Cost efficiency and risks of commercial banks in East Asia and Pacific region

Abstract

The financial system plays an important role in modern economies and the intermediary function of the banking industry has a core role in influencing economic growth. It is essential to understand and manage the efficiency of financial intermediation, especially within banks. Another issue related to bank efficiency is risk management and the effects of risk on efficiency. The interrelationship between risks and bank efficiency has received much attention in recent years, especially since the Asian Financial Crisis in 1997 and the Global Financial Crisis (GFC) in 2008. Based on the World Bank's categories, the East Asia and Pacific area's includes countries and economies ranging from China to the Pacific Islands. With nearly 40 countries and geographic entities, this wide area contains diverse landscapes, climates, societies, cultures, religions and economies. Despite the challenging external environment, the World Bank says this area, which includes representatives from all levels of economic development (underdeveloped, developing and developed economies), continues to be the world's growth engine (World Bank, 2014). This study examines the relationship between risks and environmental factors and bank cost efficiency by comparing developing and developed economies in a specific geographic area. Stochastic Frontier Analysis (SFA) was employed to estimate efficiency and Tobit regression was applied to examine the effects of credit, operational and liquidity risks and environmental factors on bank efficiency both before and after the 2008 GFC. The research sample covers both the developed and developing economies in East Asia (China, Indonesia, Malaysia, the Philippines, Thailand and Vietnam) and the Pacific region (Australia, Hong Kong, Japan, Korea, New Zealand and Singapore). There are two main stages in the analysis represented by measuring banks' cost efficiency and examining the relationship between cost efficiency and risks. The overall average efficiency scores from the first stage of the research indicate that the observed banks could have produced their outputs using sixty two per cent of their actual inputs. This is not a high score when compared with previous studies of countries in the area with the same level of development. Comparing the scores between groups of economies produced a surprising result, with the mean efficiency scores of developing countries represented in the research being up to twenty per cent higher than those of developed countries. In the second stage, the study focused on the effects of three kinds of risk (credit risk, operational risk and liquidity risk) on bank cost efficiency in the same countries' banking systems. It found significant negative effects on banks' efficiency for the three kinds of risk. However, there were differences between developed and developing economies. The research also confirmed that the environmental factors had significant effect on the banking system as most of the control variables had significant effects, at the one per cent or five per cent level, except for gross domestic product (GDP). There were different effects in the periods before and after the 2008 GFC. The findings of this study have several implications for policy makers, regulators, and bankers, especially in the observed area. First, X-efficiency can provide a quantitative tool for ranking and monitoring banks through their efficiency levels. Second, with regard to risk management, policy makers need to implement the Basel Accords, to guide banks in controlling risks and thus boosting the efficiency of banks in the region and keeping the banking systems of the East Asia and Pacific region safe. Finally, this study finds that some environmental factors, such as GDP per capita, consumer price index, interest rate, capital requirement, are important determinants of bank performance. It also indicates that policy makers need to ensure a mature and stable situation of their countries' economies in order to boost the efficiency level of commercial banks. This is crucial because the banking industry serves as the main channel for monetary policy transmission in the developing countries.

Date of Award	2015
Original language	English