Research proposal .ps



T h e I s l a m i c U n i v e r s i t y - G a z a

Higher Education Deanship

Faculty of commerce

Accounting and Finance Department

Measuring the Technical Efficiency of the Banking Sector in Palestine Using the Data Envelopment

Analysis Approach

Prepared By:

Ehab A. Hammad

Supervised By:

Prof. Yousif H. Ashour

May 2007

( Table of Contents:

( Abbreviations 2

( Background 3-4

( The Importance of the Study 5

( Problem Statement 6

(Questions 7

(Objectives 8

( Hypotheses 8

( Previous Studies 9

( Research Methodology 10-11

( Time Scale 12

( Structure 13

( References 14-15

( Abbreviations

|No. |Abbrev. |Description |

| |DCF |Direct Credit Facilitation |

| |DEA |Data Envelopment Analysis |

| |FA |Fixed Assets |

| |OEA |Other Earning Assets |

| |PMA |Palestinian Monetary Authority |

| |PTE |Pure Technical Efficiency. |

| |ROA |Return on Assets. |

| |TD |Total Deposits |

| |TE |Technical Efficiency. |

(Background

Financial institutions in a community can form the core of economic development, because of different reasons such as: (Scott & Timothy 2006)

▪ Provide money for personal borrowings

▪ Finance business sectors

▪ Lend governments and other huge projects

▪ Help in assessing and carrying out the government monetary and economic policies

▪ Provide a wide variety of financial services

Therefore, banks play a vital role in developing the different economic sectors, through them the stream of money are managed and controlled, investment opportunities are utilized and channels of funds can target productive and profitable projects. (Ismail 2004)

Based on that, the efficiency of the financial institutions is crucial for the whole economy, bank failures become a threat on the banking system, to meet that risk of failure, several models and techniques were developed to evaluate and analyze the banks performance.

Most of the evaluation models use the financial ratios analysis (profitability ratio, burden ratio, efficiency ratio .etc) and all of the ratios used to make comparison with the peers.

A key point is that it become increasingly difficult to evaluate economic entities based on reported financial statements because managers can manipulate them to disguise potential problems (Scott & Timothy 2006). A relatively new model was developed and employed to measure the relative efficiency for banks performance, this model called Data Envelopment Analysis (DEA).

Recently most of the studies focus on the developed economies fore example Drake and Hall (2003), Cavallo and Rossi (2002), Maudos et al (2002), most of these studies examined the banking sector efficiency in the developed countries. Berger and Humphrey (1997) surveyed 130 studies that have employed 130 frontier analysis in 21 country, only 8 were done in the developing countries and it seems none of them conducted in Palestine.

By the end of 2005 the number of bank in The Palestinian territories raised to 22 (10 national and 12 foreign) banks, with 137 (63 national and 74 foreign) branches. (2007)

(The Importance of Study

The importance of this study is driven from the following points:

▪ Since there is no well-developed capital and debt market in Palestine, the majority of the investments and savings are through the banking system, and for the public interest, it is valuable to find out TE of each bank and for the banking sector as a whole.

▪ The banking system in the developing countries like Palestine is facing increasing competition due to the globalization of the financial system, so it is important for the banks to realize the factors of challenge and means to respond to them.

▪ The impact or the pass-through of the central bank (PMA in Palestinian case) policies depends on the competitive structure and efficiency of the banking system, the study will help in assessing the banking sector efficiency and the sources of inefficiency (technical or scale inefficiency), that will provide a helpful background to PMA in this regard.

▪ To find out new insights on banking activities evaluation, new approach other than the conventional approach (financial ratios analysis) and to help in the proper merging between the two approaches when ever it’s possible, in other words, to add knowledge to the science of banking evaluation and analysis.

(Problem Statement

As stated in the background the financial institution are very important to the development of economy and play a crucial role in planning the monetary policy in any state, the research problem could be summarize in the following points:

• It become increasingly difficult to evaluate economic entities based on reported financial statements because managers can manipulate them to disguise potential problems (Scott & Timothy 2006).

• According the researcher knowledge, there are no previous studies handled the subject of technical efficiency in Palestine.

• Data envelopment analysis (DEA) is receiving increasing importance as a tool of evaluating and improving the performance of manufacturing and service operations. It has been extensively applied in the performance evaluation and benchmarking of schools, hospitals, bank branches, production plants, etc (Charnes et al., 1994), the model could identify new problems in operation and new insight to improve efficiency.

Accordingly the study aims to investigate the technical efficiency (TE) of banks working in Palestine, which means to determine the relative efficiency for the banks working in Palestine and to assess the efficiency among the banks base on their ownership and philosophy or culture (national, foreign) and (Islamic and commercial) banks.

The study also aims employ the DEA approach to measure the relative efficiencies of the banks working in Palestine. DEA is recognized as a modern approach of assessing the performance of organizations and their functional units, this approach entered in several academic areas (management science, operational research, economics and mathematics) and had been applied in different fields and sectors (industry, banking, agriculture, education and health care)

(Research Questions

There are several question should be answered by research, these questions are:

1. What are the efficiency scores of the banks working in Palestinian territories?

2. What is the source of technical inefficiency in the banking sector in Palestine?

3. What are the variables to be improved and the required movements (improvements) for inefficient banks to improve their technical efficiency?

4. What are the features of the so-called efficient and inefficient banks?

5. Employing the PTE as score of efficiency, is there equality of ROAs between different groups of efficient and inefficient banks in Palestine?

(Research objectives

1. Measuring the efficiency scores for the banks operating in Palestine using the DEA model

2. Indentifying the proper improvements needed by inefficient banks in Palestine.

3. Finding out the source of technical inefficiency in the banking sector in Palestine (the technical inefficiency referred to Pure technical inefficiency or Scale inefficiency)

4. Identifying the features of the so-called efficient and inefficient banks

5. Finding out if there is equality of Return On Assets (ROAs) between different groups of efficient and inefficient banks in Palestine.

(Research Hypothesis

• There are no differences in efficiency scores among different banks based on the DEA approach.

• The banks in Palestine are working at their optimal scale and the source of inefficiency is only technical.

• There are no common features for so called efficient and inefficient banks working in Palestine.

• There is equality of ROAs between different groups of efficient and inefficient banks in Palestine.

(Pervious Studies

According to the researcher knowledge this study is the first study in Palestine . As mentioned previously in the background section, Berger and Humphrey (1997) surveyed 130 studies that have employed 130 frontier analysis in 21 country, only 8 were done in the developing countries. So we can imagine how rare such studies in the Arab world and hence all of our literature sources will be foreign sources, herein below some of past studies and articles:

1- Ismail M. (2004), the aim of this study is to measure the technical efficiency of the Malaysian commercial banks and to identify the characteristics of the so called efficient banks, the study found that the average pure technical efficiency score is 93%, and by ownership it found that foreign banks more efficient than local banks.

2 – Robert M. (2003), the aim of the study is to investigate the relative efficiency level of the large UK retail banks during the period 1983-1995. It finds that the mean efficiency level are low in comparison to past studies and it finds that scale inefficiencies dominate pure technical inefficiencies and less big banks are more likely to report technical inefficiency.

3 – Kent M. (2005): the study seeks to examine the technical efficiency of the commercial banks in Malaysia, the study found that main source of the productivity growth is technical change rather than improvement in efficiency and foreign banks are more efficient than domestic banks.

4 – Allen and Robert (1997): this paper examined the intersection between problem loan literature and bank efficiency literature, the results were ambiguous concerning whether or not researchers should control for problem loans in efficiency estimations.

(Methodology

• The research will adopt both of the known research approaches, the deductive and inductive research approaches. The deductive approach through examining the research assumptions (hypothesis) and the inductive approach through studying the system and collecting more information for further analysis

• The research will use the multi-methods to find out the research results and conclusion, the research will apply the DEA technique (which is non statistical technique) to measure the relative efficiency for the banks and it will examine the results or efficiency scores by using statistical model (regression analysis) to find out if there is statistical relation with banks profitability.

• Regarding the data collection, the research will obtain primary data from banks' financial statements, banks administrative report and from the Palestinian Monetary Authority (PMA).

• The study sample will include 16 banks of working banks in Palestine (21 Bank) covering 4 years period (2002-2005), the study will be cross sectional study and not time series study.

Model inputs and outputs:

Regarding the appropriate inputs and out puts to be employed by DEA model for banks, there is debate and there are two main approaches that can be used to determine the bank inputs and outputs

Intermediate approach: By the approach, the selection made based on the bank's assets, liabilities. Bank assets including labor represent the inputs, and liabilities represent the outputs.

Production approach: which considers the bank as normal company or producer, and hence the inputs are the physical elements such as labor and capital and all other assets and liabilities are outputs, this approach argued that all deposits should be treated as output since they are produced by capital and labor.

In the research, the first approach will be adopted (intermediate approach) because from the research point of view, it is more representative of research objectives and it measures the efficiency of operation rather than capital investment efficiency.

Research variables (5 variables)

Inputs:

1. Labor represented by the number of employees (LAB)

2. Fixed Assets (FA)

3. Total Deposits (TA) …. Including demand, saving and time deposits

Outputs:

1. Direct Credit Facilitation (DCF) ….including loans

2. Other Earning Assets (OEA) ……. mainly investments in stocks

(Timescale

Year 2007

|Activity |May |June |July |August |

| |2007 |2007 |2007 |2007 |

W1W2W3W4W1W2W3W4W1W2W3W4W1W2W3W4Review literatureFinalize objectivesDraft literature reviewReview methodology literatureChoose research strategyAgree formal access to data collectionCollecting dataData analysisDraft findings chapterWitting the first draft of the reportWriting final project report

(Research structure

The research is consist of four chapters (sections)

Chapter One: Introduction (includes hypothesis, questions, objectives, and purpose)

Chapter Two: Theoretical part of the study (includes literature review)

Chapter Three: Data & Methodology

Chapter Four: Findings and Analysis (implementing the model and analyzing the results)

Chapter Five: Conclusions and Recommendations

(References

Allen R., Athanassopoulos A., Dyson, R.G. and Thanassoulis, E., (1997): Weight restrictions and value judgments in data envelopment analysis, evolution, development and future directions, Annals of Operations Research 73, 13-34.

Berger, A.N., and Humphrey, D.B. 1997. “Efficiency of financial institutions: international survey and directions for future research”, European Journal of Operational Research, 98, pp. 175-212.

Cavallo, L., and Rossi, S.P.S. 2002. “Do environmental variables affect the performance and technical efficiency of the European banking systems? A parametric analysis using the stochastic frontier approach”, the European Journal of Finance, 8, pp. 123-126.

Drake, L., and Hall, M.J.B. 2002. “Efficiency in Hardy, D.C., and di Patti, B.E. 2001. “Bank re form and bank efficiency in Pakistan”, IMF Working Paper, WP/01/138.

Ismail M. (2004): A DEA analysis for bank performance in Malaysia, Working Paper, Aston University, UK.

Kent K. and Ismail, M. (2002): Efficiency and Productivity Growth of Domestic and Foreign Commercial Banks in Malaysia, Working Paper, Cardiff University, E2006/2.

Maudos, J., Pastor, J.M., Perez, F., and Quesada, J. 2002. “Cost and profit efficiency in European banks”, Journal of International Financial Markets, Institutions and Money, 12, pp. 33- 58.

Robert M. Webb. 2003 "Levels of efficiency in UK retail banks: a DEA window analysis", international journal of the economics of business, 10, pp 305-322.

Scott S. MacDonald and Timothy, W. Koch (2006): Management of Banking (sixth edition), Thomson Corporation, USA.



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A thesis presented in partial fulfillment of the requirement for the master degree

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