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Strategy-Performance-Return Relationship in the Indian Banking Industry

Volume 18, Number 4 Article by Veena S Iyer December, 2006

Strategy-Performance-Return Relationship in the Indian Banking Industry :

A fair amount of research, both international and Indian, has gone into determining the factors affecting bank performance. However, the relationship between performance and stock returns has not received much attention. With more and more banks in India getting listed in the stock markets, shareholder value creation has assumed importance along with the traditional objectives. The challenge before banks is to create such value by differentiating themselves from the competition on the one hand, while working within the regulatory boundaries on the other.

Banks design business and operational strategy that determines their final performance. The market observes both these sets of variables through published information, makes an informed assessment and this gets captured in market returns. In this award winning student essay, Veena Iyer makes an attempt to identify those items of published information that have an impact on stock performance. Variables such as income composition, NPA ratios and capital adequacy ratios have been used to define strategy, and panel data regression models have been run to test how such strategy variables impact profitability (the only facet of performance considered in the study) and are in turn captured in stock market returns. The study represents an extension of earlier research in that it includes new private banks and uses a more recent set of data to see how performance variables impact stock returns. It also looks at another factor that impacts performance namely, the strategy adopted by the bank, and its impact at the stock market level. The study concludes that the stock market assimilates most of the relevant information in arriving at the stock price figures while most of the ‘manipulatable’ and/or transitory phenomena and pure historical variables are duly discounted. While the stock market does not reward excessive risk-taking, it does not appreciate excessive conservatism either.

Reprint No 06402