A Timely Comparison of Foreign Banks in China Against Domestic Banks

Abstract

We employ the efficient frontier methods of data envelopment analysis (DEA) and stochastic frontier analysis (SFA) to estimate efficiency of Chinese bank production in a study that directly compares locally incorporated foreign banks with domestic banks. Both methods reveal that, on average, foreign banks are less efficient than domestic banks, although SFA identifies a stronger contrast between the two cohorts. A break-down of the sources of inefficiency identifies interest income among the foreign banks as an area for major potential improvement, whereas the domestic banks appear to suffer mostly from inefficiencies in managing non-interest income and interest expense. There is a significant positive impact of market share on the efficiency of generating interest income as well as non-interest income. Interbank and cost-to-income ratios have a negative impact on efficient generation of interest income but no significant effect on non-interest income. On the other hand, regulation of the loan-to-deposit ratio does not influence interest income. DEA and SFA efficiency estimates are significantly positively correlated with each other as well as with key financial performance ratios, thus opening the way for both methods to be used together with confidence and in a complementary manner.

Keywords: Chinese banking, technical efficiency, ranking, DEA, SFA, financial ratios

JEL Classification: C67, G21