Nonlinear impacts of operating risk and demand management policy on banks’ performance: The role of leading indicator

Abstract

This paper uses the slacks-based super-efficiency DEA model and panel smooth transition regression model to evaluate the nonlinear effects of one-period lagged efficiency score, core capital ratio (the proxy of operating risk), price cost margin (the proxy of market monopoly or competition pressure) and demand management policy (monetary and fiscal policies) on banks’ current performance. In empirical, 37 New York commercial banks during 1996:3Q-2016:3Q as sample objects (i.e., 2997 observations). The empirical results show that the increases in monopoly power, leverage ratio, and real federal fund rate would reduce the banks’ performance as the leading indicator is below its threshold. However, long-run interest rates have a reverse effect. The opposite conclusion holds as the leading indicator is over the threshold. The associated policies to raise the performance are to create competitive environments and construct a dynamic leverage ratio varying with the change of the leading indicator. In addition, resolving the problem of high financing costs, reducing short-run interest rates and increasing long-run interest rates during recessionary periods are also available.