Impact of Banking Supervision on the Cost Efficiency of Banks - An Example of Five Asian Developing Countries

Abstract

The main purpose of banking supervision is to ensure stable operation of banks, minimize the risk for the stability of finance system, increase banking efficiency and promote competitiveness. However the question is whether banking supervision can benefit or damage banking efficiency. And how does banking supervision affect banking efficiency? This paper uses the stochastic frontier approach (SFA) of Battese and Coelli (1995)and stochastic metafrontier function (SMF) of Huang et al. (2012) to explore different impacts of the Financial Regulation on cost efficiency of banking industry in India, Thailand, Bangladesh, Malaysia and Mongolia. This study found out that related supervision policies is necessary but not necessary be able to benefit cost efficiency. According to the analysis of inefficiency model, capital regulation can lower the cost efficiency of banking in India, Thailand and Mongolia. However, the results are opposite for Bangladesh and Malaysia, the cost efficiency increase with government financial supervision because they avoid high risk investment activities. In the second stage, estimated SMF under meta-frontier cost function of the five countries, for the banking supervision, no matter whether it is TGR or MCE, Indian banks has the best results of 0.7527and 0.6715 respectively. Thailand has the lowest TGR value of 0.4608. Malaysia has the lowest MCE value of 0.3531; and Tobit regression consistency indicated that an increase in the strength of legal right will increase MCE and TGR; but credit depth information will increase bank’s total cost, and then decrease their cost efficiency. The result shows that higher minimum regulatory capital increase MCE, TGR, and CE is consistent with the hypothesis raised by the moral hazard approach (Mester, 1996). However, minimum capital entry requirement and MCE, TGR, and CE are negatively correlated, statistically insignificant.