Cost Efficiency of Domestic and

1

• Cost Efficiency of Domestic and
• Foreign Banks in Thailand
• Evidence from Panel Data
• A Part of The Ph.D. Thesis Reform of Thailands
• Finanical Institutions in the 1990s
• by
• Saovanee Chantapong
• Supervised by
• Prof. Dr. Lukas Menkhoff
• Geld und Internationale Finanzwirtschaft,
  Universität Hannover
• Presented at Emerging Markets Course
• Wed 6 July 2005

2

• Agenda
• Motivation
• Institutional Background
• Literature Review
• Data and Methodology
• Analysis of Empirical Results
• Conclusions

3

• Definitions
• Cost-efficiency or X-efficiency-whether banks are
  using their inputs efficiently.
• Scale Efficiency-whether banks are operating with
  the efficiency levels of outputs.
• Scope Efficiency-whether banks are operating with
  the efficiency mix of outputs.

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Motivation

• Did domestic and foreign banks perform
  differently in term of cost efficiency?
• Did production costs vary statistically across
  banks and over time?
• What are the effects of foreign bank entry on
  banking effciency in Thailand after the
  significant acquisitions by foreign banks in 1999?

5

• Objectives
• analyse and compare the cost efficiency of
  domestic and foreign banks.
• examine the choice of input combination labour
  and physical capital in banking production.
• investigate the cost efficiency effects of
  foreign bank entry through acquisitions.

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• Why cost efficiency?
• Cost efficiency mostly comes along with the
  structural and institutional reforms.
• Cost efficiency reduces the operating costs.
• Cost efficiency is advantage to other dimensions
  of bank performance (more productive loans ?
  contribute to overall economic development).
• Operating cost is one of the common financial
  indicators for identifying problem banks.

7

• Institutional Background (1)
• Deep financial system (at end-2002, total
  financial assets/GDP 158)
• Bank-oriented with limited other financial
  intermediation
• gt at end-2002, Commercial banks assets/GDP
  106 (IMF, 2004)
• Capital markets are on the way of development
  (established in 1975, SET market capitalisation
  peaked at 105 of GDP in 1993 and rebounded at
  47 of GDP at Jun-2003)

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• Institutional Background (2)
• Financial liberalisation programme (late 1980s
  and early 1990s) had four components.
• Three main objectives as follows
• Increase competition in the domestic financial
  sector
• Expand the financial sector for supporting
  economic expansion
• Establish BIBFs as the leading offshore financial
  centre in the region
• Leightner and Lovell, 1998, p. 129 .... In the
  context of the March 1997 speculative bubble,
  Thai financial liberalisation still appears to
  have been successful, but it also carried with it
  a risk that needed to be carefully monitored.

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• Literature Review
• can be summarised as follows
• The various different econometric techniques for
  estimating efficiency do not always yield
  consistent results (Berger and Hamphrey,1997).
• Inefficiency banks seem to have more fear from
  banks that are efficient producers (cost
  efficiency) than from banks that are producers
  with particular scale efficiency and scope
  efficiency (Mester, 1996).
• Regarding, foreign bank entry and bank
  efficiency, foreign banks achieve higher profits
  than domestic banks in developing countries,
  while the reverse is not true in developed
  countries (Claessens et al., 2001).
• There are both positive (exert competitive
  pressure on domestic banks gt benefit consumers)
  and negative effects of foreign bank entry
  (foreign banks decrease their exposures to
  developing countries during crisis times (Clarke
  et al., 2001, Claessens et al., 2000, Herberholz,
  2002, Mishkin, 2000, Goldberg et al., 2000 and
  Sabi, 1996) (Thailands case Herberholz, 2002
  and Intarachote and Williams, 2003).
• The hasty liberalisation process without logical
  sequence resulted in severe problems of financial
  institutions (Leightner and Lovel, 1998,
  Menkhoff, 2000) .

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• Data
• Financial data from banks income statements and
  balance sheets

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Descriptive Analysis (1)
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Descriptive Analysis (2)
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Methodology (1)

• Cost efficiency ? a measure of how close a banks
  cost is to the banks cost best-practice (see
  Berger and Mester, 1997 and Berger et al, 2004).
• COST EFFICIENCY ?
• f(.) a translog cost function,
• an inefficiency factor that
  may raise costs above the best
  practice level.
• the random error that
  incorporates measurement error
  and luck.
• Efficiency is defined relative to the best
  practice observed in the industry, rather than to
  any true minimum costs since the underlying
  technology is unknown.
• Dummy variables for the ownership and time effect
  capture

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Methodology (2)

• 1.1) Panel A DB, FB and MB
• 1.2) Panel B DB and MB ? Foreign bank entry
  effects

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Methodology (3)

• 2) CHOICE OF INPUT
• 2.1) Panel A DB, FB and MB
• 2.2) Panel B DB and MB ? Foreign bank entry
  effects

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Definitions of Dependent and Independent Variables
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Table 1 Panel A Cost Efficiency (Operating
Costs) Note shown only significant coefficients
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Emprical Results (1) Cost Efficiency Main
findings

• R1 and R2 gives almost the same resutls and most
  of the coefficients have the same sign as
  expected from the theory.
• From R 1 and R 2, per unit costs of DB are
  related to cash and interbank, Loan Loss
  Provisions (LLP) and Other Earning Assets (OEA)
  whereas Operating Costs of FB are related to
  equity and OEA.
• Finding 1 gt The production costs of domestic and
  foreign banks are different. It indicates that
  domestic and foreign banks are different in terms
  of business structures, management sytles and
  customer bases. Foreign banks concentrated in
  quality of bank management and risk and output
  quality (well-capitalisation lower NPLs) on
  the other hand, domestic banks focused on
  liquidity of banks (high liquid assets).
• 3) On average, per unit cost of production of DB
  and FB are indifferent.
• Finding 2 gt Based on cost efficiency, foreign
  banks did not outperform domestic banks
  suggesting that if foreign banks represent the
  best-practice banks in the industry, to a large
  extent, domestic banks in Thailand have caught up
  to the best-practice standards throughout the
  1995-2003.

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Table 5 Panel B Cost Efficiency (Operating
Costs)(Effects of FB entry on cost efficiency)
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Emprical Results Effects of Foreign Bank Entry
on Cost Efficiency Main findings

• Finding 1 gt Based on domestic and merged
  banks-level data set, domestic and merged banks
  have similar business structures as expected.
• Finding 2 gt Per unit production cost efficiency
  of domestic banks after the acquisition year
  declined, suggesting that the cost efficiency of
  domestic banks improved. It indicates that
  greater foreign bank participation through
  acquisition increases the competitive pressure in
  the banking industry which increases the cost
  efficiency of domestic banks.

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Conclusions

• Cost Efficiency
• Production costs of DB and FB are different in
  terms of business structures, manangement styles
  and customer bases.
• DB ? liquid assets FB ? quality of bank
  management and risk preference.
• gt Surprisingly, cost efficiency of DB and
  FB is indistinguishable.
• They have their own strength gt In term of
  physical capital cost, FB are more efficient in
  managing loans than DB whereas FB are less
  efficient in handling OEA.
• Physical Capital input depends on banks
  strategies and more long term commitments and as
  a results, less flexible.
• Cost Efficiency Effects of FB Entry through
  Aquisitions
• Cost efficiency of DB improved after the
  acquisitions suggesting that an increase in
  competition arising from FB entry exerted bank
  efficiency.