Cost Efficiency Analysis of Commercial Bank Mergers in Taiwan

By Lin, Ping-wen | International Journal of Management, September 2002 | Go to article overview
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Cost Efficiency Analysis of Commercial Bank Mergers in Taiwan

Lin, Ping-wen, International Journal of Management

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The Taiwan government authorities concerned aggressively promoted the bank mergers policy and effected reforms in the financial supervision system during the recent years, in the hope of stimulating a merger trend among banks in the new century. The stochastic frontier function approach (SF) employed in this study obtained the following empirical findings: Except for the year 1999, the average cost inefficiency score.of merger banks was lower than the average cost inefficiency score of non-merger banks. A negative correlation and statistical significance exist between cost inefficiency index and bank mergers; meaning bank engaging in mergers tend to improve cost efficiency. However, the data envelopment analysis (DEA) empirical analysis found that bank mergers did not improve significantly cost efficiency of banks. The rationale behind this difference is the difference existing between the SF and DEA methodologies.

I. Introduction

A review of the Taiwan banking environment revealed strict government control during the early period. The banking industry of Taiwan did not have an integrated banking system for development; it also lacked credible institutions and indices for bank management and operating performance evaluation purposes. Since 1991, the Ministry of Finance (MOF) licensed the establishment of sixteen new banks, afterwards, the MOF allowed the conversion of credit cooperatives, trust investment companies, and small & medium business banks into commercial banks; hence the soaring increase in numbers of commercial banks. In the process, the nation saw an excessive number of similar banking products, thus diminishing the margin between bank profits. The stiff price competition resulted to the development of "too many banks with not enough businesses to handle"; as a result non-performing accounts began to pile up. A long period of faction disputes, internal trading, excessive overdue loans eroded the asset structure of a number of banks. The high level of non-performing assets made them seek merger and acquisition deals for reorganization into commercial banks or assimilation into other banks1. Taiwan passed the Bank Mergers and Acquisitions Act in November 2000. The government aggressively promoted mergers among banks. In addition to promulgating tax incentives for merging banks and extending the legal validity deadlines, the new law also relaxed regulations on mergers between banks and nonbanking corporations2. It also granted the Ministry of Finance the right to force the receivership and merger of the credit departments of the non-profitable farmer or fishery associations. Furthermore, it provided the legal foundation for placing non-profitable credit establishments under the "asset management company" setup. The paper conducted integrated the stochastic frontier function method Battese & Coelli (1993) with the cost inefficiency result model (Battese & Coelli, 1995)3 to derive the effect of the bank cost inefficiency rate and bank merger on the cost inefficiency rate of banks. Subsequently, the data envelopment analysis (DEA) was employed to derive the relative cost efficiency of each bank. In the two-stage method, the Tobit regression method4 was employed to evaluate the effect of the bank merger on the bank cost efficiency. Finally, a comparative study was conducted on the two empirical findings to determine consistency for future study reference of government authorities concerned and bank management.

II. Literature Review

Researchers studying operating efficiency often use the following three methods: foeCEancial ratio analysis, parametric approach, and non-parametric approach. Numerous studies have been conducted using the parametric and non-parametric approaches to evaluate bank merger efficiency. Rhoades (1993) used the Logit model to evaluate 898 US bank mergers data (1981 to 1989) and found no significant improvement in the post-merger bank cost efficiency.

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Cost Efficiency Analysis of Commercial Bank Mergers in Taiwan


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