How Relevant is the Choice of Risk Management Control Variable to Non-Parametric Bank Profit Efficiency Analysis? The Case of South Korean Banks

34 Pages Posted: 21 Mar 2013

See all articles by Richard Simper

Richard Simper

Nottingham University Business School

Max J.B. Hall

Loughborough University - Department of Economics

Wenbin Liu

University of Kent - Kent Business School

Valentin Zelenyuk

School of Economics, Centre for Efficiency and Productivity Analysis, The University of Queensland, Australia

Zhongbao Zhou

Hunan University

Date Written: March 19, 2013

Abstract

Adopting a profit-based approach to the estimation of the technical efficiency of South Korean banks, we systematically analyse, within a non-parametric DEA analysis, how the choice of risk management control variable impacts upon such estimates. Using the model of Liu et al. (2010), we examine the dependency of the estimated technical efficiency scores on the chosen risk control variables embracing loan loss provisions and equity as good inputs and non-performing loans as a bad output. We duly find that, both for individual banks and banking groups, the mean estimates are indeed model dependent although, for the former, rank correlations do not change much at the extremes. Based on the application of the Simar and Zelenyuk (2006) adapted Li (1996) test, we then find that, if only one of the three risk control variables is to be included in such an analysis, then it should be loan loss provisions. We also show, however, that the inclusion of all three risk control variable is to be preferred to just including one, but that the inclusion of two such variables is just as good as including all three. We therefore conclude that the optimal approach is to include (any) two of the three risk control variables identified. The wider implication for research into bank efficiency is that the optimal choice of risk management control variable is likely to be crucial to both the delivery of un-biased estimates of bank efficiency and the specification of the model to be estimated.

Keywords: OR in banking, Korean Banks, Risk Management, Efficiency

Suggested Citation

Simper, Richard and Hall, Max J.B. and Liu, Wenbin and Zelenyuk, Valentin and Zhou, Zhongbao, How Relevant is the Choice of Risk Management Control Variable to Non-Parametric Bank Profit Efficiency Analysis? The Case of South Korean Banks (March 19, 2013). Nottingham University Business School Research Paper No. 2013-02, Available at SSRN: https://ssrn.com/abstract=2235537

Richard Simper (Contact Author)

Nottingham University Business School ( email )

Jubilee Campus
Wollaton Road
Nottingham, NG8 1BB
United Kingdom

Max J.B. Hall

Loughborough University - Department of Economics ( email )

York House
Loughborough LE11 3TU
Great Britain

Wenbin Liu

University of Kent - Kent Business School ( email )

Canterbury, Kent CT2 7PE
United Kingdom

Valentin Zelenyuk

School of Economics, Centre for Efficiency and Productivity Analysis, The University of Queensland, Australia ( email )

530, Colin Clark Building (39)
Brisbane, 4067
Australia

Zhongbao Zhou

Hunan University

2 Lushan South Rd
Changsha, CA Hunan 410082
China

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