26

CHAPTER 2

REVIEW OF LITERATURE

2.1 INTRODUCTION

The purpose of this chapter is to briefly review selected streams of major

academic research relevant to technology in banking, performance evaluation and

various tools available for analysis. An attempt is made to review the earlier studies

carried out abroad and India.

This literature review presents, the Banking technology definition and its

characteristics in section one. Developments of banking Technology in Indian

banking industry and its significance is dealt in section two of literature review .

Different types of technological impact are studied from the literature and presented

in the third section. Profit and cost efficiency literature are presented in the last

section.

2.2 BANKING TECHNOLOGY

Vadlamani Ravi (2007) defines the term “banking technology” refers to the use of

sophisticated information and communication technologies together with computer science

to enable banks to offer better services to its customers in a secure, reliable, and affordable

manner, and sustain competitive advantage over other banks. 1

Reserve Bank of India (2004): The three categories of IT investment –

hardware, software and IT services - comprise the following investments on:

1. Computer Hardware (HA): which includes spending on commercial systems

(including central processing unit and basic peripherals, such as data storage

devices, terminals, memory, and peripherals), single-user systems

(workstations and personal computers), data communications (local area

network hardware, wide area network hardware, analog modems, digital

access);

2. Software (SO): which includes spending on packaged software, application

solutions software, application tools, systems infrastructure software;

1 Vadlamani Ravi (2007) ,”Advances in Banking Technology and Management: Impacts of ICT

and CRM", published by IGI Global, USA, 2007.

27

3. Services (SE): spending on consulting services, implementation services,

operational services, training and education, support services. 2

Sivakumaran (2005), believes that adoption of technology has led to the

following benefits: greater productivity, profitability, and efficiency; faster service

and customer satisfaction; convenience and flexibility; 24x7 operations; and space

and cost savings.3

Berger (2003), the usage of information technology (IT)xx broadly

referring to computers and peripheral equipment, has seen tremendous growth in

service industries in the recent past. The most obvious example is perhaps the

banking industry, where through the introduction of IT related products in internet

banking, electronic payments, security investments, information exchanges, banks

now can provide more diverse services to customers with less manpower.4

Willcocks (1994), Information systems/information technology investment

may be described as any acquisition of software or hardware which is expected to

expand or increase the business benefits of an organization’s information systems

and render long-term benefits5

2.3 BANKING TECHNOLOGY IN INDIAN BANKING

The Indian banking sector consists of the Reserve Bank of India (RBI),

which is the central bank, commercial banks and co-operative banks. Commercial

banks are of two types – scheduled, which are subject to statutory requirements and

non-scheduled, which are not. Scheduled banks can be further classified into public

sector banks [comprising of the State bank of India, its seven associates, other

nationalised banks and the Regional Rural Banks (RRBs)] and private sector banks,

which can be either domestic or foreign. The Indian Banking Industry has

2 Reserve Bank of India (2004) ‘Computerisation in banking industry – statistics’

(http://www.rbi.org.in, accessed on 17 May 2008). 3 Sivakumaran, M.V. (2005). Banking technology course material for MTech (IT) with

specialization in banking technology and information security, IDRBT. 4 Allen N. Berger (2003), “The Economic Effects of Technological Progress: Evidence from the

Banking Industry “ Journal of Money, Credit and Banking, Vol. 35, No. 2 (Apr., 2003), pp.141-

176. 5 Willcocks, L. (1994),"Information Management: The Evaluation of Information Systems

Investments'', ch. 1, Chapman & Hall, London:1-27.

28

undergone tremendous growth since nationalization of 14 banks in the year 1969.

There has an almost eight times increase in the bank branches from about 8000

during 1969 to more than 60,000 belonging to 289 commercial banks, of which 66

banks are in private sector.

It was the result of two successive Committees on Computerization

(Rangarajan Committee) that set the tone for computerization in India. While the

first committee drew the blue print in 1983-84 for the mechanization and

computerization in banking industry, the second committee set up in 1989 paved the

way for integrated use of telecommunications and computers for applying

technogical breakthroughs in banking sector.

Narasimham Committee (1991): The banking industry has introduced various

new customer services and products using IT. The banking industry has gone

through many changes as a result of the introduction of IT. In fact, the structure of

the industry is continuously changing because of rapid development of IT . Banks

are the backbone of the economy of the country. Implementation of information

technology and communication networking has brought revolution in the

functioning of the banks and the financial institutions. The status of automation in

the banks in India is not uniform. There are banks functioning for decades, having a

sizable number of branch networks in the rural and semi-urban centers. Compared to

this, there are banks which are generally regional in character and not having a large

number of branches in the country. In the recent past a few private sector banks have

been established with the latest technology. Foreign banks located at major

commercial centers of the country also transact their business in a computerized

environment. The level and extent of automation in the banks are generally vary

because of their history, work culture and policies/strategies adopted by their

management in branch expansion and investment in technology 6

.

6 Narasimham Committee (1991) Report on Banking Sector Reforms (Chairman M.

Narasimham) (http://www.rbi.org.in, accessed on 17 May 2007).

29

Rangarajan Committee (1989) : IT came into picture as early as in the 1980’s

in Banking Technology through the Rangarajan committee recommendations. It

involves many phases.

First phase : Accounting process and back office functions

Second phase : Automate the front office as well as the back office function

Third phase : Networking concept and centralized operation

Fourth phase : ATM and mobile banking and internet banking

Fifth phase : “inter-bank” connectivity.7

Bernardo Bátiz- Lazo and Douglas Wood (2001) argued that outstanding

IT-based innovations are considered and grouped into four distinct periods: early

adoption (1864-1945),specific application (1945-1965), emergence (1965-1980) and

diffusion (1980-1995) and two dimensions of technological progress in retail

banking. These dimensions describe the nature of change brought about by

technological innovation externally (product or service offerings) and internally

(operational function) to banking organizations.8

Jarunee Wonglimpiyarat (2006) is concerned with the technological

learning and capabilities of Thai banking. The results show that the use of

technology in the mass automation regime is carried through to the smart automation

regime, showing that the technological change in the banking sector is not

revolutionary but evolutionary.9

Costas Lapavitsas And Paulo L. Dos Santos (2008), argued technological

innovation has contributed to recent changes in the conduct and character of

banking, but its impact has been contradictory. First, money-dealing transactions

have become cheaper, but investment costs have increased and a broader range of

services had to be provided. The cost efficiency of banks has not improved.10

7 Rangarajan Committee (1989),"Report on the Modernisation of the Banking Sector'' (Chairman

C. Rangarajan) (http://www.rbi.org.in, accessed on 20 May 2007).

8 Ba t́iz-Lazo, B. and Wood, D. (2001), ‘'Management of core capabilities in Mexican and

European banks'’, International Service Industry Management Journal (Special Issue, Service

Management in Latin America), 10(5): 430–48. 9 Jarunee Wonglimpiyarat (2006) , ‘'Technological Change And Capabilities In Thai Banking”

International Jounal of financial services management,1(2):289-307 10 Costas Lapavitsas And Paulo L. Dos Santos(2008),” Globalization And Contemporary Banking:

On The Impact Of New Technology'' ,Contributions to Political Economy, 27, 31-56.

30

According to the World Bank (2003) report on ICT and the Millennium

Development Goals, information technology reduces transaction costs per customer

and enables banks to provide small loans and services to a larger number of rural

customers.11

2.3.1 Effectiveness of Information Disclosure

In India not many studies have been conducted on internet disclosure levels.

There are numerous papers that sought to study the process of internet disclosure

internationally. These studies investigated the nature and extent of disclosure on

corporate websites.

According to Cucuzza and Cherian (2001) E-Business tools are providing

new ways to communicate vast quantities of information, in an environment where

information flows continuously and without hindrance. Another difference is the

release of company information on third party websites, where no financial reporting

may be present on a company’s primary website. It is an attempt to examine the

effectiveness of information disclosure of Indian public sector banks on their

websites.12

Pirchegger and wagenhofer (1999) compared the disclosure scores of the

Austrian companies with German companies and found that Austrian larger

companies disclosed more.13 Marshon (2003) found that internet reporting was well

established among leading Japanese companies.14

Balwinder Singh and Pooja

Malhota (2004) identified banks were not making full utilization of internet to

disclose information to stakeholders.15

Accounting organizations and standard

setters are also paying attention to the rapid growth of dissemination of accounting

11 World Bank. (2003). "ICT and MDGs—A World Bank Group perspective''. Washington, D.C.:

World Bank Group MIT Press.

12 Cucuzza, T. G. and J. Cherian. (2001), "The internet and e-business: Trends and implications

for the finance function'', Journal of Cost Management (May/June): 5-14. 13

Pirchegger, B and Wagenhofer, A (1999), “Financial Information on the Internet: a survey of

the Homepages of Austrian Companies,” European Accounting Review, Vol. 8, No. 2, pp. 383-

395. 14 Marston, C, & Leow, C Y (1998), “Financial Reporting on the Internet by Leading UK

Companies,” Paper Presented at the 21st Annual Congress of the European Accounting

Association, Antwerp, Belgium. 15 Balwinder Singh and Pooja Malhotra (2004),"Reporting on the Internet by Indian Banks”, The

ICFAI journal of bank management 2004, 71-99

31

information on the internet. The International Accounting Standards Committee

(IASC) commissioned a discussion paper for business reporting on the internet .

This IASC report provided a survey of web-based financial reporting practices of the

660 public corporations in 22 countries. The study concluded that a significant

number of companies in many countries use the web for communication of business

performance to stakeholders.16

Petrarick and Gillett (1996) reported that 69% of

fortune 150 companies in the USA had websites with 81% of them disclosing some

financial information.17

Grove (1997) coined the term ‘inflection point’ which he defined as “a

change in business environment that has the potential to alter the way a company

operates”.18 According to King (2001) the Internet is an inflection point that has an

impact that has not yet been fully determined. He also pointed out that the most

important effects on cost management practices have been in the areas of

information communication and transaction processing. This would imply that

companies which are using the internet for accounting and financial information

presentation may see additional benefits over additional costs by providing financial

reports on a website.19

2.3.2 Quantitative Evaluation of Banks’ Web Sites

A review of the recent literature on web site assessment reveals some

attempts to measure web site quality (Selz and Schubert, 1997; Liu, et al, 1997; Ho,

1997, Evans and King, 1999; Palmer, 2002). In spite of the fact that some

researchers have attempted to find out the various methods for evaluating business

web sites (Boyd, 2002; Merwe and Bekker, 2003), there exists subjectivity and need

for theoretical justification in the selection of evaluation factors/criteria. Most of the

previous approaches have focused either on basis content management or a specific

set of website outcomes.

16

Allam, A and Lymer, A. (2003), “Developments in Internet Financial Reporting: Review &

Analysis across Five Developed Countries,” Working Paper, University of Birmingham, UK. 17

Petravick, S, Gillet, J (1996), “Financial Reporting on the World Wide Web,” Management

Accounting, July, pp. 26-29. 18

Dr Andrew S. Grove(1997),"Navigating Strategic Inflection Points”, Business Strategy Review,

Volume 8 Issue 3, pp 11-18 19

King, J., 2000, ‘Mom-and-pop Shops Gain Clout on Web’, Computerworld 34(1), 8.

32

The web site Quality Evaluation Method (QEM) proposed by Olsina et al.

(1999)20

can be considered as one of the main approaches and this study analysed

the main factors such as functionality (global search, navigability and content

relevancy), usability (site map, address directory), efficiency and site reliability.

However, the application of more number of factors raised problems while

computing. Thus, better evaluation can be done by using only a few but highly

relevant factors/attributes/criteria.

Murray (1997) found that merely counting hits on a web page is not an

accurate measurement of quality or success of a website.21 The presence and

advantages of more links to the website was highlighted by Miranda et al (2004).

Some studies have revealed that there is significant correlation between website

download speed and web user satisfaction (Muylle et al, 1998; Hoffman and Novak,

1996). Few studies have identified the factors used to quantify the content quality of

the websites (Young and Benamati, 2000; Buenadicha et al., 2001; Miranda and

Banegil, 2004). 22

Charumathi and Surulivel (2008) developed a Bank Disclosure Attribute

Index (BADI) and used the same to examine the effectiveness of information

disclosure of Indian public sector banks on their website. The information

disclosure attributes were categorized into four categories, viz., general attribute,

financial attribute, investor attribute and corporate governance attribute.23

Trying to

avoid the main weaknesses of previous models, Buenadicha et al. (2001) developed

a new Website Assessment Index (WAI) that can be employed to compare the

current use of the internet by different organizations. This index had four categories

of factors such as accessibility, navigability, speed and content quality.24

20

Olsina, L., Godoy, D., Lafuente, G.J. and Rossi, G. (1999) “Specifying quality characteristics

and atrribtes for websites”, First ICSE Workshop on Web Engineering, los Angeles, USA. 21

Murray, M. (1997): “Evaluating web impact – the death of the highway metaphor”, Direct

Marketing, Vol. 59, pp.36-39. 22

Miranda, F.J. Cortes, R and Barriuso, C. (2006) “Quantitative Evaluation of e-Banking Web

Sites: an Empirical Study of Spanish Banks”, The Electronic Journal Information Systems

Evaluation, Volume 9 Issue 2, 73 – 82 . 23

Charumathi, B., Surulivel, S. T., (2009), “Effectiveness of Information Disclosure of Indian

Public Sector Banks on Their Web Sites - An Empirical Study”, SMART - An International

Journal of Business Management Studies”, Vol.5, no.2, pp. 5-12. 24

Buenadicha, M, Chamorro, A., Miranda, F. J. y González, O. R. (2001): “A new Web

Assessment Index: Spanish Universities analysis”, Internet Research: Electronic Networking

Applications and Policy, vol.11, no 3.

33

Charumathi and surulivel (2009), evaluate the websites of public sector

banks by using WAI and found that the website quality is not up to the mark.25

2.3.3 Impact of Information technology on the performance of the bank

Cron and Sobol (1983) examined the relationship between

computerization and several measures of overall firm performance based on a

sample of 138 medical wholesalers. Using correlation analysis, the results

showed that computerization was related to overall performance. Non-users

tended to be small firms with about average overall performance. On the other

hand, firms owning computers and making extensive use of them in a variety of

ways tended to be either very high or low performers.26

Bender (1986) surveyed 132 life insurance companies in 1983 to

investigate the financial impact of IT on firms in this industry. Organizational

performance was measured in terms of the ratio of total operating expense to

total premium income. The IT impact was represented by the ratio of

information-processing expense to total general expense (IPE/EXP ratio). The

results revealed that an appropriate level of investment in IT could have a

positive impact on total expense. A range in the IPE/EXP ratio of 15% to 25%

seemed to produce optimum results in the life insurance industry. Contrarily, a

company that had an IPE/EXP ratio of less than 15% was mostly likely not

sufficiently automated to combat the escalation costs of doing business.27

Alpar and Kim (1990) utilized 424-759 U. S. banks during 1979-1986

to analyze the impact of IT on economic performance. Applying cost function

approach they found that IT was able to reduce operating costs, increase capital

25 Charumathi, B., Surulivel, S. T., (2009), “Quantitative Evaluation of Indian Public Sector

Banks’ Web Sites: An Empirical Study”, International Journal of Computer Science, System

Engineering and Information Technology, Vol.1, No.2, July-December 2009 (ISSN No. 0974-

5807)

26 Cron, W. L. and Sobol, M. G. (1983), “The Relationship between Computerization and

Performance: A Strategy for Maximizing Economic Benefits of Computerization”,

Information and Management, 6(3), 171-181.

27 Bender, D. H. (1986), Financial Impact of Information Processing, Journal of

Management Information Systems, 3(2), 22-23.

34

expenditures of banks, save personnel costs, reduce demand deposits, and

increase time deposits.28

Strassman (1990) investigated the relationship between IT and return

on investment in a sample of 38 service sector firms using correlation analysis.

He found that some top performers invested heavily in IT, while some did not.

He concluded that there was no correlation between spending for computers,

profits and productivity.29

Weill (1992) studied 33 medium and small-scaled valve manufacturing

companies to explore the relationship between the IT investments and

organizational performance using hierarchical regression. Although

transactional IT investment was found to be strongly related to superior

organizational performance, there was no evidence that strategic IT investment,

on a long-term basis, would increase or decrease organizational performance.

However, the results implied that strategic IT investment was beneficial to

relatively poor performing firms in the short run.30

Mahmood and Mann (1993) utilized canonical correlation analysis to

explore the organizational impact of IT investment of 100 U. S. listed

companies. The results indicated that economic performance measures such as

sales by employee, return on sales, sales by total assets, return on investment,

and market to book value were affected by IT investment measures such as IT

budget as percentage of revenue, percentage of IT budget spent on training of

employees, number of PCs per employee, and IT value as a percentage of

revenue. The organizational performance measure growth in revenue and IT

investment measure percentage of IT budget spent on staff were not

significantly related to other measures and therefore were not indicated to be

28

Alpar, P. and Kim, M. A. (1990), “A Microeconomic Approach to the Measurement of

Information Technology Value,” Journal of Management Information Systems, 7 (2), 55-

69.

29 Strassman, P. A. (1990), “The Business Value of Computers: An Executive’s Guide,” New

Canaan, CT: Information Economics Press.

30 Weill, P. (1992), “The Relationship between Investment in Information Technology and

Firm Performance: A Study of Value Manufacturing Sector,” Information Systems

Research, 3 (4), 307-333.

35

useful for investigating possible effects of IT investment on organizational

economic performance.31

Loveman (1994) utilized OLS regression to assess the productivity

impact of IT based on a sample of 60 manufacturing firms during 1978-1984.

The results showed that during the five-year period, the contribution of IT

investment to the output of manufacturing firms was nearly zero. There existed

no sufficient evidence to support the benefit of IT from productivity

enhancement.32

Berndt and Morrison (1995) explored relationships between industry

performance measures and investments in high-tech office and IT capital for

two-digit manufacturing industries during 1968-1986. They found limited

evidence of a positive relationship between profitability and the share of high-

tech capital in the total physical capital stock (OF/K). They also found that

increases in OF/K were negatively correlated with multi-factor productivity and

tended to be labor-using. Furthermore, they found some evidence that

industries with a higher proportion of high-tech capital had higher measures of

economic performance, although within industries increasing OF/K did not

appear to improve economic performance.33

Kivijarvi and Saarinen (1995) used a sample of 36 Finnish firms to

probe the relationship between IT investments and of firm financial

performance. Utilizing regression analysis, the results demonstrated that IT

investments had no direct relationship with financial performance. However, IT

investments were able to improve firm performance in the long term.34

31

Mahmood, M. A. and Mann, G. J. (1993), “Measuring the Organizational Impact of

Information Technology Investment: An Exploratory Study,” Journal of Management

Information Systems, 10 (1), 97-122.

32 Loveman, G. W. (1994), “An Assessment of the Productivity Impact of Information

Technologies,” In: Allen, T. J., and Scott Morton, M. S. (ed.), Information Technology

and the Corporation of the 1990s: Research Studies, Oxford: Oxford University Press, 84-

110.

33 Berndt, E. R. and Morrison, C. J. (1995), “High-Tech Capital Formation and Economic

Performance in U.S. Manufacturing Industries: An Exploratory Analysis,” Journal of

Econometrics, 65 (1), 9-43.

34 Kivijarvi, H. and Saarinen, T. (1995), “Investment in Information Systems and the

Financial Performance of the Firm,” Information and Management, 28, 143-163.

36

Brynjolfsson and Hitt (1996) used 367 large firms during 1987-1991 as

a sample to study the benefits of information systems (IS) spending. The results

indicated that IS spending had made a substantial and statistically significant

contribution to firm output. It was also found that the gross marginal product

(MP) for computer capital was at least as large as the MP of other types of

capital investment and that IS labor spending generated at least as much output

as spending on non-IS labor and expenses.35

Hitt and Brynjolfsson (1996) applied OLS regression and iterated

seemingly unrelated regression (ITSUR) to explore the business value of IT

based on a sample of 370 large firms. The findings indicated that IT had

increased productivity and created substantial value for consumers. However,

they did not find evidence that these benefits had resulted in supranormal

business profitability.36

Mitra and Chaya (1996) used a sample of over 400 large and medium-

sized U.S. corporations to analyze the performance impact of IT investment.

They found that higher IT investments were associated with lower average

production costs, lower average total costs, and higher average overhead costs.

They also found that larger companies spent more on IT as a percentage of their

revenues than smaller companies. However, they did not find any evidence that

IT reduced labor costs in organizations.37

Byrd and Marshall (1997) investigated the relationship between IT

investment and organizational performance using a sample of 350 public

companies during 1989-1991. Applying correlation analysis, they found that

the number of PCs and terminals as a percentage of employees was

significantly and positively related to sales by employee. The value of

35

Brynjolfsson, E. and Hitt, L. (1996), “Paradox Lost? Firm-Level Evidence on the Returns

to Information Systems,” Management Science, 42 (4), 541-558.

36 Hitt, L.M. and Brynjolfsson, E. (1996), “Productivity, Business Profitability, and

Consumer Surplus: Three Different Measures of Information Technology Value,” MIS

Quarterly, 20 (2), 121-141.

37 Mitra, S. and Chaya, A. K. (1996), “Analyzing Cost-Effectiveness of Organizations: The

Impact of Information Technology Spending,” Journal of Management Information

Systems, 13 (2), 29-57.

37

supercomputers, mainframes, and minicomputers as well as the percentage of

IT budget spent on IT staff were significantly and negatively associated with

the sales by employee. The IT budget as a percentage of revenue was

significantly and negatively associated with sales by total assets. The

percentage of IT budget spent on IT staff training was not related to any

performance variable.38

Devaraj and Kohli (2000) examined monthly data collected from 8

hospitals over a recent three-year time period to study the relationship between

IT and performance. Applying correlation analysis, the results provided support

for the relationship between IT and performance that is observed after certain

time lags. Such a relationship may not be evident in cross-sectional data

analyses. Also, results indicated support for the impact of technology

contingent on business process reengineering practiced by hospitals.39

Sircar, Turnbow and Bordoloi (2000) explored the relationship

between firm performance and IT investments based on a sample of 624 firms.

They used canonical correlation analyses as a research method and found that

IT investments had a strong positive relationship with sales, assets, and equity,

but not with net income. Spending on IS staff and staff training was positively

correlated with firm performance, even more so than computer capital.40

Osei-Bryson and Ko (2004) employed the same data set used by

Brynjolfsson and Hitt (1996) to explore the relationship between IT

investments and firm performance using regression analysis. The results

exhibited that depending on the conditions that applied, an unbiased observer

could either conclude that investments in IT had a positive statistically

38 Byrd, T. and Marshall, T. (1997), “Relating Information Technology Investment to

Organizational Performance: A Causal Model Analysis,” Omega: International Journal of

Management Science, 25 (1), 43-56.

39 Devaraj, S. and Kohli, R. (2000),” Information Technology Payoff in the Health-Care

Industry: A Longitudinal Study,” Journal of Management Information Systems, 16 (4),

Spring, 41-68.

40 Sircar, S., Turnbow, J.L. and Bordoloi, B.A (2000), “Framework for Assessing the

Relationship Between Information Technology Investments and Firm Performance,”

Journal of Management Information Systems, 16 (4), Spring, 69-98.

38

significant effect on productivity, or that there was a ‘productivity’ paradox.

This suggested that the relationship between IT investments and organizational

performance is much more complex than that found in some other studies.41

Ham, Kim and Joeng (2005) examined the effect of IT applications on

performance based on a sample consisted of 13 five-star hotels and 8 four-star

hotels in Korea. Using hypothesis test, the results supported the relationship

between IT usage and the performance of lodging operations. Furthermore, they

found that front-office applications, restaurant and banquet management

systems, and guest-related interface applications significantly and positively

affected performance of lodging operations; however, guest related interface

applications were not significant.42

Andersen and Foss (2005) investigated the role and effects of

information and communication technology in multinational enterprises. They

suggested that the attendant cost–benefit tradeoff could be influenced by

computer-mediated communication. Based on a sample of 88 organizations in

the computer products industries, they found that multinationality in itself did

not guarantee a higher level of strategic opportunity. Instead, use of

information technology to facilitate communication among managers across

functional and geographical boundaries enhanced coordination of multinational

activities in the development of strategic opportunity, which in turn was

associated with superior performance.43

41 Osei-Bryson, K.-M. and Ko, M. (2004), “Exploring the Relationship Between Information

Technology Investments and Firm Performance Using Regression Splines Analysis,”

Information and Management Systems, 42, 1-13.

42 Ham, S., Kim, W. G. and Joeng, S. (2005),” Effect of Information Technology on

Performance in Upscale Hotels,” Hospitality Management, 24, 281-294.

43 Andersen, T. J. and Foss, N. J. (2005), “Strategic Opportunity and Economic Performance

in Multinational Enterprises: The Role and Effects of Information and Communication

Technology,” Journal of International Management, 11 (2), June, 293-310.

39

Elena Beccalli (2003) studied the influence of IT (in terms of hardware,

software and IT services) on the performance of banks and found that there is an

insignificant positive correlation and the existence of a productivity paradox.44

Sangjoon jun (2006) explored the nexus between the information

technology (IT) investment of Korean banks using panel data and found that large

banks comparatively improve their returns.45

Alpar and Kim (1990) concluded that key ratios could be particularly

misleading after studying key ratios and cost function.46

Brynjolfsson and Hitt (1996) caution that these findings do not account for

the economic theory of equilibrium which implies that increased IT spending does

not imply increased profitability.47

Dober (1994) identified organizations are becoming increasingly

competitive in seeking to implement the effective use of IT.48

Baba Prasad, Patrick T. Harkery (1997) examines the effect of IT

investment on both productivity and profitability in the retail banking sector in the

United States. This paper concludes that additional investment in IT capital may

have no real benefits and may be more of a strategic necessity to stay even with the

competition.49

Strassmann (1990) reports disappointing evidence in several studies. In

particular, he found that there was no correlation between IT and return on

investment in a sample of 38 service sector firms. He concludes that "there is no

relation between spending for computers, profits and productivity"50

44

Elena Beccalli (2007),”Does IT investment improve bank performance? Evidence from

Europe”Journal of banking Finance,31,7,pp2205-2230

45 Sangjoon jun , “The Nexus between IT Investment and Banking Performance in Korea” Global

Economic Review Vol. 35, No. 1, March 2006, 67_/96. 46

Alpar, P. and Kim, M. A Comparison of Approaches to the Measurement of IT Value. In

Proceedings of the Twenty-Second Hawaii International Conference on System Science (1990,

Honolulu, HI). 47

Brynjolfsson, E. and Hitt, L.M. (1996). Paradox Lost? Firm-level Evidence on the Returns to

Information Systems Spending. Management Science, 42(4), 541-558. 48 Dober, G. (1994) Managing IT - its organizational impact, value and cost (Part 1). Off-Line,

28(1):19-21 49

Baba Prasad and Patrick T. Harker (1997),”Examining the Contribution of Information

Technology Toward Productivity and Profitability in U.S. Retail Banking” ,The Wharton

Financial Institutions Center, working paper series. 50

Strassmann, P.A. The Business Value of Computers. Information Economics Press,New Canaan,

Conn, 1990

40

Erik Brynjolfsson (1992) reviewing and assessing the research to date and

reports that the shortfall of IT productivity is due to deficiencies in our measurement

, methodological tool kit , mismanagement by developers and users of IT. 51

Brynjolfsson (1996) proposes four explanations for the productivity paradox

including: Mismeasurement of inputs and outputs, Lags due to learning and

adjustment, Mismanagement of information and technology, and Redistribution and

dissipation of profits.52

Barua, Kriebel and Mukhopadhyay (1991) traced the causal chain back a

step by looking at IT's effect on intermediate variables such as capacity utilization,

inventory turnover, quality, relative price and new product introduction. Using the

same data set, they found that IT was positively related to three of these five

intermediate measures of performance,although the magnitude of the effect was

generally too small to measurably affect return on assets or market share.53

Barua et al. (1991) and Barua et al. (1995) both find that even though IT

spending improves intermediate variables of organizational performance such as

capacity utilization, inventory turnover, or relative price, it does not necessarily lead

to improvements in higher-level productivity variables such as Return on Assets

(ROA) or market share.54

Sangjoon jun (2006) explores the nexus between the information

technology (IT) investment Of Korean banks using panel data. He identified that

IT investment of large banks shows a stronger positive influence on improving bank

returns than that of small banks. The IT investment of wholesale banks specializing

51

Brynjolfsson, Erik & Hitt, Lorin M., 2004. "Computing Productivity: Firm-Level Evidence,"

Working papers 4210-01, Massachusetts Institute of Technology (MIT), Sloan School of

Management 52

Brynjolfsson, E.; 1996; The contribution of information technology to consumer welfare;

Information Systems Research, vol. 7, no. 3, pp. 281-300. 53

Barua, A., Kriebel, C. and Mukhopadhyay, T. (1991). An Economic Analysis of Strategic

Information Technology Investments. MIS Quarterly, 15(3), 313-331.

54 Barua, A., Kriebel, C. H. and Mukhopadhyay, T. (1995), “Information Technologies and

Business Value: An Analytic and Empirical Investigation,” Information Systems Research,

6(1), March, 3-23.

41

in corporate loans produces greater positive effects on bank profitability than that of

retail banks.55

Sumon Bhaumik and Jenifer Piesse (2004), show that while foreign banks

have high credit-deposit ratios, the domestic banks experienced much greater

improvements in technical efficiency in the context of credit. The most significant

improvements in technical efficiency are registered by the domestic banks.56

Namchul Shin (2006), identified Information technology (IT) is widely

used to achieve more efficient coordination by reducing the costs of coordinating

business resources across multiple markets. This research also showing business

value of IT complementarity between IT and strategy in firm performance.57

William C. Hunter; Stephen G. Timme (1991), examines technological

change,its relationship to firm size, and its impact on the efficient scale of output

and product mix for large U.S. commercia1 banks. The results suggest that

technological change lowered real costs by about 1.O % per year, increased the cost-

minimizing scale of outputs, and affected product mix. We do not find support for

the Galbraith-Schumpeter hypothesis. This suggests that the largest banks cannot

use innovation alone to outpace smaller banks.58

Gunter Lang and Peter Welzel (1998), cover about 40% of German

banking, and specify multi-product translog cost function for cost inefficiency when

evaluating the technology of banking. Scale economies are found to exist up to a

55 Sangjoon Jun(2006),”The Nexus between IT Investment and Banking Performance in Korea”

journal of Global Economic Review,35 , 1 Pages: 67-96. 56 Sumon Bhaumik and Jenifer Piesse, ”Are Foreign Banks Bad for Development Even If They

Are Efficient?Evidence from the Indian Banking Industry” William Davidson Institute,Working

Paper Number 619, April 2004. 57 Namchul Shin, ”The impact of information technology on the financial performance of

diversified firms”, Decision Support Systems 41 (2006) 698– 707. 58

William C. Hunter and Stephen G. Timme (1986),”Technical Change, Organizational Form, and

the Structure of Bank Production“, Journal of Money, Credit and Banking, Vol. 18, No.2,

pp.152-166.

42

size of about 5 billion DM of total assets and smaller banks turn out to be more

responsive to input prices.59

Alpar and Kim (1990) note that the methodology used to assess IT impacts

can also significantly affect the results. They applied two approaches to the same

data set. One approach was based on key ratios and the other used a cost function

derived from microeconomic theory. They concluded that key ratios could be

particularly misleading.60

Wolff (1999) argued that computerization does not appear to exert a positive

effect on productivity growth.61

Vijayakumar Bharathi & Ms. Manisha Akolkar (2004) explain

Information Technology has basically been used under two different avenues in

Banking. One is Communication and Connectivity and other is Business Process

Reengineering, both basically focusing on increasing its customer reach.

Information technology enables sophisticated product development, better market

infrastructure, implementation of reliable techniques for control of risks and helps

the financial intermediaries to reach geographically distant and diversified

markets.62

Shirley J. Ho and Sushanta K. Mallick (2008) believed that IT can

improve bank’s performance in two ways: IT can reduce operational cost (cost

effect), and facilitate transactions among customers within the same network

(network effect).This paper attempts to explain the inconsistency by stressing the

heterogeneity in banking services; in a differentiated model with network effects.

The results are tested on a panel of 68 US banks over 20 years, and they find that the

59 Gunter Lang And Peter Welzel (1998) “Technology and Cost Efficiency in Universal Banking A

“Thick Frontier”- Analysis of the German Banking Industry“. Journal of Productivity Analysis,

10, 1, Pages 63-84.

60 Alpar, P. and Kim, M. (1990). “A microeconomic approach to the measurement of information

technology value”, Journal of Management Information Systems, 7 (2), 55-69.

61 Wolff, Edward. 1996. “The Growth of Information Workers in the U.S. Economy, 1950-1990:

The Role of Technological Change,” unpublished paper, New York University 62

Vijayakumar Bharathi& Ms. Manisha Akolkar (2004), ”Banking Service at the Customers’

Palms – Study with Special Reference to Mobile-Banking”

43

bank profits decline due to adoption and diffusion of IT investment, reflecting

negative network effects in this industry.63

Luca Casolaro and Giorgio Gobbi (2003) analyzes the effects of

investment in information technologies (IT) in the financial sector using micro-data

from a panel of 600 Italian banks over the period 1989-2000. Stochastic cost and

profit functions are estimated allowing for individual banks’ displacements from the

best practice frontier and for non-neutral technological change. The results show that

both cost and profit frontier shifts are strongly correlated with IT capital

accumulation.64

T. Ravichandran And Chalermsak Lertwongsatien (2005) draw on the

resource-based theory to examine how information systems (IS) resources and

capabilities affect firm performance. The results suggest that variation in firm

performance is explained by the extent to which IT is used to support and enhance a

firm’s core competencies. 65

2.3 Impact of Technology in the Cost and profit Efficiency of Banking.

Rai et al. (1997) employed Cobb-Douglas cost function approach to

probe the relationship between IT investment and business performance based

on a sample of 497 firms during 1994. The results suggested that IT

investments could make a positive contribution to firm output and labor

productivity. However, various measures of IT investment did not appear to

have a positive relationship with administrative productivity. Furthermore, IT

was likely to improve organizational efficiency, its effect on administrative

productivity and business performance might depend on such other factors as

63

Sushanta K. Mallick & Shirley J. Ho, 2008. "On Network Competition And The Solow Paradox:

Evidence From Us Banks," Manchester School, University of Manchester, vol. 76(s1), pages 37-

57, 09.

64 Casolaro, Luca and Gobbi, Giorgio, “Information Technology and Productivity Changes in the

Banking Industry” (July 2003). Available at SSRN: http://ssrn.com/abstract=478323 or

doi:10.2139/ssrn.478323. 65

T. Ravichandran et al (2009), “Diversification and Firm Performance: Exploring the

Moderating Effects of Information Technology Spending”, Journal of Management Information

Systems archive, 25 , 4,205-240.

44

the quality of a firm’s management processes and IT strategy links, which

could vary significantly across organizations.66

Lee and Menon (2000) used DEA and Cobb-Douglas cost function

approach to analyze the financial data on the hospitals during 1976-1994. They

found that hospitals that were characterized by high technical efficiency also

used a greater amount of IT capital than firms that exhibited low technical

efficiency and that a group of hospitals exhibiting high technical efficiency also

exhibited low allocative efficiency, indicating that, while processes might have

been efficient, resource allocation and budgeting between various categories of

capital and labor had not been efficient. Moreover, they found that IT labor had

a negative contribution to productivity and that non-IT capital had a greater

contribution to productivity than IT capital.67

Shao and Lin (2001) investigated the relationship between IT

investments and technical efficiency of 370 large U.S. firms during 1988-1992.

Using both Cobb-Douglas and Translog cost functions and hypothesis test, the

results indicated that IT had a significantly positive effect on technical

efficiency and, hence, contributed to the productivity growth in organizations.68

Simon H. Kwan (2004) investigated the cost efficiency of commercial

banks in Hong Kong using the stochastic frontier approach and he found that the

average X-efficiency of Hong Kong banks was about 16 to 30 percent of observed

total costs.69

66

Rai, A., Patnayakuni, R., and Patnayakuni, N. (1997), “Technology Investment and

Business Performance,” Communications of the ACM, 40 (7), 89-97.

67 Lee, B., and Menon, N. M. “Information Technology Value through Different Normative

Lenses,” Journal of Management Information Systems (16:4), 2000, pp. 99-119. 68

Shao, B. B. M. and Lin, W. T (2001), “Measuring the Value of Information Technology in

Technical Efficiency with Stochastic Production Frontiers,” Information and Software

Technology, 43, 447-456.

69 Simon H. Kwan, 2001. "The X-efficiency of commercial banks in Hong Kong," Working Papers

in Applied Economic Theory 2002-14, Federal Reserve Bank of San Francisco.

45

Namchul Shin (2006) identified the importance of business value of IT in

relation to strategic firm performance to reduce the cost of coordinating business

resources across multiple markets.70

William C. Hunter, Stephen G. Timme (1991), after examining

technological change, its relationship to firm size, and its impact on the efficient

scale of output and product mix for large U.S. commercia1 banks, suggested that

technological change can lower the real costs by about 1% per year.71

Costas Lapavitsas and Paulo L. Dos Santos (2008), argued money-dealing

transactions have become cheaper, but investment costs have increased. According

to the World Bank (2003) report on ICT and the Millennium Development Goals, IT

reduces transaction costs per customer and enables banks to provide small loans and

services to a larger number of rural customers.72

Shirley J. Ho and Sushanta K. Mallick(2008) believed that IT can

improve bank’s performance in two ways viz., IT can reduce operational cost (cost

effect), and facilitate transactions among customers within the same network

(network effect). 73

74

Baker and Berenblum (1996), identified investment in IT is one of the

major factors determining the success or failure of organizations.75

Morrison and Berndt (1990) concluded that additional IT investments

contributed negatively to productivity, arguing that “estimated marginal benefits of

investment in IT are less than the estimated marginal costs”.76

70

Namchul Shin ,”The impact of information technology on the financial performance of

diversified firms”, Decision Support Systems 41 (2006) 698– 70. 71 William C. Hunter; Stephen G. Timme”Technological Change in Large U.S.Commercial

Banks”,The Journal of Business, Vol. 64, No. 3. (Jul., 1991), pp.339-362. 72

Lapavitsas, Costas and Dos Santos, Paulo L, Globalization and Contemporary Banking: On the

Impact of New Technology (2008). Contributions to Political Economy, Vol. 27, Issue 1, pp. 31-

56, 2008. Available at SSRN: http://ssrn.com/abstract=1153220 or doi:bzn005

73 Shirley J. Ho and Sushanta K. Mallick ,”The Impact of Information Technology on the Banking

Industry: Theory and Empirics” Queen Mary, University of London, UK

74 Sushanta K. Mallick & Shirley J. Ho, 2008. "On Network Competition And The Solow Paradox:

Evidence From Us Banks," Manchester School, University of Manchester, vol. 76(s1), pages 37-

57, 09.

75 Yao Chen and Joe Zhu, ”Measuring Information Technology’s Indirect Impact on Firm

Performance” Information Technology and Management 5, 2004 9–22.

46

Kaparakis, Miller and Noulas (1994) examined the cost efficiency of 5,548

American banks with assets of over $50 million. In their study negative correlation

was found between efficiency and the bank’s size. They also found a positive and

significant correlation between X-efficiency and the ratio of capital to total assets,

i.e., better-capitalized banks tend to be more efficient. Finally, a negative correlation

was found between cost efficiency and the bank’s credit risk, which is measured by

the ratio of lost debts to total credit.77

The stochastic frontier or composed error framework was first introduced in

Meeusen and vanden Broeck (1977) and Aigner, Lovell and Schmidt (1977) and

has been used in many empirical applications. In particular, stochastic frontier

models have been applied in studies of production and cost efficiency in the banking

sector. All these empirical studies used the sampling theory (classical) methods of

inference.78

, 79

Simon H. Kwan (2004) investigate the cost efficiency of commercial banks

in Hong Kong using the stochastic frontier approach and he found that the average

X-efficiency of Hong Kong banks was about 16 to 30 percent of observed total

costs. Cost efficiency was found to decline over time, indicating that Hong Kong

banks were operating closer to the cost frontier than before, consistent with

technological innovations in the banking industry. Furthermore, the average large

bank was found to be less efficient than the average small bank.80

76 Morrison, C., and E. Berndt. 1990. "Assessing the Productivity of Information Technology

Equipment in the US Manufacturing Industries." Working Paper No. 3582 (January). Cambridge,

MA: National Bureau of Economic Research. 77

Kaparakis, E., S. Miller and A. Noulas (1994): “Short-Run cost Inefficiency of Commercial

Banks: A Flexible Stochastic Frontier Approach”, Journal of Money, Credit and Banking 26,

875-893.

78 Aigner, D. J., Lovell, C. A. K. and Schmidt, P. (1977), “Formulation and Estimation of

Stochastic Frontier Production Function Models,” Journal of Econometrics, 6 (1), July,

21-37.

79 Meeusen, W. and van den Broeck, J. (1977), “Efficiency Estimation from Cobb-Douglas

Production Functions with Composed Error,” International Economics Review, 18 (2),

June, 435-444. ]

80 Simon H. Kwan, 2001. "The X-efficiency of commercial banks in Hong Kong," Working Papers

in Applied Economic Theory 2002-14, Federal Reserve Bank of San Francisco.

47

Jeffrey A. Clark; Thomas F. Siems (2007) investigate the importance of

including aggregate measures of off-balance-sheet (OBS) activities. The results

indicate cost X-efficiency estimates increase with the inclusion of the OBS measure.

Profit X-efficiency estimates are largely unaffected. Further, the composition of

banks' OBS activities appears to help explain inter bank differences in cost and

profit X-efficiency estimates.81

Altinkemer, Kemal, Ozdemir, Zafer (2006) investigate whether the

reengineering efforts of companies to leverage potential benefits of using

Information Technology (IT) in their business processes improve their productivity

and overall firm performance. He employ standard variables for measuring firm

productivity and performance, including labour productivity, return on assets, return

on equity, inventory turnover, profit margin, asset utilization, and Tobin’s q. He

show that (i) firms’ performances remain unaffected during the implementation

period of the reengineering projects, and (ii) on average, returns to reengineering

seem to accrue two to three years after the end of implementation period.82

Claudia Girardone, Philip Molyneux And Edward P. M. Gardenerx

(2004), study Italian banks’ cost efficiency by employing a Fourier-flexible

stochastic cost frontier in order to measure X-efficiencies and economies of scale.

The results show that mean X-inefficiencies range between 13 and 15 per cent of

total costs and they tend to decrease over time for all bank sizes. Economies of scale

appear present and significant.83

Laurent Weill (2009) provide new evidence about the consistency of

efficiency frontier methods on European banking samples.He measure the cost

efficiency of banks from five European countries (France, Germany, Italy, Spain,

81 Jeffrey A. Clark; Thomas F. Siems, "X-Efficiency in Banking: Looking beyond the Balance

Sheet”,Journal of Money, Credit and Banking, Vol. 34, No. 4. (Nov., 2002), pp. 987-1013.

82 Altinkemer, Kemal; De, Prabuddha; and Ozdemir, Zafer (2006) "Information Systems and

Health Care XII: Toward a Consumer-to-Healthcare Provider (C2H) Electronic Marketplace,"

Communications of the Association for Information Systems: Vol. 18, Article 19. Available at:

http://aisel.aisnet.org/cais/vol18/iss1/19

83 Barbara Casu & Claudia Girardone, (2005). "An analysis of the relevance of off-balance sheet

items in explaining productivity change in European banking," Applied Financial Economics,

Taylor and Francis Journals, vol. 15(15), pages 1053-1061, October.

48

Switzerland) with three approaches: stochastic frontier approach, distribution-free

approach, data envelopment analysis. conclude there are some similarities in

particularly between parametric approaches. Several techniques have been suggested

in the literature to measure banking efficiency, based either on econometric

techniques (stochastic frontier approach (SFA), distribution-free approach (DFA),

thick frontier approach (TFA)) or linear programming tools (data envelopment

analysis (DEA), free disposal hull (FDH)). He concluded that parametric techniques

provide consistent results according to efficiency means and rankings.84

For the definition of inputs and outputs, we adopt the intermediation

approach proposed by Sealey and Lindley (1977) which assumes that the bank

collects deposits to transform them, using labor and capital, in loans by opposition to

the production approach which views the bank as using labor and capital to produce

deposits and loans.

Two outputs are included: Y1 = loans, Y2 = investment assets. The inputs,

whose prices are used to estimate the cost frontier, include labor, physical capital

and borrowed funds.85

Altunbas et al. (2000) As data on the number of employees are not

available, the price of labor, w1, is measured by the ratio of personnel expenses on

total assets, following The price of physical capital, w2, is defined as the ratio of

other non-interest expenses on fixed assets. The price of borrowed funds, w3, is

measured by the ratio of paid interests on all funding. Total costs are the sum of

personnel expenses, other non-interest expenses and paid interests.86

______________________

84

Weill, Laurent, (2009). "Convergence in banking efficiency across European countries," Journal

of International Financial Markets, Institutions and Money, Elsevier, vol. 19(5), pages 818-833,

December

85 Sealey C. and Lindley J. (1977). "Inputs, Outputs, and a Theory of Production and Cost at

Depository Financial Institutions", Journal of Finance 32, 1251—1266. 86 Altunbas Y., Liu M.H., Molyneux P. and Seth R. (2000). "Efficiency and Risk in Japanese

Banking", Journal of Banking and Finance 24, 1605--1628.