Academic journal article International Journal of Business and Society

Determinants of Cost Efficiency in Malaysian Banking

Academic journal article International Journal of Business and Society

Determinants of Cost Efficiency in Malaysian Banking

Article excerpt

ABSTRACT

This study estimates the cost efficiency and its decompositions of Malaysian banks over the period of 1995 to 2010 by utilising data envelopment analysis (DEA) method. Instead of estimating efficiency based on DEA separate frontiers approach; this study departs from practice of many previous studies by pooling the data set to build a DEA common frontier. This study contributes to the existing literature by integrating determinants of banking efficiency into the areas of DEA methodology in the context of Malaysian banking system across individual domestic banks. The first objective of this study is to estimate cost efficiency and its decompositions, which are technical and allocative efficiency as well as to estimate sources of technical efficiency namely pure technical efficiency and scale efficiency. Next, Tobit regression analysis is undertaken to identify the determinants of various measures of banking efficiency. The results indicate that government ownership, population density, demand density and market concentration are positively associated with several measures of efficiency while year that merger takes place, macroeconomic condition, capitalization, credit risk, asset quality and management quality have a negative relationship with various measures of efficiency. However, the size of banks is found to have mixed sign, positive coefficient with technical and pure technical efficiency while the negative relationship with scale efficiency, cost and allocative efficiency.

Keywords: Determinants, Cost efficiency, Malaysian banking

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Within a competitive environment, financial institutions are forced to examine their performance as their survival depends upon their productive efficiencies. It has been argued that factors hindering the ability of emerging economies to adopt optimal stabilization policies are ranged from recurring credit reversals in the global capital market; constraints of political economy; inappropriate exchange rate regimes; financial instability; inefficiencies; and financial market imperfections (Blejer, 2006). Financial efficiency is the root of a successful economy and countries should bring to light the issues of financial efficiency as it would enhance banking stability. Lozano-Vivas & Pastor (2006) claim that financial development is fundamental to economic growth; the technical change in banking productivity in particular, has a significant effect on economic productivity and its convergence. The aforementioned study concur with the role of financial institutions in the nation's growth, as asserted by Schumpeter (1969) that the more efficient the financial system, the better the economy.

Thus, an improvement in the banking performance represents a better allocation of financial resources which results in higher private investments that favours economic growth. One of the main challenges of 10th Malaysian Plan is to stimulate private investment; additionally, the New Economic Model of Malaysia has also listed private investments as one of the core of strategic reform initiatives to transform Malaysia to a high income economy. On top of that, the second thrust of 10thMalaysian Plan states the urgency to create conducive environment to unleash economic growth, by emphasizing on 12 sectors of National Key Economic Areas and financial services sector is listed as one of the areas to be exploited. In this vein, measurement of the performance of financial institutions is important.

The investigation of financial institutions efficiency is important from both a microeconomic and macroeconomic point of view (Berger & Mester, 1997). From the micro perspective, the issue of inefficient banking system is crucial given increasing competition and improvements in the institutional, regulatory and supervisory framework. From the macro perspective, the efficiency of banking sector influences the cost of financial intermediation and the soundness of financial market. …

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