Off-balance sheet activities and cost inefficiency in Taiwan's Banks

Abstract

In this study, we adopt a stochastic cost frontier method to investigate the influence of off-balance sheet (OBS) activities on the cost efficiency of Taiwan's banks. We estimate and compare cost inefficiency with or without OBS outputs of 46 Taiwanese commercial banks during the period, 1998 through 2001. The conclusions of this empirical study are as follows. First, omitting off-balance sheet outputs in estimating the cost frontier function of banks results in an underestimation of bank efficiency by approximately 5 per cent. Second, large banks are associated with a higher cost efficiency and have an increased ability to develop OBS activities. This is consistent with Taiwan's regulatory policies, which focus on promoting efficiency in the banking industry of emerging markets. Banks with higher employee productivity are also more cost efficient. Finally, we observe evidence of economies of scale in both models with or without OBS specification in Taiwan's bank industry. Economies of scope between loans and OBS outputs are also observed.

Measuring cost efficiency in presence of heteroskedasticity: The case of the banking industry in Taiwan

“…The M2 multiplier serves as a proxy for the overall liquidity in the economy and TRIM serves as the foreign currency reserves against the country's balance of payments. 9 The firm-specific variables selected for our study are bank ownership (e.g., Altunbas et al, 2001a;Berger et al, 2009); GOV, a dummy variable (1 = government-owned banks and 0 = privately owned banks); asset size (SIZE) as a proxy for the impact of bank size; and total equity-to-asset ratio (EA) as a proxy for insolvency risk (e.g., Allen and Rai, 1996;Lieu et al, 2005). Prior studies find evidence that when the underlying cost function does not control for a bank's quality of assets, performance measures of firms including cost efficiency are likely to be biased (e.g., Mester, 1996;Altunbas et al, 2001b;Hughes and Mester, 2008).…”

“…Using the DEA, Chen and Yeh (2000) estimate operating efficiency (technical efficiency) of commercial banks in Taiwan over the 1995-1996 period. Lieu et al (2005) examine the effects of off-balance sheet activities on inefficiency in Taiwan's banks. Huang (2005) applies a single-step method to study the effects of information technology, capital and labor on technical efficiency.…”

“…Following Pitt and Lee (1981), several studies have used basic SF model and a two-step estimation procedure (e.g., Allen and Rai, 1996;Rai, 1996;Berger and DeYoung, 1997;Berger and Mester, 1997;Resti, 1997;DeYoung and Hasan, 1998;Bos and Kolari, 2005;Lieu et al, 2005;Bonin et al, 2005;Yildirim and Philippatos, 2007;Berger et al, 2009;Lin and Zhang, 2009 among others) to study the effects of macroeconomic variables and bank-specific factors such as size, ownership, and branch banking on cost inefficiency of banks. In the first step, the optimal stochastic frontier cost model (basic SF model) is estimated.…”

Technical efficiency of Tunisian banks

“…Using the SFA method, Lieu et al (2005) studied the influence of non-traditional activities on the efficiency of Taiwanese banks. They estimated and compared the cost inefficiency of these banks during the period 1998-2001 by the adoption of two different models (i.e., with and without non-traditional activities such as www.ccsenet.org/ibr International Business Research Vol.…”

The Impact of Non-interest Income on the Efficiency of China’s Banking Sector

“…Therefore,improvements should be attributed to technological change rather than efficiency change. Lieu et al [11] investigate the impact of nontraditional activities on the cost efficiency of Taiwan banks and find that the exclusion of non-traditional activities from the bank's output results in an approximate 5% underestimation of the bank's efficiency level and large banks with higher cost efficiency present increased ability to develop non-traditional activities. Rachita Gulatia and Sunil Kumara [12] investigate the relevance of the inclusion of non-traditional activities in the specification of banks' output on the efficiency of Indian banks and find that the exclusion of non-traditional activities not only understates the cost, technical and allocative efficiencies of individual banks but also affects the ranking of ownership groups in the industry.…”