Analysis of Efficiency of Chinese Commercial Banks - Research Proposal Example

Analysis on efficiency of Chinese commercial banks Table of Contents 0 INTRODUCTION 3 1 Background Information 3 2Statement of Problem 4 1.3 Purpose of the Study 5 1.4 Relevance of Study 6 1.5 Objectives 6 1.6 Research Questions 7 2.0 PRELIMINARY REVIEW OF LITERATURE 7 2.1 Chinese banking Reforming 7 2.2 Banking Efficiency 8 3.0 METHODOLOGY 10 3.1 Data Collection 11 3.2 Data Analysis 12 3.3 Time Plan 13 References 15 1.0 INTRODUCTION The efficiency of a bank reflects on the comprehensive evaluation of all the output and input projects which include the operating achievements inferred from several kinds of financial reporting as well as operating outcome (Chen-guo, Ting & Jie, 2007). It may be challenging for the operating outcome of a bank to be taken into account during the financial analysis. The Chinese banking system consists of a number of institutions which vary in nature. The most notable characteristic of the system is that commercial banks which are owned by the state dominate the Chinese banking sector and are further the primary sources of funding and loans to companies in the country(Chen-guo, Ting & Jie, 2007). A series of banking reforms have been implemented in China since 1979. These reforms aim to create a safe and sound system of banking within the country (Dong, 2009). The structural and institutional arrangements characterizing the banking sector in China as well as the banking reforms implemented in China in the past 20 years will provide the background and foundation of the study(Dong, 2009). The researcher felt that for efficiency to be discussed in-depth, it may be necessary for historical antecedents and facilitators of the same to be analyzed in order to provide the reader with a wealth of information. 1.1 Background Information In the last 40 years, financial sectors across the globe have witnessed substantial developments(Dong, 2009). The change in the operating environment of banks has had significant implications for the business activities of banks as well as their economic role. Globalization, deregulation, technological progress and financial innovation to mention but a few have all gradually reduced the cost of processing and transmitting information which have been major forces impacting the performance of the international banking sector. Since the embarking of the open door policy in 1979, the Chinese banking sector has witnessed gradual yet notable reforms(Dong, 2009). A key objective of the said reforms implemented by the government was to build a competitive, effective and stable banking system to improve reliability and efficiency. The reforms aimed at moving the country from a planned economy supplemented with market elements to a socialist market economy. The Chinese government deregulated and liberalized operations in the Chinese banking sector as part of national reforms in the economy. The program applied includes among others the establishment of a double-tier system, separation of the lending policy form commercial lending, removal of credit ceilings on loans and deposits, reduction of systematic risk in the banking sector, privatization of state-owned banks and relaxing of entry by foreign banks into the country. The official state objective of deregulation and liberalization was to enhance the productivity and efficiency levels of banks in China. It is, therefore, important to investigate the efficiency levels of the Chinese banking sector over the reform period. 1.2 Statement of Problem Banking systems in developing countries are traditionally considered prone to excessive government control and intervention which inhibits competition and efficiency in the allocation of resources. Due this factor, the performance of banks in the developing countries has been relatively poor. Fortunately, in a majority of developing states, government instruments and regulators have accepted the role of banking deregulation in promoting efficiency and competition. This awareness has led to the implementation of reforms which aim at creating competitive, efficient and ultimately stability in the banking sector. The reforms and actions of the government and other key players in the industry over the years can be attributed to the current state of banking in China. Had the reforms not been taken, then perhaps the banking sector in China would still be inefficient. It is through the progress of the banking sector in ensuring a sound, safe and efficient banking system over the years that the researcher has the opportunity of taking a study in analyzing the said efficiency of the banking in China. 1.3 Purpose of the Study With the study, the researcher seeks to analyze the efficiency of Chinese commercial banks. Two main approaches will be employed when measuring the performance of banking institutions. The classical approach which is based on the simple analysis of profit and cost is a naïve and simple measure of efficiency that will be employed in the study. In the approach, conventional performance ratios that concentrate on examining of such financial rations as ROA, ROE, growth rate of total revenue, capital asset ratio, and cost/income ratio all of which are frequently used by regulators and institution managers as well as industry consultants in evaluating performance. The Frontier efficiency approach will also be used in measuring performance and establishing the efficiency of the banking institutions. With the X-efficiency approach, the researcher will measure the deviations in performance from the best-practice firms on the frontier and control the effect of a couple of exogenous factors like the prices in local Chinese markets. With the approach, performance of an institution will be measured relative to the predicted performance of the best banks which also face the same market conditions in the banking sector. The model represents the ability of an institution’s management to use resources and control costs to produce output. A combination of both approaches is expected to facilitate the achievement of the research objectives and answer the research questions. The shortcomings of the classical approach will be tackled by the more superior Frontier approach in evaluating performance and analyzing the efficiency of commercial banks in China. 1.4 Relevance of Study Bank efficiency not only concerns itself with the manifestation of the comprehensive strength, but also the comprehensive evaluation index of the bank’s achievement. As such, analysis of the efficiency of commercial banks in China will not only benefit the management, but also the administrative personnel greatly. These persons will have a crisp understanding of the status of their organizations in both the national and international environments. What is more, they will also know the gap between their institutions and others through analysis which will foster the adoption of measures that have a clear aim. Furthermore, administration and management can greatly be improved in the banks to realize sustainable development. An assessment of the deregulation and liberalization program of the Chinese banking efficiency will also assist the government instruments and regulators in policy choice. It will also enable the improvement of allocation of resources by bank management across the several investment opportunities available. With this, the objectives of the study are outlined. 1.5 Objectives 1. To analyze the factors affecting the efficiency ofChinese commercial banks 2. To improve the efficiency of Chinese commercial banks 3. To compare the differences of efficiency between Chinese and foreign commercial banks 1.6 Research Questions 1. What are the relationships among efficiency of performance of Chinese commercial banks? 2. How can the efficiency of Chinese commercial banks be improved? 2.0 PRELIMINARY REVIEW OF LITERATURE 2.1 Chinese banking Reforming The Chinese banking scene has only recently undergone liberalization, because of economic reforms in China. Prior to these reforms, the People’s Bank of China was the only large bank in China. A consequence of this liberalization was the establishment of four state commercial banks alongside several other joint equity banks as well as policy banks (Yao, Han, & Feng, 2008). One of the most significant banking reforms was the establishment of the China Banking Regulatory Commission (CBRC). One of the biggest problems facing the state owned commercial banks was high levels of non-performing loans (NPLs). The poor state of these state-owned banks was mainly due to political influence from the ruling class. Consequently, privatization of the commercial banks was deemed an appropriate solution to in order to alleviate this problem. The state therefore moved to provide support to these banks in order to strip them of their NPLs. With the loans stripped, the banks were suitably attractive to investors and were consequently listed. Another important reform in the Chinese banking sector is the entry of foreign banks. The Chinese banking sector was opened to foreign banks in 1981. However, the participation of foreign banks was severely restrictive. The turnaround point was when China joined the World Trade Organization in December 2001. These two reforms have had a significant impact on the Chinese Banking Sector (Yao, Han, & Feng, 2008). They have prompted a change in the manner in which Chinese banks perform their operations. According to the Almanac of China’s Finance and Banking (2005), the four largest state owned banks account for approximately 60 percent of the total deposits within the country and about 57 percent of the total loans. The average ratio of non-performing loans of the big four banks was over 30 percent in the 90s. For commercial banks in China to compete and survive within a liberalized environment, it is imperative to have further reforms. A critical element of the reforms undertaken was the restructuring of the big four banks and other commercial banks to enable the listing of the same in the stock markets and subject them to monitoring and control by shareholders and not politicians. Foreign investment and ownership reform in the Chinese banking sector have been providing significant impetus for the domestic commercial banks in China to improve performance through strict control, restructuring and the monitoring of lending activities and the reforms of corporate governance. By the year 2006, foreign banks in China and their subsidiaries had no business or geographical restriction to serve customers in the country. 2.2 Banking Efficiency Since the 90s, many studies have been focusing on measuring the efficiency of banks in China. Berger and Humprey (1997) for instance, documented 130 studies on the efficiency of financial institutions using data from 21 countries from several institutions including bank branches, banks, savings and loan institutions, insurance companies and credit unions. In 2002, Richard et al. used a constrained multiplier and input oriented DEA model in evaluating the production efficiency of commercial banks in the U.S form 1984 to 1998. From the studies, the researchers found out that there was a consistent and strong relationship between independent measures of performance and efficiency. The efficiency of banks in Hong Kong and Taiwan has been attracting strong academic interests. In the study by Chen and Yeh (2000), an intermediation approach is adopted in which the deposits of a bank are treated as input. The rationale is that the main business that banks engage in is the borrowing of funds from depositors and lending the same to others with an interest. The approach specified three outputs namely portfolio investment, provision of loan services and non-interest income. Three inputs were proposed in the study which included assets, bank staff and deposits. Moreover, the researchers noted that an increase in market competition and staff salaries may result in difficulties when improving technical efficiency. Drake’s study (2003) used data from the Hong Kong banking sector to examine the regulatory and macroeconomic factors which influence efficiency in banking. By using the Tobit regression, it was possible for external factors such as government expenditure and the GDP to be analyzed instead of firm characteristics. Few studies address the issues of efficiency in China’s banking in English. Majority of the studies are in Mandarin. Fu and Heffernan (2005) measured market share, concentration, X-efficiency as well as the scale of efficiency of Chinese banks. They further tested both the market power and efficient structure hypotheses. The results of the study indicated that during the first phase of the reform, the large state-owned banks which were exercising market power by being the major loan providers were subsidized by the government. In the second phase of the reforms, the state-owned banks were cut so as to allow the X-efficient joint stock banks harness higher profits even though they were less scale efficient. Studies by Chen et al. (2005) also examined the technical, cost and allocative efficiency of 43 banks in China during the periods of 1993-2000. Results from the study showed that the larger state-owned banks and smaller banks were more efficient than mid-sized banks. Moreover, the financial deregulation of 1995 was concluded to have improved both allocative and technical efficiency. Furthermore, there was evidence noted that there was continuous dominance of technical efficiency over allocative efficiency. This implied that the Chinese banks needed to improve their ability of minimizing cost through combinations of input. Yao et al. (2006) employed a stochastic production frontier function in investigating the effects of ownership structure as well as hard budget constraint on the technical efficiency of domestic banks in China. Findings indicated that non-state owned banks are approximately 8 to 18 percent more efficient than the state owned banks. Additionally, banks facing harder budget were found to be performing more efficiently than those banks with heavy capital injected by the state or regional governments. 3.0 METHODOLOGY The proposed methodology in the study will be the Data Envelopment Analysis (DEA) model. Secondary sources of data such as books, journals, periodicals and past research studies will be used to provide data for the study (Bhattacharya, 2006). The population of interest, as mentioned earlier, is Chinese commercial banks. The sample size to be used in the study will be comprised of 4 state-owned banks, 4 joint-equity commercial banks and 4 urban commercial banks. Data will be collected from public reports published by the institutions in the periods of May to July. The data will be analyzed using the DEA model. In establishing the efficiency of the commercial banks in China, the study will assess progress and performance of the 12 banks over a period of the past five years. 3.1 Data Collection As aforementioned, information will be obtained from a variety of existing literature. Inspired by Chilisa (2011), who sensitized the importance of research methods in the achievement of research objectives, the researcher developed a three-step criterion in ensuring that the sources of data were reliable. First, the researcher will engage in a scrutiny of the authenticity of the data sources being used in the study by gauging the soundness of the data and authorship. Soundness of the data will depend on the documentation of the entire data as a whole. As such, the researcher will ensure that all pages of the source are available and that there are no errors and misprints in the data. Authorship will depend on who wrote the original document. Some documents are notorious for attributing their authorship to individuals who did not actually write them. Secondly, the researcher will check the credibility of the sources of data to be used in the study by investigating the number of editions that the print has in order to anticipate distortions that may occur during editing and translation. Finally, the researcher will ensure that the secondary data sources used in the study have sound meanings. This will be done by making sure that the language style and language use fall within the study scope. Terminologies related to banking, economics and investigation of efficiency will be used to provide hints to the researcher that the data source being used falls within the scope of the research study. However, according to Babbie (2001) secondary research methods can present some limitations to a research. For example, the quality of a research can be compromised by data collected from a self-governed primary research reports. Such reports can present biased conclusions thus reducing the credibility of data acquired from such sources. What is more, data from the secondary sources can be presented in a manner that does not satisfy the objectives of a researcher. Hence, a researcher can be forced to spend extra time in searching for data that satisfies the objectives and needs of the study. Secondary data was, however, preferred to primary data due to the availability of the same. Moreover, collecting data from secondary sources will savethe researchera significant amount of time when compared to the time that would be needed in performing primary research. It is also perceived that the secondary data sources will give the researcher leverage in fabricating feasible recommendations and conclusions to the research study. 3.2 Data Analysis Both qualitative and quantitative data will be used in the study. Quantitative data in the study will be presented in table and charts for analysis to identity trends, patterns and draw conclusions on the variables of the study. Qualitative data used in the research will enable the researcher have in-depth understanding of the variables and datasets. In the research, non-parametric methodologies will be used in preference to parametric methodologies. The DEA frontier method will be the primary methodology used in the analysis and investigation of the efficiency of Chinese banks. A two-stage DEA procedure will be used in investigating the key determinants of Chinese banking efficiency. More specifically, the Tobit regression model that regresses the scores of efficiency from the DEA models on the environmental variables such as size, ownership structure and market structure will be used. The DEA presents a more flexible approach for the estimation of efficiency as does not involve any explicit estimation of the cost function and an error term associated with a bank and thus avoids any risk of mis-specification. The DEA is also a purely deterministic model of cost efficiency which takes no account of potential and random errors in data being analyzed. The approach seems to be superior when compared to other approaches such as the SFA in terms of specification problem. Two DEA models will be applied in the analysis. The traditional cost DEA and new cost DEA will be used in the empirical analysis. Both models will use the same cost efficiency concept in the banks being analyzed. By using the two approaches, the accuracy and robustness of the results can be used for cross checking purposes in a methodological fashion. 3.3 Time Plan As noted by Kothari (2004), it may be very easy for a researcher to spend excessive time doing a single task. The researcher, therefore, intends to ensure that the research study is completed on time and last minute rush is avoided. To ensure the same is achieved, a well-constructed plan is needed. A draft tome plan is included which will be used to manage time and activities while undertaking the research study. The project will of course require regular reviewing over the course of the research study. The time plan will thus require some degree of flexibility to make room for unforeseen events and circumstances that may arise along the way. Maintaining a good relationship with the supervisor will prevent deviation from the focus of the study. Regular communication via mail and meetings with the supervisor are perceived to foster a good working relationship during the study. The formalized meetings will keep the supervisor informed on the progress of the research. The researcher plans to make effective use of the formal meetings by sending a copy of the work to the supervisor before the actual meeting. This will enable the supervisor provide enough feedback during the formal meeting sessions. Apart from concentrating on one task and wasting time, the issue of data collection is also of concern. Researchers are at times not able to find relevant information for the study or have access to necessary databases. The researcher plans to start the collection of data early enough in May till July. The ample time is perceived to allow the collection of concrete data. Table 1: Gantt Chart Activity March April May June July August September Proposal Writing Data Collection Data Analysis and Interpretation Report Writing Compilation of final report Submission of Final Report References Babbie, E. (2001). The Practice of Social Research: 9th Edition. Belmont, CA: Wadsworth Thomson. Berger, A. N. and D. B. Humphrey (1997), ‘Efficiency of Financial Institutions: International Survey and Directions for Future Research’, European Journal of Operational Research, 98, 175-213. Bhattacharya, D. K. (2006). Research methodology. New Delhi: Excel Books. Chilisa, B. (2011). Indigenous research methodologies. Sage. Chen-guo, D., Ting, L., & Jie, W. (2007). ‘Efficiency Analysis of China’s Commercial Banks Based on DEA: Negative Output Investigation.’ China-USA Business Review, Vol. 6, 2 (35), 50-56. Chen, T-Y. and T-L. Yeh (2000), ‘A Measurement of Bank Efficiency, Ownership, and Productivity Changes in Taiwan’, Service Industries Journal, 20, 1, 95-109. Chen, X., M. T. Skully and K. Brown (2005), ‘Banking Efficiency in China: Application of DEA to Pre-and Post-Deregulation Eras: 1993-2000’, China Economic Review, 16, 229-45. Dong, Y. (2009). Cost Efficiency in the Chinese Banking Sector: A Comparison of Parametric and Non-Parametric Methodologies. Retrieved from: Fu, X. and S. Heffernan (2005), ‘China: The Effects of Bank Reform on Structure and Performance’ (Cass Faculty of Finance Working Paper WP-FF-19-2005). Kothari, C. R. (2004). Research methodology: Methods and techniques. New Delhi: New Age International (P) Ltd. Richard, B. S., K. A. Kory, S. F. Thomas and Z. Sheri (2002), ‘Evaluating the Productive Efficiency and Performance of U.S. Commercial Banks’, Managerial Finance, 28, 8, 3-22. Yao, S., Han, Z., & Feng, G. (2008). Ownership Reform, Foreign Competition and Efficiency of Chinese Commercial Banks: A Non‐parametric Approach. The world economy, 31(10), 1310-1326. Yao, S., C. Jiang, G. Feng and D. Willenbockel (2006), ‘WTO Challenges and Efficiency of Chinese Banks’, Applied Economics, forthcoming. Read More