What drives the profitability of Indian banks: Level or growth efficiency?

This study investigates the determinants of profitability among Indian commercial banks from 2005 to 2024, with a specific focus on the novel role of dynamic growth efficiency (GE), a concept capturing a bank's ability to transform input growth into output growth, alongside conventional static efficiency measures such as level efficiency (LE) and cost-to-income ratio (CIR). As the first to operationalize GE in the Indian context, the study employs data envelopment analysis (DEA) on a panel dataset of 50 commercial banks (12 public, 17 private, and 21 foreign). Results from a system GMM estimator reveal GE to be a consistently significant driver of profitability, outperforming both LE and CIR across various market power indicators and model specifications. A key methodological advance supporting this analysis is the inclusion of technology expenditures (which account for 29% of operating and 13% of total expenses in 2024) as a fundamental input, correcting a major misspecification in prior literature. We demonstrate that omitting this crucial input artificially inflates market power and deflates efficiency estimates. The positive impact of GE is more pronounced for public-sector and new private banks, underscoring divergent strategic drivers across ownership structures and highlighting the paramount importance of fostering dynamic capabilities for sustaining profitability in a rapidly evolving banking landscape.