For commercial banks operating in India, improvement of asset quality has become important in the reform years because of the following reasons: (1) The deregulation of the banking sector entry and relaxation of branch licensing policy resulted in substantial decline in the banking sector spread, compelling the commercial banks to drastically reduce inefficiency; (2) The introduction of prudential asset classification, income recognition, and capital adequacy norms in effect increased penalties for commercial banks with low asset quality. The paper seeks to compare the Indian commercial banks (for the reform period) in respect of their ability to generate operating profit by using the data envelopment approach under both constant and variable returns to scale. The years of analysis are 1998-99, 2000-01, and 2002-03.The results show that the observed commercial banks have diverged in terms of technical and scale efficiency in 2000-01 as compared to 1998-99. However, the trend has been somewhat reversed in 2002-03. Further, most of the commercial banks exhibited decreasing returns to scale for the years of study. The observed private sector banks have higher mean technical efficiency scores as compared to their public sector counterparts. A comparison of the mean technical and scale efficiencies of the public sector commercial banks with regard to private sector commercial banks shows that for 1998-99 and 2002-03, the observed public sector commercial banks have higher mean scale efficiency scores than the observed private sector commercial banks.

During the reform years, there has been distinct regulatory and bank level initiatives to contain the growth of non-performing assets of the commercial banks operating in India so as to improve the asset quality of the commercial banking sector. Following the recommendations of the Committee on Financial System (1991), the RBI introduced the prudential asset classification, income recognition, and provisioning norms for the commercial banks. At the same time, it considered various other initiatives such as the introduction of credit risk management guideline and provision of adequate autonomy to the commercial banks in respect of their credit disbursement decisions. The commercial banks themselves also responded to the new situation by incorporating risk management practices into their decision making system. During the reform period, there has been a secular decline in the proportion of non-performing asset in the portfolio of commercial banks in India. It is, therefore, of interest to know where the banks stand in respect of generation of performing assets.

As has been indicated earlier, in the 1990s, there has been a perceptible change in banking operations. While on the one hand, the phasing in of prudential accounting, provisioning income recognition, and valuation norms compelled the banks to act cautiously in respect of their lending and investment programs, on the other, there were regulatory/institution-specific initiatives to take care of the various problem areas which hitherto acted as stumbling blocks in respect of the efficiency enhancement exercise.

Applied Finance Journal, Indian Commercial Banks, Banking Sector, Private Sector Commercial Banks, Public Sector Commercial Banks, Risk Management, Decision Making System, Banking Operations, Financial Sectors, Data Envelopment Analysis, Technical Efficiency.