DEA efficiency measurement with undesirable outputs: an application to Taiwan's commercial banks

Abstract

Non-performing loans (NPLs) after the 1997 Asian financial crisis have been accumulating swiftly in Taiwan as well in for many other Asian economies. A loan always contains an ex ante risk of eventually becoming non-performing. A fair way of measuring the performance of bank should take into account the fact that NPLs are undesirable outputs. This study applies the input-oriented BCC model, which is invariant under the translation of outputs, to measure the efficiency of Taiwan's banks by treating the NPLs as undesirable outputs. Empirical results show that the ranking of technical efficiencies, from the highest to the lowest, lists public, mixed, and private banks and that the average value of technical efficiency of banks established after the industry's deregulation is larger than that of banks established before deregulation.