Radial and non-radial decompositions of profit change: With an application to Indian banking

Grifell-Tatje and Lovell [Grifell-Tatje, E., Lovell, C.A.K., 1999. Profits and productivity. Management Science 45, 1177–1193] made significant contributions to the literature on the extended radial DEA framework by decomposing profit change into six mutually exclusive components. Their approach, however, poses two basic problems. First, the radial estimates on these components might give conflicting signals about the direction of profit change after the full radial efficiencies are achieved when slacks are present. Second, evaluations of these components, using base-period prices as weights, can be potentially misleading. To address these concerns, we first introduce non-radial DEA models, and then, provide a few strong theoretical arguments in favor of using as weights either current-period prices or an average price covering both periods to value the contributions of each of these components. The Indian banking sector is taken as a case study to illustrate the radial and non-radial decompositions of profit change so as to empirically examine the role of competition on profit change and its drivers. Our broad empirical results are as follows: first, radial and non-radial models yield diametrically opposite results on the contributions of various components. Second, the increasing efficiency change trends in all ownership groups after 2002 indicate that the Government reform process instituted on the banking industry has had a favorable effect on the performance of the Indian banking sector. Third, despite the fact that nationalized banks are the oldest banks, their output and resource allocation behaviors do not reflect their learning experience.