Measuring bank performance with a dynamic network Luenberger indicator

Abstract

We construct and estimate a dynamic network Luenberger productivity indicator for Japanese banks during fiscal years 2006–2012. The network aspect to the model recognizes that banks produce deposits in the first stage of production using inputs such as labor, physical capital, and equity capital and then in the second stage use those deposits to generate a portfolio of loans and securities investments. Because of asymmetric information between borrower and lender and uncertainty about the future state of the economy the second stage of production also generates an undesirable by-product: some loans become nonperforming. The dynamic aspect to the model recognizes that nonperforming loans generated in one period will typically constrain production in a subsequent period. Moreover, bank managers have discretion over when to transform deposits into the portfolio of loans and investments so that when faced with a high risk lending environment managers can choose to save some deposits as excess reserves for use in a subsequent period when they anticipate a more favorable lending environment.