Cost Efficiency Analysis of Local Commercial Banks in Taiwan

• DOI: http://doi.org/10.1111/asej.12170
• Published date: 01 March 2019
• Author: Russell Kashian,Elaine Yiling Lin,Yuhan Xue
• Date: 01 March 2019

Cost Efficiency Analysis of Local Commercial

Banks in Taiwan*

Russell Kashian, Elaine Yiling Lin and Yuhan Xue

Received 20 May 2016; Accepted 1 November2018

This study uses a stochastic frontier analysis (SFA) model to evaluate the relative

cost efficiency of commercial banks in Taiwan in the wake of liberalization. The

model is estimated using data made available through Taiwan’s Banking Bureau

and Financial Supervisory Commission. With data from before and after the 2008

financial crisis, our central result is that banks affiliated with bank holding compa-

nies (BHC) have become increasingly more efficient. While unaffiliated banks

have generally increased their efficiency, they have not kept pace with respect to

efficiency gains. Secondary findings are that, independent of ownership structure,

both balance sheet and income statement composition affect efficiency. In particu-

lar, bank efficiency increases with growth in loans and capital prices. We also find

evidence that labor productivity is a key explanatory factor behind efficiency dif-

ferences across banks. As a result, a policy recommendation is made that banks

invest in maximizing worker productivity. Finally, in addition to the insights

gained from this study we contribute to the general literature on both bank effi-

ciency and the use of the SFA model by applying it to newdata in a new setting.

Keywords: cost efficiency, stochastic frontier analysis, Taiwanese banking

industry.

JEL classification codes: D24, G21, L25.

doi: 10.1111/asej.12170

I. Introduction

The banking sector has played an integral role in promoting economic growth

throughout the world. While banks provide multiple benefits, one of the most

compelling arguments for a strong and well-developed banking sector is that

banks promote overall efficiency in an economy by matching savers and bor-

rowers in a manner that coordinates savers with the lowest opportunity costs,

and borrowers that wish to finance the projects with the highest returns. While it

is well accepted that banks promote efficiency and growth in an economy, the

matter of how efficient the banks themselves are remains relatively understudied

*Kashian (corresponding author): Professor of Economics, University of Wisconsin/Whitewater,

Whitewater, WI 53538, USA. Email: kashianr@uww.edu. Lin: University of Wisconsin/Whitewater,

Whitewater, WI 53538, USA. Xue: Assistant Professor of Economics, University of

Wisconsin/Whitewater, Whitewater, WI 53538, USA. Email: xuey@uww.edu.

© 2019 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2019, Vol.33 No. 1, 87–108 87

and potentially of tremendous value given the enormous benefits that banks have

the potential to bestow on an economy.

Taiwan represents a fertile arena to consider the efficiency of banks from the

standpoint that Taiwan has experienced tremendous and sustained economic

growth throughout the past half century and may offer valuable lessons for other

nations hoping to emulate Taiwan’s successful path. In addition, Taiwan closely

fits the description of a small, open economy that is so prominent in economic

theory.

In addition, Taiwan’s banking sector merits a new and closer look because the

nation has embarked on a path of liberalization and reform of its banking sector.

This has passed through multiple stages, with the most meaningful set of

reforms coming in the years following the turn of the century. Very broadly, the

government of Taiwan has implemented financial liberalization and facilitated

the establishment of private commercial banks. In doing so, they have broken

the oligopolistic structure of banking that had existed in Taiwan since the estab-

lishment of the Republic of China.

This study explores the cost efficiency of local commercial banks in Taiwan

during the post-reform period, 2006 to 2014. We also seek to identify how own-

ership structure and balance sheet composition have impacted bank efficiency.

We use a stochastic frontier analysis (SFA) model to analyze the annual finan-

cial statements of commercial banks whose financial statements are recorded

with the Banking Bureau of Taiwan’s Financial Supervisory Commission.

We find that banks associated with Bank Holding Companies (BHC) are con-

siderably more efficient than non-affiliated banks regardless of observable char-

acteristics. Furthermore, we document the increases in bank productivity across

ownership types in the years following bank liberalization. In addition, we find

that a key factor explaining efficiency across banks is labor productivity. This is

an important policy consideration for banks to improve their efficiency.

Our paper makes at least three meaningful contributions. First, we use cur-

rent and high-quality data to update the research community’s understanding

of bank efficiency in Taiwan to incorporate information from recent and sub-

stantial reforms that have fundamentally altered the banking landscape. In par-

ticular, we document the increases in bank efficiency in the years that have

followed liberalization. Second, we use new methods that have not been

applied to the banking sector in Asia to reach our conclusions. Third, we show

that labor productivity is a key driver of cost efficiency and issue a recommen-

dation that banks prioritize actions that have the potential to increase their

employees’contributions.

The remainder of the paper is organized as follows: Section II provides back-

ground on liberalization of banking in Taiwan and potential efficiency effects;

Section III reviews the relevant literature; Section IV provides an overview of

our methodology and describes the data; Section V documents our empirical

results; and Section VI concludes.

ASIAN ECONOMIC JOURNAL 88