Cost Efficiency, Credit Risk-Taking and Capital Adequacy: an Empirical Study on Ethiopian Commercial Banks
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Date
2015-06
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Addis Ababa University
Abstract
The purpose of this study is twofold, first to investigate the cost efficiency level of Ethiopian
commercial banks; and second, to analyze the relationship between cost efficiency, credit risk-
taking and capital adequacy based on the notion of causality. Balanced panel data from samples
of eight banks which have data for the period 2000 to 2014 have been used. The study applied
Stochastic Frontier Analysis (SFA) techniques provided by Battese and Coelli (1995) to
investigate the banks‟ cost efficiency level and Granger causality techniques to analyze causal
relationship among cost efficiency, credit risk-taking and capital adequacy. The findings of the
study highlight that the average cost efficiency level of the studied commercial banks is 89
percent. At individual bank level, Ethiopian Commercial Bank (CBE) is the most cost efficient
while Construction and Business Bank (CBB) is the least cost efficient. State ownership has
negative impact on cost efficiency due to the averaging effect of the two studied state owned
commercial banks. Bank size has positive impact on cost efficiency indicating that large banks
on average tended to be more cost efficient than small banks. With regard to the causal
relationship, the results of the Granger model show that negative and bidirectional causality
exists between cost efficiency and credit risk-taking supporting both the “luck” and “bad
management” hypotheses. The study also shows that improvement in cost efficiency Granger
cause increase in capital adequacy level. Capital adequacy and credit risk-taking also have
bidirectional causality supporting both “luck” and “moral hazard” hypothesis. Overall, the
results of the Granger model indicate that the severity of one of the three variables may increase
unless the other is carefully managed.
Key words: Cost efficiency; Credit risk-taking; Capital adequacy; Granger causality; Stochastic
Frontier Analysis; System GMM
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Keywords
Cost efficiency, Credit risk-taking, Capital adequacy, Granger causality, Stochastic Frontier Analysis