1. The influenceof bank efficiency on bank performanceThe efficiency of a specific bankcan have various impacts on its performance, which can be viewed on the ratiosand data from the banks’ balance sheet. In recent academic literature, the efficiency of a bank can be measuredin a different way. Berger (1993) introduced a way to derive efficiency ratiofrom the profit function, since the profit function allows to measureinefficiencies on the output side, as well as the input side.
Another technical approach is commonly usedin measuring efficiency, the DEA Method, which was first introduced by Charnes,Cooper and Rhodes (1978) who employed a mathematical planning model ( the CCRmodel) to measure the technical efficiency frontier based on the concept of thePareto Optimum. In this study, an alternative approach of measuring theefficiency is going to use, which is the efficiency ratio derived from the datafrom the income statement and balance sheet. The efficiency ratio is calculatedby dividing the bank’s non-interest expenses by its net income. Banks arestriving for lower efficiency ratio, since a lower efficiency ratio indicatesthat the bank’s income is exceeding its expenseIn order to figure out the influenceof bank efficiency on bank performance, this study is focusing on the relationbetween a bank’s efficient ratio and its performance ratio, since the tendencyof the ratio can reflect the impact of a bank’s efficiency on its performance.To specify the study, the banking industry in Great Britain is closed as themajor research object, and all the data analysis is based on data given by theBloomberg.According to the data on Bloomberg,seven banks are listed in Britain, including two new-comers, Metro Bank PLC andCYBG PLC, both of which are listed on the market less than four years. Sincethe period of the research ranges from S1 2005 to S1 2017, the analysis ofthose two banks will only cover the data from the date they went public now.In this study, efficiency ratiocalculated from the data in balance sheet stands for the efficient level of aspecific bank, with the lower ratio the higher efficient, while three returnratios ( Return on Common Equity, Return on Assets and Return on Capital) standfor the performance of a selected bank, with the higher ratio the betterperformance.
When it comes to the positive aspectof the efficiency-performance relationship, a bank with lower efficiency ratiousually have a higher performance ratio. That is to say. Higher efficiency can lead to a better performance of abank. Since the efficiency ratio is calculated by the following formula, lowerefficiency ratio stands at a relatively lower operating expense and arelatively higher income, which will naturally lead to a better banking performance.The following graphs show theefficiency ratio variation and the performance ratio (Return on Common Equity,Return on Assets and Return on Capital) variation. Profit efficiency iscomputed using three different measures, ROA, ROE and ROC.
ROA is earningsafter taxes as a percent of total assets. For ROE, the numerator is identicalwith for ROA, but the denominator is shareholders equity. The use of both ROAand ROE is important since small banks, many of which are privately held,differ from larger publicly traded banks in their use of leverage. Small banksgenerally use less leverage, which lowers ROE relative to ROA.
And Return onCapital is a profitability ratio. It evaluates the return that an investmentgenerates for capital contributors, i.e. bondholders and stockholders. Returnon capital indicates how effective a company is at turning capital intoprofits. The dominator of ROC is identical with ROA and ROE, while thenumerator is Net Income minus Dividends. So ROC can be regarded as earningsafter dividends as a percent of total assets.In the above graphs, it is obviousto note that banks with lower efficiency ratio (higher efficiency) tend to havehigher performance ratio, which is rather significant in the before- crisisperiod (periods happened before the 2008 financial crisis).
For example, in S22006, the rank of return on common equity is the reverse order of the rank ofthe efficiency ratio, which strongly proves the conclusion mentioned before.Similar relationship can be discovered in the graphs of return on assets andthe return on capital, both of which stand for the performance in a slightlydifferent way.When it comes to the negative aspectof the relationship, it can be seen that a bank with lower efficiency tend tohave worse performance than the industry average.
As Epure (2015) mentioned,risk variables can be used as an efficiency measure, efficiency ratios containthe information that the potential risk that a bank is facing. A bank with relevantlower efficiency is exposed at a higher risk, since risk variables can be seenas an alternative to measure a bank’s efficiency. While higher risk is a signalthat leads to a possibility of a bank’s failure. In academic literature, measure efficiency byusing risk parameter is a widely -accepted approach. . Altunbas et al. (2000)express loan portfolio quality through the ratio of non-performing loans (NPL)to total loans, which may be considered an endogenous measure of risk.
According to Berger and DeYoung (1997) and Van Hoose (2010) this variablecaptures the quality of monitoring over loan portfolios. So it is easy toconstruct a communal connected relationship among riskiness, efficiency andperformance. The efficiency ratio is in negative correlation with performanceand in a positive relationship with risk.
Back to the result of the study,this relationship can be discussed in the above graphs. Before the 2008financial crisis, the potential risk of the banking industry is relevant lower,while the risk is relevant higher when the crisis is happened. It can be seenfrom the graph of the efficiency ratio, before the crisis, the efficiency ratiois applicable lower when it compared to the ratio in the crisis period (S22008-S1 2010). When it comes toperformance, it can be seen from the graphs of performance that the returnratio is relatively higher than the return ratio in and after the crisisperiod. This tendency matches the relationship among them mentioned before.That just says, when banks are facing higher risk, their efficiency will beaffected negatively and their performance will be negatively affected sincetheir efficiency is no longer higher than before.A bank can be categorised by theportion of its major shareholders, since the Ownership of banks varies.
Berger(2009) divides banks into the following category solely based on theirownership when he made his research on bank ownership and efficiency in China.With respect to the uniquecharacteristic of Britain’s banking industry, the above classification is nolonger part suitable for British Banks, since most banks share the similarownership structure and the only difference is the portion. In order to conducta more detailed study, we then focus on the two major owners with the greatestportion of shares of each bank. The result shows in the following table, withdata quoted in 10/12/2017.From the table, it is easy to findthat “investment Advisor” play a dominate role in each bank exceptfor the Royal Bank of Scotland Group PLC, whose majority owner is thegovernment. In Bloomberg, the term “investment Advisor” stands for agroup of mutual funds and global investment group, which come from differentcountries. In this study, the group that “investment Advisor” can betreated as foreign investors when it compared with domestic investors such asSovereign Wealth Fund and government.
Armed with this criterion, it is obviousthat six out of seven banks are majorly foreign owned, while only the RoyalBank of Scotland Group PLC is majorly owned by the government. However, theefficiency varies a lot in these six foreign owned banks, even thoughinvestment Advisors is the dominate owners.Firstly, different major ownershiphas different impact on efficiency. Whencompared the efficiency ratio of Royal Bank of Scotland Group PLC (RBS) withthat of other six banks, the efficiency ratio of RBS is significantly higherthan other banks except for CYBG PLC and Metro Bank PLC, which can be expressedas the fact that compared to the major government-owned bank, the majorforeign-owned bank have a relevant higher efficiency. Similar conclusion wasconducted by Bonin (2005) when he made his research on efficiency and ownershipin transition countries, who said that “foreign participation enhances theefficiency of domestic banking”.
Based on his research and my ownunderstanding, the reason why majority foreign-owned banks have higherefficiency can be explained that the foreign owner is an incentive for a bank’sefficiency, which allows the bank to access world-widely. This wide connectioncan improve the efficiency.Secondly, in the group of majorforeign-owned banks, efficiency still varies due to the portion of shares thatforeign investors hold. By reviewing the portion held by foreign investorsamong six banks, it can be seen that the potion ranks in the following order:Lloyds Banking Group PLC (81.
34%), HSBC Holdings PLC (77.67%), Barclays PLC(75.66%), Metro Bank PLC (68.
84%), Standard Charted PLC (64.71%) and CYBG PLC(61.69%). Then we can derive the rank ofefficiency from the graph of the efficiency ratio, which ranks (from low tohigh) HSBC Holdings PLC, Lloyds Banking Group PLC, Barclays PLC, StandardCharted PLC, Metro Bank PLC and CYBG PLC. It is evident that those two ranksroughly match in the same order. From this similarity, it can be derived thatfor the major foreign-owned banks, the portion of foreign shares and theefficiency levels are in a positive correlation, meaning that the more sharesowned by foreign investors, the more efficient the bank will be.
This tendencycan be attributed to using the same explanation when we compared the efficiencybetween majorly foreign-owned banks and majorly government-owned banks. Foreignownership gives the bank prior to access world-widely, making it operated moreefficient. In a conclusion, the influence ofbank efficiency on bank performance can be divided into two parts. From theprogressive aspect, higher efficiency stands for generating profits with lowercost, which directly links to better bank performance. From the negativeaspect, efficiency can be treated as a measurement for risk. The performance ofa bank may suffer when it is facing for high risks, which lead to lowerefficiency.
In the further study, the ownershipstructure is an important element in the efficiency of a bank. Compared withthe major domestic-owned banks, majority foreign-owned banks are moreefficient. And among major foreign-owned banks, banks with larger foreign-ownedshares are more efficient. Both facts can be attributed to the same reason.Foreign ownership gives the bank more exposure world-widely, making themoperate more efficient.