Partial privatization and bank performance : evidence from India

Abstract

This paper examines the impact of partial privatization on performance of state-owned banks using data from the Indian banking industry during the period 1986-2003. We test the hypothesis that privatization leads to improvement in performance even when the government retains controlling stakes. Employing the technique of stochastic frontier analysis, we obtain bank-specific estimates of total factor productivity which we consider as a measure of performance along with four accounting measures. We then employ panel regression models to assess the impact of partial privatization on these performance indicators. We find that partial privatization resulted in significant improvement in performance of state-owned banks. This finding is robust to alternative model specifications and different techniques for controlling potential selection bias. The results suggest that faced with political opposition to full privatization, even if the government does not relinquish control, the exposure to market discipline through partial privatization may be an effective way of improving performance of state-owned banks.