Scale Economies in Indian Commercial Banking Sector

Two alternative estimation models, i.e., a translog cost function and data envelopment analysis (DEA) based on a cost model are compared and contrasted in revealing scale economies in the Indian commercial banking sector. The empirical results indicate that while the translog cost model exhibits increasing returns to scale for all the ownership groups, the DEA model reveals economies of scale only for foreign banks, diseconomies of scale for nationalized banks, and both economies and diseconomies of scale for private banks. The divergence of the results obtained from these two estimation models should concern model builders. From an empirical perspective the definition of scale economies through a constant input mix is very restrictive. The DEA cost model is much more flexible in this respect: It neither requires the restrictive assumptions that the unit factor prices are always available with certainty, nor that these prices are exogenous to the firms. However, the very volatile nature of the banking industry might question the validity of the empirical estimates in this deterministic setting. Therefore, further research is required to examine the bank performance behavior using both SFA and chance constrained DEA for the comparison in a stochastic setting.