Data Approaches for Identifying Input and Output Finance Essay

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According to prior literatures, it is very important to identify the input and output of the depository institution (bank) in the production process when evaluating bank efficiency. Casu and Girardone (2004) stated that the analysis of bank efficiency or profitability might be limited and influenced by the different banking concepts. Since no unified rules had been documented, there was no explicit definition for the determinants of both input and output. Different authors applied different approaches when they analyzed bank efficiency. For example, Sherman and Gold (1985) considered number of transactions as outputs in their research; while Favero and Papi (1995) treated loans and deposits as outputs. In Freixas and Rochet (2008), they summarised and distinguished three branch approaches in identifying inputs and outputs: the production approach, the intermediation approach and the modern approach. The first two approaches ‘apply the classical microeconomic theory of the firm to the banking sector’ (p.77) and they are widely used methods of collecting outputs and inputs to evaluate bank efficiency. The modern approach ‘goes further and modifies the classical theory of the firm by incorporating some specificities of banks’ activities’ (ibid), such as information processing and risk management. This approach also mentioned ‘some form of agency problems, which are crucial for explaining the role of financial intermediaries’ (ibid). Since this approach focused on the micro-economic functions and the former two approaches concentrate on the large scale economic, in order to find a more suitable approach to address the input and output, this paper will discuss the production approach and the intermediation approach in further steps.

The Production Approach
Based on the researches of Benston (1965) and Bell and Murphy (1968), the production approach considers banking activities as the production of services to depositors and borrowers. Specifically, in this approach, banks play the role of ‘producer’ who use labour and physical capital as input and its services to depositors and borrowers (deposits) as output. As mentioned before, Sherman and Gold (1985) employed the production approach, in which the number of transactions was treated as outputs and labour, capital and cost of supplies were viewed as inputs. Later, more authors such as Rangan et al. (1988) and Ferrier and Lovell (1990) applied this production approach as well. The former author considered labour, capital purchased funds as inputs, while loans and deposits were outputs; the latter author defined occupancy costs labour and expenditures on materials as inputs, while the number of deposits, accounts and loans were treated as outputs.
The Intermediation Approach
Sealey and Lindley (1977) sketched the intermediation approach. This approach took banks as financial intermediaries to flow funds between depositors and borrowers. This would require some conditions, which Freixas and Rochet (2008) concluded as follows: deposits are typically divisible, liquid, short-term and riskless; loans are typically indivisible, illiquid, long-term and risky. Hence, in this approach, the inputs are usually financial capitals (borrowed funds, loanable funds, short-term funds) and labour while the outputs are loans, securities and other earning assets. For example, Aly et al. (1990) used labour, capital and loanable funds as inputs and loans, demand deposits as outputs to evaluate U.S. banking efficiency. Altunbas (2001) et al. studied the bank efficiency and ownership while applying this approach as well. They chose labour, deposits and physical capital as input and loans and other earning assets as output.
Choosing approach and identifying inputs and outputs
Literarily, the intermediation approach differs from the production approach by the specification of banking activities. The production approach suits well when investigating more basic level cases, such as local branches. Branches played the producer role as they are in contact with customers and providing their services to both depositors and borrowers directly. When analyzing efficiency of banks in large scale, e.g. headquarters, the intermediation approach is the more appropriate one. Freixas and Rochet (2008) processed several data sets and many authors’ researches. (e.g. Murray and White (1983) for Canadian credit unions and Mester (1987) for California savings and loans cited in Freixas and Rochet 2008, p.79). They found out that these studies applied both approaches and surprisingly found that the results of applying both approaches were not significantly differ from each other. For evaluating Japanese banking efficiency, this paper will choose intermediation approach and view ‘fixed assets’, ‘deposits and short-term funding’ and ‘personnel cost’ as input while consider ‘loans’ and ‘other earning assets’ as output.
Most of authors utilised fixed asset as an input because fixed asset is the physical capital which usually considered as a basic input element. Similarly, labour is another basic element of input. Since it is not possible to find formal and well-statistic labour information for all these banks, this paper will use personnel cost to substitute it. Personnel cost stands for the emolument which employees had been paid. This information is equivalent to the labour element. Deposits and short-term funding meet the condition for intermediation approach as deposits need to be typically divisible, liquid, short-term and riskless. Loans and earning assets are the basic output element under the intermediation approach. After identifying inputs and outputs, panel data set of 21 Japanese commercial banks from 2004 to 2009 will be discussed and utilised in this paper. Details will be discussed in next data selecting part.
Data selecting
The sample set this paper utilises came from Bankscope database. It is a database of banks’ financial statements, ratings and intelligence, with very detailed accounts. It contains comprehensive information on banks across the globe. It is very useful when researching specific individual banks and to find banks with specific profiles for further analysis. Specifically, when searching the data for Japanese banks in Bankscope, there were 1275 Japanese banks by March 2009, in which 345 banks are commercial banks. Within these commercial banks, 21 relatively high-ranking banks with available information have been chosen to evaluate the efficiency of Japanese banks. The chosen banks used unconsolidated statement report basis and local GAAP account standard. The list is showed in Table 1.
By March 2009, the ranking one bank in Japanese banking system is the Japan Post Bank Company Ltd with total assets 194.678 billion Japanese Yen. Since it was established on 1st September 2006 and started operation in October 2007, it is not possible to get the pervious data of this large bank from Bankscope. Moreover, the other high-ranking banks (such as Resona Bank Ltd, ranking 8; Mitsubishi UFJ Trust and Banking Corporation, ranking 9) are excluded from the list because that very key information on the statement of these banks is not available, e.g. the ‘personnel cost’ data is not available for Resona Bank Ltd for year 2006 and 2008. The selected sample banks are the relatively highest-ranking banks with all key information available from year 2004 to 2009. The efficiency results of these selected banks may represent the Japanese banks’ efficiency at certain level and show the general trend of its development. Additionally, there is no foreign bank in the selected sample. The highest ranking foreign bank is the Citibank Japan Ltd., ranking 28 with total assets 6057 billion Japanese Yen. With the same reason as those excluded high-ranking banks, key information is not available for this bank in Bankscope.
Table 1 Bank list
Number of bank
Ranking
Bank name
1
2
Bank of Tokyo-Mitsubishi UFJ Ltd
2
3
Sumitomo Mitsui Banking Corporation
3
5
Mizuho Bank
4
4
Mizuho Corporate Bank
5
10
Sumitomo Trust & Banking Company Ltd
6
12
Chou Mitsui Trust & Banking Company Ltd
7
14
Bank of Yokohama, Ltd
8
15
Shinsei Bank Ltd
9
19
Chiba Bank Ltd
10
21
Bank of Fukuoka Ltd
11
22
Joyo Bank Ltd
12
25
Bank of Kyoto
13
24
Nishi-Nipon City Bank Ltd
14
27
Hiroshima Bank Ltd
15
31
Gunma Bank Ltd
16
30
Hachijuni Bank
17
32
Chugoku Bank, Ltd.(
18
34
77 Bank
19
33
Hokuriku Bank Ltd.
20
35
Yamaguchi Bank
21
29
Aozora Bank
The bank ranking refers to the bank’s overall ranking in Japan by March 2009.
As mentioned before, this paper will adopt intermediation approach. The key information data collected from Bankscope is showed in Appendix 1 in detail. A brief preview is presented below in Table 2.
Table 2 Overview for input and output variables of sample banks from 2004 to 2009 in billion Japanese Yen
Year
Variables
2004
2005
2006
2007
2008
2009
Fixed Assets
Mean
202.13
191.43
184.86
173.69
173.9
176.04
Standard Deviation
296.4965
279.0659
271.0223
249.2493
249.3533
248.9635
Deposit & Short-term funding
Mean
19265.98
19263.00
19897.68
19498.6
20169.20
20773.1
Standard Deviation
31075.46
31007.2887
31155.867
29457.58
30323.99
30990.05
Personnel Cost
Mean
71.53
63.0
63.609524
59.70
62.47
71.08
Standard Deviation
103.5786
87.26643
86.49363
82.84263
84.34491
96.33516
Loans
Mean
12401.21
12109.64
12635.00
12836.10
12934.55
13589.89
Standard Deviation
18329.46
17613.32
18193.85
18153.49
18497.02
19127.04
Other Earning Assets
Mean
9078.33
9308.54
9684.96
9177.21
9157.18
9551.52
Standard Deviation
15634.77
16279.31
16290.36
14896.1
14573.84
15748.24
The blue numbers stand for decreased data compare to the previous year; the red numbers stand for increased data compared to the previous year. Two input elements, fixed assets and deposits and short-term funding, had a dramatic decrease when comparing the variables number between 2004 and 2009. Another input element, personnel cost, changed very little by result but showed a fluctuate process between these two years. The output elements showed very healthy increase though there was a small decrease in 2007. In general, it is obvious that almost all variables number are decreasing in year 2007, the only exception is the average loans, which showed a very promising continuous growth from 2006 to 2009. Another obvious change could be concluded that almost all variables number increased right after the decreasing gap year 2007, with the exception of one output element – other earning assets, which showed an increasing trend later in 2009. The 2007 financial crisis would be a reasonable guess for these changes before analyse the result. Moreover, the immediate rising back trend might indicate that the Japanese banking industry somehow avoided the major impact of the financial crisis and showed a promising recovery. The reasons will be discussed in the next finding chapter with the interpretation of the DEA results.
Reference (Data chapter)
Altunbas, Y., Evans, L. and Molyneux, P. (2001), ‘Bank Ownership and Efficiency, Journal of Money, Credit, and Banking’, Vol. 33 No. 4, pp926-954.
Bell, F. W., and N. B. Murphy, (1968) ‘Economies of scale and division of labor in commercial banking’, National Banking Review, Vol.5, pp.131-139
Beston, G.J. (1965) ‘Branch banking and economies of scale’, Journal of Finance, Vol.20, pp.312-331
Beston, G,J., G. A. Hanweck, and D.Humphrey, (1982), ‘Scale economies in banking’, Journal of Money, Credit, and Banking, Vol.14, Issue 1, pp.435-546
Casu B. and Girardone C. (2004), ‘Large Banks’ Efficiency in the Single European Market’, The Service Industries Journal, Vol.24, Issue 6, pp.129-142
Favero, C.A. and Papi, L. (1995) ‘Technical Efficiency and Scale Efficiency in the Italian Banking Sector: A Non-Parametric Approach’, Applied Economics, Vol. 27 Issue 4, pp385-395.
Ferrier, G.D. and Lovell, C.A.K. (1990), ‘Measuring Cost Efficiency in Banking Econometric and Linear Programming Evidence’, Journal of Econometrics, Vol. 46 Issue 1-2, pp229-245
Rangan, N., Aly, H.Y., Pasurka, C. and Grabowski, R. (1988) ‘The Technical Efficiency of US Banks’, Economic Letters, Vol. 28 Issue 2, pp169-175.
Sealey, C.W. and Lindley, J.T. (1977) ‘Inputs, Outputs, and a Theory of Production and Cost at Depository Financial Institutions’, Journal of Finance, Vol. 32 Issue 4, pp1251-1266.
Sherman, H.D. and Gold, F. (1985) ‘Bank Branch Operating Efficiency: Evaluation with Data Envelopment Analysis’, Journal of Banking and Finance, Vol. 9 Issue 2, pp.297-315.
Xavier Freixas and Jean-Charles Rochet. (2008), The Microeconomics of Banking, 2nd edn, MIT Press, Cambridge, MA, pp. xxi + 363.

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