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Bank efficiency and risk during the financial crisis: Evidence from weight restricted DEA models

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  • Mette Asmild

    ()
    (Institute of Food and Resource Economics, University of Copenhagen)

  • Minyan Zhu

    (Centre for Competition Policy, University of East Anglia, UK)

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    Abstract

    The recent nancial crisis highlighted how banks' funding and investment portfolios are associated with their risk taking. In a "normal" DEA banking efficiency model this risk element, embedded in banks' business models, is indicated by possibly inappropriate mixes of funding portfolio and/or investment portfolio which, in turn, is revealed by the weights assigned by each bank to the inputs and outputs in the model. Using the crisis as a natural experiment, we defie weight restrictions to be imposed on all banks by using the banks that were not bailed out during the crisis, or with relatively higher external rating, and which are efficient in the normal DEA model, as our model banks. Thus, banks seemingly taking excessive risks by using inappropriate weights to make themselves look efficient, are restricted to only applying weights also used by efficient non-bailed-out banks. Analysing data collected from audited financial statements of around 70 of the largest EU banks from 2006 to 2009, we find a clear pattern indicating that non-bailed-out banks with relatively high external rating become significantly more efficient than the other banks once weight restrictions are applied to control for risk, even if this pattern was not clear from the models without weight restrictions. In models already incorporating some risk elements, the non-bailed-out banks are significantly more efficient even before weight restrictions are included, but the imposition of weight restrictions makes the pattern even stronger.

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    File URL: http://okonomi.foi.dk/workingpapers/MSAPpdf/MSAP2012/MSAP_WP03_2012.pdf
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    Bibliographic Info

    Paper provided by University of Copenhagen, Department of Food and Resource Economics in its series MSAP Working Paper Series with number 03_2012.

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    Length: 26 pages
    Date of creation: Jul 2012
    Date of revision:
    Handle: RePEc:foi:msapwp:03_2012

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    Web page: http://www.msap.life.ku.dk/
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    Keywords: Data Envelopment Analysis (DEA); weight restrictions; banking; efficiency; risk; financial crisis.;

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    1. Simon Kwan & Robert Eisenbeis, 1997. "Bank Risk, Capitalization, and Operating Efficiency," Journal of Financial Services Research, Springer, vol. 12(2), pages 117-131, October.
    2. Charnes, A. & Cooper, W. W. & Huang, Z. M. & Sun, D. B., 1990. "Polyhedral Cone-Ratio DEA Models with an illustrative application to large commercial banks," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 73-91.
    3. Ching-Cheng Chang, 1999. "The Nonparametric Risk-Adjusted Efficiency Measurement: An Application to Taiwan's Major Rural Financial Intermediaries," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(4), pages 902-913.
    4. Koutsomanoli-Filippaki, Anastasia I. & Mamatzakis, Emmanuel C., 2011. "Efficiency under quantile regression: What is the relationship with risk in the EU banking industry?," Review of Financial Economics, Elsevier, vol. 20(2), pages 84-95, May.
    5. H. Semih Yildirim & George Philippatos, 2007. "Efficiency of Banks: Recent Evidence from the Transition Economies of Europe, 1993-2000," The European Journal of Finance, Taylor & Francis Journals, vol. 13(2), pages 123-143.
    6. Altunbas, Y. & Gardener, E. P. M. & Molyneux, P. & Moore, B., 2001. "Efficiency in European banking," European Economic Review, Elsevier, vol. 45(10), pages 1931-1955, December.
    7. Hughes, Joseph P. & Mester, Loretta J. & Moon, Choon-Geol, 2001. "Are scale economies in banking elusive or illusive?: Evidence obtained by incorporating capital structure and risk-taking into models of bank production," Journal of Banking & Finance, Elsevier, vol. 25(12), pages 2169-2208, December.
    8. Williams, Jonathan, 2004. "Determining management behaviour in European banking," Journal of Banking & Finance, Elsevier, vol. 28(10), pages 2427-2460, October.
    9. Brockett, P. L. & Charnes, A. & Cooper, W. W. & Huang, Z. M. & Sun, D. B., 1997. "Data transformations in DEA cone ratio envelopment approaches for monitoring bank performances," European Journal of Operational Research, Elsevier, vol. 98(2), pages 250-268, April.
    10. Fiordelisi, Franco & Marques-Ibanez, David & Molyneux, Phil, 2011. "Efficiency and risk in European banking," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1315-1326, May.
    11. Jose Pastor & Lorenzo Serrano, 2005. "Efficiency, endogenous and exogenous credit risk in the banking systems of the Euro area," Applied Financial Economics, Taylor & Francis Journals, vol. 15(9), pages 631-649.
    12. Yener Altunbas & Santiago Carbo & Edward P.M. Gardener & Philip Molyneux, 2007. "Examining the Relationships between Capital, Risk and Efficiency in European Banking," European Financial Management, European Financial Management Association, vol. 13(1), pages 49-70.
    13. Berg, Sigbjorn Atle & Forsund, Finn R & Jansen, Eilev S, 1992. " Malmquist Indices of Productivity Growth during the Deregulation of Norwegian Banking, 1980-89," Scandinavian Journal of Economics, Wiley Blackwell, vol. 94(0), pages S211-28, Supplemen.
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    Cited by:
    1. Cristian Barra & Sergio Destefanis & Giuseppe Lubrano Lavadera, 2013. "Regulation and the Crisis: The Efficiency of Italian Cooperative Banks," CSEF Working Papers 338, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.

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