Banking efficiency in emerging economies: Does foreign banks entry matter in the Ghanaian context?

• Published date: 01 July 2019
• Date: 01 July 2019
• Author: John Kwame Akuma,Isaac Doku,Daniel Ofori‐Sasu,Lord Mensah
• DOI: http://doi.org/10.1002/ijfe.1707

RESEARCH ARTICLE

Banking efficiency in emerging economies: Does foreign

banks entry matter in the Ghanaian context?

Daniel Ofori‐Sasu

1,2

| Lord Mensah

1

| John Kwame Akuma

2

| Isaac Doku

2

1

Department of Finance, University of

Ghana Business School, Accra, Ghana

2

Department of Banking and Finance,

Data Link University College, Tema,

Ghana

Correspondence

Daniel Ofori‐Sasu, Department of

Finance, University of Ghana Business

School, P.O Box LG 78, Legon Accra,

Ghana.

Email: doforisasu@yahoo.com

Abstract

This study empirically examines the effect of foreign banks entry on banking

efficiency scores, using the truncated regression data envelopment analysis

model for 25s banks in Ghana, over a 6‐year period (2010–2015). We decom-

pose the efficiency scores into three (technical, cost, and allocative efficiency),

and the results indicate that banks in Ghana are marginally inefficient in oper-

ating closer to their optimal capacity. The findings show that the input‐

oriented model slacks are needed to push an inefficient bank closer to where

an efficient bank is positioned. From the results, an immediate and a short‐

term entry of foreign banks have a consistent negative relationship with both

technical‐and cost‐efficiency scores whereas long‐term entry of foreign banks

shows an inconsistent relationship with the three banking efficiency scores.

Thus, the drive towards a positive impact of foreign banks entry on the three

efficiency scores is dependent on the form of banking efficiency considered

and the interaction term between competitive banking environment (competi-

tion) and foreign banks' entry. The study suggests that policymakers and man-

agers in emerging markets should improve on their bank efficiencies in both a

competitive banking environment and during periods of foreign bank entry.

Moreover, managers of banks should make adjustment to their input resources

in order to cope with new banking technologies from foreign bank entry—

thereby improving banking efficiencies.

KEYWORDS

banking efficiency scores, DEA slacks, foreignbank entry

1|INTRODUCTION

In recent years, banking systems, especially in develop-

ing economies, have undergone severe transformation

through financial liberalization, increased openness

to international capital flows, and financial and

technological innovations (Gelos & Jorge, 2004). The

most notable has been the penetration of foreign banks

(Claessens, Demirguc‐Kunt, & Huizinga, 2001).

Financial liberalization allows markets to freely

determine the allocation of credit, thereby increasing

the inflow of foreign banks (Clarke, Cull, & Peria,

2001). Foreign banks entry isobservedtoincreasecom-

petition among counterparts and then improve bank

soundness in emerging markets, particularly when the

parent bank originated from a well‐regulated financial

system and are themselves healthy. The increase in

foreign banks entry in emerging financial markets is

eventually to grab more profit and expand operations

by increasing the number of branches and clients

internationally (Claessens et al., 2001) as well as

improving efficiency.

Received: 19 April 2018 Revised: 18 July 2018 Accepted: 10 September 2018

DOI: 10.1002/ijfe.1707

Int J Fin Econ. 2019;24:1091–1108. © 2018 John Wiley & Sons, Ltd.wileyonlinelibrary.com/journal/ijfe 1091

There is a wide recognition that increased penetration

of foreign banks has significant effect on banking

efficiency in emerging economies. For policymakers, the

impact of increased foreign bank entry on the efficiency

of banks is a critical concern. Earlier studies predicted that

the entry of foreign firms threatens the survival of local

firms (Clarke et al., 2001) whereas a more recent study

by Sufian and Habibullah (2010) highlights that the entry

of foreign rivals positively affect the efficiency of incum-

bent domestic banks and foreign banks. This study argues

a positive significant effect of foreign bank entry on

banking efficiency. However, the effect does not happen

immediately; foreign banks enter an emerging economy.

Thus, instead of predicting a direct impact on banking effi-

ciency, we are of the view that foreign banks compete with

existing banks in emergingmarkets, which in turn leads to

improved efficiency scores in the long term. The study

employs an interactive term between foreign bank entry

and competition, as well as the lag difference of foreign

entry in order to find the true effect on banking efficiency.

A cursory look at some developing economies like the

Ghanaian banking market suggests that multinational

subsidiary banks appear to settle in the country with

“relative ease”(Saka, Aboagye, & Gemegah, 2012). Miller

and Eden (2006) observe that most multinational banks

appear to be doing better than their local rivals and that

host country banks are entirely inefficient. According to

Venaik, Midgley, and Devinney (2005), host countries face

fierce competition from foreign banks and lose the race in

specific areas like technological and service portfolio inno-

vation. The question is, does foreign entry affect banks

efficiency in emerging countries?

This paper empirically analyses the interaction

between foreign banks entry and banking efficiency scores

in the presence of competition by employinga data set that

covers an emerging economy, particularly, Ghana. It takes

into account two critical hypotheses: First, foreign bank

entry reduces bank efficiency (with the presence of com-

petition) in the short‐term. Second, foreign bank entry

increases bank efficiency in the long‐term. Although no

study has tested these hypothesis from the Ghanaian

perspective, several papers have looked at the effect of

competition on bank efficiency in Ghana (Alhassan &

Ohene‐Asare, 2016). Evidence shows that the entry of

foreign banks puts pressure on the financial sector to

perform (Demirgüç‐Kunt & Levine, 2008). Thus, the

entry of foreign banks affects the performance of domes-

tic firms. Previous studies focused on analysing the

impact of foreign entry on domestic bank performance

(Lehner & Schnitzer, 2008; Lensink & Hermes, 2004;

Nsiah, 2013) in developing countries. Moreover, these

studies have been consistent in the use of profitability

ratios as a performance measure without focusing on

banking efficiency. From the Ghanaian context, it

appears no work has been done on the effect of foreign

entry, using different proxies for banking efficiency

scores.

Evidence in literature shows that the use of ratio

analysis (earliest technique) as a standard measure of

efficiency can be very misleading (Barnes, 1987; and

Sherman & Gold, 1985), despite the wide use of profitabil-

ity ratios in the finance literature (Berger, Hunter, &

Timme, 1993). Weill (2004) stated that the earliest tech-

niques used profitability ratios to measure performance

of banks (Michaelas, Chittenden, & Poutziouris, 1999),

whereas most studies use the parametric and non‐

parametric approaches to measure the efficiency of banks

(Altunbas, Evans, & Molyneux,1995; Ferrier & Lovell,

1990; Karapakis, Miller, & Noulas, 1994; Porcelli, 2009).

Data envelopment analysis (DEA), which uses the non‐

parametric approach, has received the attention by

researchers as a tool for measuring efficiency of banks

(Aboagye, Akoena, Antwi‐Asare, & Gockel, 2012; Korsah,

Nyarko, & Tagoe, 2001). Results from these studies show

inefficiencies among banks, and empirical findings were

restricted to developed economies (Mok, Yeung, Han, &

Li, 2007; Weill, 2004; Yang, 2009). The question is

whether foreign bank penetration is the reason for such

differences in efficiency scores among banks in emerging

countries.

Most of the studies conducted on foreign bank entry

were done using European (Claeys & Hainz, 2006a,

2006b, 2014), Asian (Luo, Dong, Armitage, & Hou, 2017),

and American (Peria & Mody, 2004) data. However, these

studies cannot be conclusive because of differences in

efficiencies for bank groups and country levels. Moreover,

the results from their analyses differ due to the dynamics

of banking in these regions. However, in the case of

emerging countries, like Ghana, the positive effect of

foreign entry on bank efficiency may not be applicable

due to changes in banking environment. According to

Weill, different results on efficiency come from the differ-

ent use of efficiency measures as well as the influence of

institutional framework relative to specific countries.

However, there is a knowledge gap in the banking litera-

ture, particularly on banking efficiency in Ghana, using

the DEA. The use of different measures of bank efficiency

variables and the effect of foreign bank entry on these

variables remain scanty in emerging countries.

The paper is situated in the context of emerging

economies where the capital market is still developing

and that banks are the main financial providers of

economic activities. The contribution of the study is to

analyse the efficiencies of the banks in Ghana by

employing the DEA technique, slack analysis, and input‐

oriented benchmarks of banks. It appears to be the first

1092 OFORI‐SASU ET AL.