Cost metafrontier approach for measuring the Malmquist productivity index: An example of bank groups formed after the financial reform in Taiwan

Published date01 October 2020
AuthorTsui‐Yueh Cho
Date01 October 2020
DOIhttp://doi.org/10.1111/1468-0106.12273
ORIGINAL MANUSCRIPT
Cost metafrontier approach for measuring the
Malmquist productivity index: An example of bank
groups formed after the financial reform in Taiwan
Tsui-Yueh Cho
National Taichung University of Science and
Technology, Taichung City, Taiwan
Correspondence
Tsui-Yueh Cho, Department of Insurance and
Finance, National Taichung University of Science
and Technology, No.129, Section 3, Sanmin Road,
North District, Taichung City 404, Taiwan.
Email: yueh@nutc.edu.tw
This study attempts to provide a framework under the var-
iable returns to scale hypothesis to account for the effect
of the cost scale efficiency change in the decomposition
of the cost metafrontier Malmquist productivity index
(CMMPI). In addition, the meta-cost efficiency and cost
frontier gap between subordinate banks of financial hold-
ing companies (FHC) and independent banks are also
examined. A total of 34 banks in Taiwan are empirically
analysed from 1999 to 2012. The results indicate that the
meta-cost efficiency, meta-technical efficiency and meta-
allocative efficiency scores of subordinate banks of FHC
are better than those of independent banks. The banking
industry in Taiwan is found to have an improvement in
cost metafrontier Malmquist productivity. The subordinate
banks of FHC are also found to exhibit positive CMMPI
and decomposition components, but do not achieve a sig-
nificant improvement except in the case of the technical
gap ratio change. The empirical results recommend that
Taiwanese banks place more policy focus on the issue of
scale adjustment, which should be beneficial. Based on
the CMMPI decomposed results, we can gain further
understanding of the growth path to enhance operational
performance.
1|INTRODUCTION
Strict financial regulations have always been implemented in Taiwan. With the increasing complexity
of financial trading behaviour and the extensive effect of internationalization, significant changes in
banking operations have evolved, during which time amendments to the Banking Act have gradually
led to the lifting of many restrictions on financial as well as business regulations, such as allowing
Received: 16 January 2017 Revised: 2 February 2018 Accepted: 19 May 2018
DOI: 10.1111/1468-0106.12273
Pac Econ Rev. 2020;25:475494. wileyonlinelibrary.com/journal/paer © 2018 John Wiley & Sons Australia, Ltd 475
the establishment of new banks and encouraging the privatization of publicly-owned banks. Since
then, the banking industry in Taiwan has moved from a period of monopoly into an era of free com-
petition. However, excessive numbers of banks and market saturation have also led to lower returns
and higher past due loan ratios, resulting in a deterioration in the operating risks associated with the
banking industry. Therefore, the government has included financial reform as one of its reform objec-
tives in its national development plan. In 2002, the First Financial Reform in Taiwan was implemen-
ted with a view to lowering the past due loans ratio to 5% and raising the capital adequacy ratio to
8%. In 2004, the government carried out the Second Financial Reform in Taiwan, with reform, privat-
ization and integration forming the core of the financial reform policies. After a series of financial
reforms and the enforcement of the Financial Institution Merger Law and the Financial Holding
Company Law during 20002001,
1
16 financial holding companies (FHC) had been established by
the end of 2017. On average, the assets of banks affiliated with the FHC, which exceed several bil-
lions of dollars, are greater than those of the independent banks. According to data compiled by the
Central Bank of Taiwan, the assets of the largest bank in Taiwan amount to 4.05 trillion NT dollars,
while those of the smallest bank total only 94.1 billion NT dollars. The former is 43 times greater
than the latter. With the governments positive assistance in bank enlargement, such practices have
changed the banking system and operating structure.
The advantages of setting up FHC have been found to lie in affiliated companies being able to
share resources and relevant information and increase their economic scope, as well as spread their
fixed costs and managerial overheads over an expanding product mix. Therefore, if banks affiliated
with FHC could adapt swiftly to the operating environment following their establishment, they, in
theory, would at least be better at technology improvement and closer to reaching an optimal scale.
Because the FHC is a newly-established organizational structure in Taiwan, more empirical evidence
is needed to determine whether the banks that are subordinate to them are able to hold information in
a timely manner to generate the anticipated productivity growth. Productivity growth deeply affects
the development of banks (Fiordelisi & Molyneux, 2010; Havrylchyk, 2004; Yang & Huang, 2009).
Therefore, a complete understanding of the factors that influence the productivity of banks is crucial.
There has been relatively little comparative research on the cost Malmquist productivity index (CM).
Most of the existing studies cover either the production Malmquist productivity index (MPI) or a lim-
ited number of metafrontier MPI (MMPI). Moreover, they either fail to take the price effect change
and allocative efficiency change into account or ignore the importance of scale efficiency change.
The price effect change reflects the residual impact of relative input price changes on the shift of the
cost boundary. The allocative efficiency captures banksability to choose an optimal input and output
bundle. The literature (Färe et al., 2004) on bank performance also reveals that allocative inefficiency
is a larger source of profit loss than technical inefficiency, implying the importance of cost efficiency
change.
One of the notable features of Taiwans banking industry is the variable returns to scale (VRS)
production technology (Chan & Liu, 2006; Yang & Huang, 2009). Therefore, the banks in Taiwan
either have increasing returns to scale (IRS), caused by a lack of full utilization of capacity, or
decreasing returns to scale (DRS), which is caused by a crowded utilization of capacity. More specifi-
cally, a decreasing input used in the IRS phase further results in the production scale deviating from
the optimal productive scale, and causing a reduced cost scale efficiency change. Such a result again
warns us to respect the problem that might ascend when we ignore the potential effect of group-
1
The Financial Institutions Merger Law provides both tax and non-tax incentives for financial institutions to merge on their own initia-
tive, while the Financial Holding Company Law allows financial institutions to undertake a wider range of financial activities so as to
benefit cross-selling synergies.
476 CHO

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