Interbank funding, bank risk exposure and performance in the UK: A three-stage network DEA approach

Abstract

Operating on unsecured interbank markets exposes banks to various risks which trigger changes in bank strategic outcomes such as risk management and performance. This paper proposes a novel three-stage network data envelopment approach with feedback and alliance to examine the importance of bank risk exposures through interbank funding on bank efficiency levels. Our results show that overall bank performance management is achieved via a complement of good alliance between risk and funding, and financial performance. In addition, high financial or overall performance may not imply better risk management or allied process performance. Rather, banks are inherently performance-driven institutions whose performance objectives are independently optimal but aggregately suboptimal. Further analyses show that, for international banks, high financial or overall performance may not necessarily limit high allied process and risk management. Moreover, risk governance in large banks has not improved despite the increased regulatory pressure induced after the 2007–2008 credit crisis. Our results remain robust regardless of whether the alliance or financial performance stage is given priority in the overall efficiency decomposition, and when the novel resource imbalance index is used to assess and enhance the discriminatory power of performance.