Linking Relative Efficiency and Operating Financial Decisions of Commercial Banks in Ethiopia: Application of Data Envelopment Analysis Model in conjunction with Financial Ratios.
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Date
2002-02
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A.A.U
Abstract
Banking institutions perform inter mediation functions and consequently influence
the level of money stock through their ability to create deposit liabilities. Therefore,
it is critical for depositors, investors, regulators, and the public at large to have
vested interest in the performance of banking institutions. Performance evaluation
of bank should be linked to decision models so as to associate the results obtained
with the decision.
To this end, this study initiated with the objective of accurately classifYing the
commercial banks in Ethiopia based on their relative efficiency scores has also
identified the major financial operating decisions that lead them to better
performance. Introducing the Data Envelopment Analysis model is also the purpose
of this study. To sum up, the primary purpose is to demonstrate through this
empirical evidence that DEA in conjunction with financial ratio analysis can
effectively aggregate and reclassifY the perplexing ratios into meaningful financial
dimensions, which enable us to gain insight into the financial operating strategies of
banks. DEA is the index of sum of weighted outputs to sum of weighted inputs. This model
is used to classifY six commercial banks in Ethiopia - those have operated in the
industry for at least two years before 2000 - based on their relative efficiency
scores. While others may not agree with the input and output variables selected in
this study for the DEA model, this study uses interest income, non-interest income,
and total loans as outputs and Interest expenses, non-interest expenses, and total
deposits as inputs. The financial operating decisions like capital ยท adequacy,
profitability, asset utilization, and liquidity for 1995 to 1999 are also captured
through twelve financial ratios extracted from the banks' financial statements.
For the purpose of this study efficiency is defined as an 'intermediary approach'
which examines the bank's function as a financial intermediary between savers 'and
borrowers. According to the DEA efficiency score derived, this study divides the
banks into three categories - high, medium, and low DEA efficiency - for financial
peer group analysis.
The empirical results indicate that those banks with higher DEA scores also have
higher ratios in capital adequacy, asset utilization and profitability efficiency, and
lower ratios in financial leverage and liquidity than those with lower DEA scores.
That is banks with more capital (in a relative magnitude) tended to engage in higher
loan risk lending for higher profits; while those with less capital were more
conservative in lending money. This shows that the application of DEA in
conjunction with financial ratios can not only accurately categorize banks with
respect to each other in terms of their DEA efficiencies but can also somehow link
the evaluated efficiencies with the bank's actual financial operating decisions.
Description
Linking Relative Efficiency and Operating Financial
Decisions of Commercial Banks in Ethiopia:
Application of Data Envelopment Analysis Model in
conjunction with Financial Ratios.
Keywords
conjunction with Financial Ratios., Data Envelopment Analysis