The Interrelationship between Bank Cost Efficiency, Capital and Risk-Taking in ASEAN Banking

Abstract

The objective of this paper is to investigate the importance of bank cost efficiency on capital and risk-taking of banks in six countries in the Association of the Southeast Asian Nations (ASEAN) that is, Indonesia, Malaysia, Singapore, Thailand, the Philippines and Vietnam. The panel data is taken from Bankscope database for the period 2003-2008. This study applies the Stochastic Frontier Analysis (SFA) to estimate bank cost efficiency and a three-stage least squares (3SLS) method to estimate the interrelationship between bank cost efficiency, capital and risk-taking. Ten bank specific variables and three environmental variables are employed. Banks’ cost efficiency, capital and risk-taking are set as instrumental variables. In the first stage of analysis, efficiency (EFF) is regressed against ETA, LTA, LASSET, LDR, RISK, PERSTEX, FIXTAS, CIR, EGRAW, CORRUPT and FREE. In the second stage of analysis, capital (ETA) is regressed against LTA, EFF, LASSET, RISK, OBSA, CIR, FIXTAS, ROA, EGRAW, CORRUPT and FREE. In the third stage of analysis, risk-taking (LTA) is regressed against ETA, EFF, LASSET, RISK, ROA, PERSTEX, DEPTA, OBSA, EGRAW, CORRUPT and FREE. The result for ASEAN banks’ mean cost efficiency is 87.4%. On the interrelationship between bank’s cost efficiency, capital and risk-taking, the study finds that bank cost efficiency determines the capital position and risk-taking while banks’ capital position and risk-taking determine bank cost efficiency. It indicates that, bank cost efficiency is the foundation for banks’ capital position and risk-taking.

Keywords: Bank cost efficiency, capital, risk-taking, ASEAN