An empirical evaluation on the credit risk efficiency of financial institutions in Malaysia with data envelopment analysis model

Abstract

The evaluation on the efficiency of financial institutions has received much emphasis from the researchers in recent years. Nevertheless, limited attention has been paid to obtain efficiency measures with regard to credit risk. Since significant exposure to credit risk has always been a leading source of problems in the financial firms, it is vital to efficiently and effectively manage credit risk in these firms. The objective of this study is to assess and compare the credit risk management and efficiency of the financial institutions by utilizing the Data Envelopment Analysis (DEA) model. DEA is a linear programming model that evaluates the relative efficiency of a set of financial institutions with multiple inputs and multiple outputs. The model derives the firm’s overall performance into a single unit free efficiency index. This study empirically analyzes the efficiency of 20 financial institutions in Malaysia from year 2000 to 2017. The results from this study indicate that LPI, MANULFE, and P&O are efficient in managing their exposure to credit risk. The efficient financial institutions identified can be used for benchmarking so that further improvement can be made on the inefficient financial institutions. This study is significant as it helps to determine the efficient and inefficient financial institutions from the financial sector in Malaysia with the DEA model.