The Effect of Electronic Banking on the Cost Efficiency of Commercial Banks: An Empirical Study

By Lin, Jui-Chu; Hu, Jin-Li et al. | International Journal of Management, December 2005 | Go to article overview

The Effect of Electronic Banking on the Cost Efficiency of Commercial Banks: An Empirical Study


Lin, Jui-Chu, Hu, Jin-Li, Sung, Kang-Liang, International Journal of Management


This study investigates the effect of electronic banking, as measured by the extent to which banks make use of automatic teller machine (ATM), on their cost efficiency, before and after the 1997 Asian financial crisis. We use stochastic frontier analysis (SFA) approach to investigate the cost efficiency of 35 commercial banks in Taiwan from 1995 to 2001 and compare their operating performance before and after the Asian financial crisis. A bank's efficiency cannot be improved by merely increasing its ATM numbers: It should perhaps be in coordination with other electronic businesses, such as interactive video terminal (IVT) system, automated clearing house (ACH) system, point of sale (POS) system, remote banking system, financial electronic data exchange interchange, and even internet banking. The more bank branches there are, the more inefficient the banks. On average, a bank's cost inefficiency is significantly higher after the 1997 Asian financial crisis.

Introduction

During recent years, the financial environment faced by Taiwan has changed quite dramatically. The government has enforced policies to release various financial restrictions gradually. In addition to loosening the interest rate and restrictions on the exchange rate, the government also has continued to adopt different measures of financial liberalization up to the present. Currently, there are 47 local banks in Taiwan including 5 public and 42 private banks. Their total assets are NTD18.2504 trillion, which is 87.76% of the total assets of all banks in Taiwan. Moreover, these banks' total deposit balance amount is about NTD14.2841 trillion, which is 90.96% of this economy's total deposits. Their loan balance amount is about NTD11.9833 trillion, which counts for 90.11% of this economy's total loans.

While facing the various financial sector changes, the banks are trying to think up ways to improve their operating performance and increase their competitiveness. Electronic banking seems to be the most often used method adopted by banks. This entails using the technology of computer and communications to deliver and handle the transactions and information of banks and the software and hardware of electronic equipment in order to try their best to replace manual and paper operations. Electronic banking does not require a clerk to complete the transaction. On the contrary, the customer can start different service procedures through the terminator that is linked with the banks. Through the delivery of communication lines to enter the bank's server, the customer can enjoy the multitudes of service operating systems in real time.

Researchers generally use the following methods to analyze operation efficiency: (1) financial ratio analysis, (2) parametric approach, and (3) non-parametric approach. Given that there are at least ten measurement methods of the financial ratio analysis and different banks have different goals and policies so that the financial index focused by each bank is totally different, it will be inappropriate to analyze the operating performance of each bank solely based on a few financial indices. Therefore, in practice most researchers adopt the parametric and non-parametric approaches. The SFA is the major one in the parametric approach and the DEA is the popular one in the non-parametric approach.

Ferrier and Lovell (1990) compared the operating performance of 575 banks in the U.S. in 1984 by using both DEA and translog and obtained a pretty close result; i.e., most banks are in the stage of increasing remuneration by scope and small banks are the most efficient ones. Favero and Papi (1995) used the DEA model to evaluate the technology efficiency and scope efficiency of 174 banks in Italy in 1991 and conducted a cross-section analysis. They discovered that larger banks have a higher efficiency and banks with a higher performance are all dedicated to businesses that are different from the ones conducted by traditional banks. …

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