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Introduction

The Indian financial sector comprises a large network of commercial banks, financial institutions, stock exchanges and a wide range of financial instruments. It has undergone a significant structural transformation since the initiation of financial liberalization in 1990s. Before financial liberalization, since mid-1960 till the early 1990, the Indian financial system was considered as an instrument of public finance (Agarwal, 2003). The evolution of Indian financial sector in the post independent period can be divided in to three distinct periods. During the first period (1947-68), the Reserve Bank of India (RBI) consolidated its role as the agency in charge of supervision and banking control (Sen & Vaidya, 1997). Till 1960s the neoKeynesian perspective dominated, argued interest rates should be kept low in order to promote capital accumulation (Sen & Vaidya, 1997). During this period Indian financial sector was characterized by nationalization of banks, directed credit and administered interest rates (Lawrence & Longjam, 2003). The second period (1969 - mid 1980s), known as the period of financial repression. The financial repression started with the nationalization of 14 commercial banks2 in 1969. As a result interest rate controls, directed credit programmes, etc. increased in magnitude during this period (Sen & Vaidya, 1997 & Nair). The third period, mid 1980s onwards, is characterized by consolidation, diversification and liberalization. However a more comprehensive liberalization programme was initiated by the government of India during early 1990s.The impetus to financial sector reforms came with the submission of three influential reports by the Chakravarty Committee in 1985, the Vaghul in 1987 and the Narasimham Committee in 1991. But the recommendations of the Narasimham Committee provided the blueprint of the reforms, especially with regard to banks and other financial institutions. In 1991, the government of India initiated a comprehensive financial sector liberalization programme. The liberalization programme includes de-controlled interest rates, reduced reserve ratios and slowly reduced government control of banking operations while establishing a market regulatory framework (Lawrence & Longjam, 2003). The major objectives of the financial liberalization were to improve the overall performance of the Indian financial sector, to make the financial institutions more competent and more efficient. As mentioned earlier, the financial sector comprises commercial banks, stock exchanges and other financial institutions. However, Indian financial system continues to be a bank based financial system and the banking sector plays an important role as a resource mobiliser. It remains the principal source of resources for many households, small and medium enterprises and also caters the large industries. And also provides many other financial services. Underlining the importance of the banking sector, several banking sector specific reforms3as a part of financial reforms were

introduced to improve the performance of the Indian banking sector and to make the Indian banks more competent and efficient. Against this backdrop, the present paper intends to study the performance of the Indian banking sector in the post liberalization period. At the same time, it also aims to determine the cost efficiency of the Indian banks in context of financial liberalization.
INTRODUCTION
The year 1991 marked a decisive changing point in India's economic policy since Independence in 1947. Following the 1991 balance of payments crisis, structural reforms were

initiated that fundamentally changed the prevailing economic policy in which the state was supposed to take the "commanding heights" of the economy. After decades of far reaching government involvement in the business world, known as the "mixed economy" approach, the private sector started to play a more prominent role (Acharya, 2002, pp. 2-4; Budhwar, 2001, p. 552; Singh, 2003, p. 1f.). The enacted reforms not only affected the real sector of the economy, but the banking sector as well. Characteristics of banking in India before 1991 were a significant degree of state ownership and far-reaching regulations concerning among others the allocation of credit and the setting of interest rates. The blueprint for banking sector reforms was the 1991 report of the Narasimham Committee. Reform steps taken since then include a deregulation of interest rates, an easing of directed credit rules under the priority sector lending arrangements, a reduction of statutory preemptions, and a lowering of entry barriers for both domestic and foreign players (Bhide, Prasad and Ghosh, 2001, p. 7; Hanson, 2001, pp. 5- 7). The regulations in India are commonly characterized as "financial repression". The financial liberalization literature assumes that the removal of repressionist policies will allow the banking sector to better perform its functions of mobilizing savings and allocating capital what ultimately results in higher growth rates (Levine, 1997, p. 691). If India wants to achieve its ambitious growth targets of 7-8% per year as lined out in the Common Minimum Programme of the current government, a successful management of the systemic changes in the banking sector is a necessary precondition. While the transition process in the banking sector has certainly not yet come to an end, sufficient time has passed for an interim review. The objective of this paper therefore is to evaluate the progress made in liberalizing the banking sector so far and to test if the reforms have allowed the banking sector to better perform its functions.