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The IUP Journal of Bank Management

Credit Risk Management, Technical Efficiency, and Financial Performance of Indian Banking Sector: A Mediation Analysis

Article Details

Pub. Date	: Aug, 2023
Product Name	: The IUP Journal of Bank Management
Product Type	: Article
Product Code	: IJBM010823
Author Name	: Aparna Bhatia and Megha Mahendru
Availability	: YES
Subject/Domain	: Finance
Download Format	: PDF Format
No. of Pages	: 19

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Abstract

The study aims to capture the mediating effect of technical efficiency on the relationship between credit risk and financial performance in the Indian banking sector. This paper is based on secondary data extracted from the financial reports of commercial banks operating in India for the year 2021-22. Simple mediation analysis is used to analyze the data. The technique of data envelopment analysis (DEA) was deployed to calculate technical efficiency score. The findings show that credit risk has a negative and significant relationship with both financial performance and technical efficiency when taken alone as an independent variable. Overall, the results show that technical efficiency fully mediates the relationship between credit risk and banks' profitability. The mediating effect suggests that scheduled commercial banks operating in India can achieve both technical efficiency and good financial performance through vigilant supervision of credit risk. With specific reference to India, such empirical work showing the mediating effect of technical efficiency on financial performance and credit risk has not been taken up before. The findings of the study are expected to provide a better understanding of the role of managing nonperforming assets in determining technical efficiency and financial performance.

Introduction

The Global Financial Crisis in 2007-08 drew worldwide attention towards the risk management practices in banks. Lending to the subprime borrowers led to massive increase in the nonperforming assets (NPA) of banks, so much so that a gigantic investment bank, Lehman Brothers, collapsed due to the eruption of the credit crisis, thereby reinforcing the lesson that credit risk needs to be managed timely. No doubt, Hennie (2003) and Srikanth and Kishore (2014) pointed out that many banks operating worldwide collapsed due to failure in managing credit risk efficiently. Even Masood and Ashraf (2012) and Siddique et al. (2021) proposed that high NPA in banks lead to credit risk and result in financial crisis in the economy. NPA are the