The performance evaluation of banks considering risk: an application of undesirable relation network DEA

Abstract

AbstractThe probability of losses for financial institutions fluctuates in accordance with commodity prices and risk managers’ investment tolerance. For the financial service sector, when the capital base increases through lending and investment instruments, the associated financial risks often grow proportionally higher. In other words, the inherent risk of a loss is the financial institution's principal trade. However, with risk comes reward, and therefore banks often engage in complex financial risk management in order to capitalize on their profits. To assess a bank's performance, traditional data envelopment analysis (DEA) incorporates various inputs and outputs and runs through preset formulae to arrive at conclusions. As a result, traditional DEA models often overlook the duality of risks. This paper discusses network DEA by considering the inputs and outputs of a bank's surrounding production processes as additional undesirable factors and integrates the dual nature of risks. We employ and analyze Taiwanese banks’ data to assess the local financial service sector's performance efficiency. The results provide a basis for future recommendations.