References Banker, R.D., Charnes, R.F., and Cooper, W.W., (1984). Some Models for Estimating

Technical and Scale Inefficiencies in Data Envelopment Analysis, Management Science 30, pp. 1078–1092.

Beccalli, E., Casu, B., and Girardone, C., (2006). Efficiency and stock performance in European banking. Journal of Business, Finance and Accounting.33, pp. 218-235.

Benninga, S., 2001. Financial Modeling, 2nd ed., The MIT Press, Cambridge, MA. Berger, A. N., and Humphrey, D.B., (1997). Efficiency of financial institutions: International

survey and direction for future research. European Journal of Operational Research. 98, pp.175 – 212.

Berger, A.N. and Mester, L. J., (1997). Inside the black box: What explains differences in the efficiency of financial institutions? Journal of Banking and Finance, 21, pp. 895-947.

Charnes, A., Cooper, W.W., and Rhodes, E. (1978). Measuring efficiency of decision making units. European Journal of Operations Research, 2, pp. 429-444.

Cooper W.W., Seiford, L.M., and Zhu, J., (2004). Data Envelopment Analysis: History, Models and Interpretations”, In Cooper W.W., Seiford, L.M., and Zhu, J., (Ed.) Hand Book on Data Envelopment Analysis, Kluwer Academic Publishers, New York, NY, pp. 1-39.

Das, A., and Ghosh, S., (2006). Financial deregulation and efficiency: An empirical analysis of Indian banks during the post reform period. Review of Financial Economies. 15, pp. 193- 221.

Drake, L., and Hall, M.J.B., (2003). Efficiency in Japanese banking: An empirical analysis. Journal of Banking & Finance, 27, pp.891–917.

References Drake, L., Hall, M.J.B., and Simper, R., (2006). The impact of macroeconomic and regulatory

factors on bank efficiency: A non - parametric analysis of Hong Kong’s banking system. Journal of Banking and Finance.30, pp.1443-1466.

Miller, M. S., and Noulas G. A., (1996). The technical efficiency of large bank production. Journal of Banking and Finance. 20, pp. 495 – 509.

Mukharjee, K., Ray, S.C., and Miller, M. S., (2001). Productivity growth in large US commercial banks: The initial post - deregulation experience. Journal of Banking and Finance .25, pp. 913 – 939.

Saha, A., Ravisankar, and T. S., (2000). Rating of Indian commercial banks: A DEA approach. European Journal of Operational Research.124, pp. 187 -203.

Sathye, M., (2003). Efficiency of banks in a developing economy: The case of India. European Journal of Operational Research. 148 (3), pp.662-671.

Sealey, C.W. and Lindley, J.T., (1977). Inputs, outputs and theory of production cost at depository financial institutions. Journal of Finance, 32, pp.1251-1266.

Shanmugam, K.R., and Das, A., (2004). Efficiency of Indian commercial banks during the reform period. Applied Financial Economics, 14, pp.681–686.

Sufian F., (2009). Determinants of bank efficiency during unstable macroeconomic environment: empirical evidence from Malaysia. Research in International Business and Finance 23, pp. 54 – 77.

Yeh, Q. (1996). The Application of Data Envelopment Analysis in Conjunction with Financial Ratios for Bank Performance Evaluation. Journal of Operational Research Society, 47, pp. 980-988.