group 05 efficiency on local and foreign bank in bangladesh

GROUP- 05Bank Fund Management

Section- BCourse Instructor: MD. JOYNAL ABEDIN

EFFICIENCY MEASUREMENT OF LOCAL AND FOREIGN BANK IN BANGLADESH

No Particulars Page No

i | P a g e

1 Introduction 1

2 The banking System 1

2.1 The evolution of banking system 1-2

2.2 Banking system Characteristics 2

3 Literature review 3

3.1 Nonparametric approach 3

3.2 Parametric approach 3-4

4 Empirical Methodology 4

5 Data and construction of variables 4

5.1 Data 4

5.2 Variables 4-5

5.2.1 Bank efficiency measure 5-17

5.2.2 Bank regulation and supervision 17

5.2.3 Specific characteristic of banking financial institutions

17-18

6 Results 18-20

7 Conclusion 20

8 References 21-22

9 Appendix 22-25

ii | P a g e

1. Introduction: Bank is a financial intermediary which is accepting the deposits and granting the loans.

They offer the widest range of financial services. From ancient time to today bank is

providing good bulk amount of services. In the banking sector there is huge qualitative

changes occurred. Man’s life becoming harder day by day if he is not enjoying the

facilities of Bank. Bank is very old institution that is contributing toward the

development of any economy and is treated as an important service industry in modern

world. In Bangladesh banks are main vehicles for mobilizing invisible funds and channel

those funds to faster the growth of productive sectors of the economy in the absence of a

healthy capital market. After the creation of Bangladesh, then the government

nationalized all the commercial banks and financial institution functioning in the East

Pakistan. But during 1982-83 government allowed commercial bank to operate in private

sector side by side with the public sector banks to start a meaningful and constructive

competition in the banking sector. Now about two decades in Bangladesh that bank is

operating under both public and private sector. Several analysis has been done to identify

which sector is able is in the lead position. Somehow industrial revolution affected by the

profound changes of modern banking sector.

2. The Banking System2.1 The Evolution of the banking system:

The word bank comes from the Garman word ‘‘Banck’’, Italian word ‘‘Banco”, and French word ‘‘Banque/Bancus’’. Banks have been important financial institution linking the economies of the world. Historically banks functioned to provide loan, deposit and currency exchange services. Before 1640 there was no such a word as ‘Banking’. In 1157 the first bank called the ‘Bank of Venice’ was established in Venice, Italy. But the modern banking system with the English goldsmiths only after 1640.Then in 1770 the first bank of India was established by Alexander & Co which was ‘Bank of Hindustan’. Again in 1806 the first bank in the modern sense was established in the Bengal Presidency as the Bank of Bengal. And the next stage was the goldsmith. The goldsmith was the founder of special precautions against theft of gold and ornaments. As this practice spread, he thought to start charging something for talking care of the money, ornaments and bullion. To talking prove he issued a receipt for receiving valuables .At this time the gold and silver had no marks of owner, but the goldsmith also started lending them. Since the goldsmith issued receipt and give the holder equal amount of money on demand, the receipt plays like cheques as a medium of exchange and a means of payment. At the last the reason for growing of banking system is the moneylender. He saw that the withdrawals of coins were much less than the deposits with him. That’s why he thought advancing the coins on loan against charging interest.

1 | P a g e

Thus the money lender became a banker by participating two functions of modern banking that are accepting deposits and advancing loans.

With times these banking services become increasingly important to a nation’s economic advancement. Evaluating the level of efficiency of the banking system is an extremely important and difficult task. The methodology of the comparative evaluation of the level of effectiveness by the government toward the banking system should consist of the following stages: introduction of performance indicators of the banking activity, standardization of the actual values, use of cluster analysis, and economic interpretation of the achieved results. The most important indicators of the banking system are the ROA and the ROE. The banking system functions efficiently, when it is constantly maintains profitability at a sufficient level with ROA over 1%, and ROE over 7%.Regulatory capital adequacy ratio reflects the bank’s ability to promptly and fully pay for its obligations which are arise from trade, credit, or other monetary operations nature. Regulatory capital adequacy ratio is set to prevent excessive rearrangements by a bank with a credit risk and a risk of non- return of banking assets to bank creditors. Standard value of regulatory capital adequacy ratios, under the Basel regulations, should not be less than 8%. Thus the banks evaluate their banking system efficiency.

2.2 Banking System characteristics:

Banking system plays a mentionable role in the world for their economic growth as well as currency factor. Majority development for a country depends on banking sector which is a financial intermediary accepting deposits and granting loans, offer the widest menu of service to any financial institution. Banks also have a profound effect on our lives, influencing the availability of jobs, the cost of living, the adequacy of our saving and the quality of our existence.Banking system involves some important characteristics. The following characteristics as written:-

Dealing in Money: A bank deals money by lending and deposits them among the people.

Individual/Firm/Company: A bank might be a firm, a person or a company. Acceptance of Deposits: A bank accepts money from the people whose

have surplus of money. o Giving Advances: A bank gives advances to those who require it for

different purpose.o Payment and Withdrawal: A bank gives payment and withdrawal

facilities in term of cheques and drafts. Agency and Utility service: A bank gives the facilities of agency services and

utility services. Profit and Service Orientation: A bank is a profit and service oriented

institution. Connecting Link: A bank is connection linkers of borrowers and lenders of

money. Name Identity: A bank should always put the word “ bank’’ to its name to

aware people that it is dealing in money. Banking in Business Sector: A bank’s priority activity should be to do

business of banking which should not be subsidiary to any other business.

2 | P a g e

3. Literature Review:

3.1 The nonparametric approach:

For banking sectors the parametric approach is more feasible rather than non-parametric approach. That’s why non-parametric approach is not applicable for this report.

3.2 The parametric approach:

Johan and Hui [3] compared the financial performance of different ownership structured commercial banks in Nepal based on their financial characteristics by taking CAMEL model into consideration. They analyzed eighteen commercial banks for the 2005-2010 periods. The results have shown that public sector banks are significantly less efficient than their counterparts. This study also revealed that return on assets is significantly influenced by capital adequacy ratio, interest expenses to total loan and net interest margin while capital adequacy ratio has considerable effect on return on equity.

San et al [4] analyzed the performance of domestic and foreign banks operated in Malaysia using Data Envelopment Analysis. For this purpose, they used data of 9 domestic and 12 foreign banks. Their results revealed that the domestic banks are more efficient and competitive than foreign banks.

Aktaş and Kargın [2] compared foreign and domestic banks in Turkish banking sector using varying financial ratios. According to the results of their study, foreign banks had higher “capital adequacy” and “liquidity” ratios. They also revealed that there are statistically significant differences about the ratios related with “revenue-cost structure between foreign and domestic commercial banks activated in Turkish Banking Sector.

Ally [5] analyzed the financial performance of commercial banking sector in Tanzania for the period of 2006 to 2012 by using analysis of variance (ANOVA) to test the significant mean differences of profitability among peer bank groups. This study shows that there are significant differences among bank groups in terms of ROE and NIM, but not in terms of ROA.

Claessens et al [1] examined how net interest margins, overhead, taxes paid, and profitability differ between foreign and domestic banks by using 7900 bank observations from 80 countries for the period of 1988-1995. They found that foreign banks have higher profits than domestic banks in developing countries, but the opposite is the case for developed countries. Their estimation results suggested that

3 | P a g e

an increased presence of foreign banks is associated with a reduction in profitability and margins for domestic banks.

4. Empirical Methodology:To build this report some approaches are taken. Here, 3 foreign banks and 3 local banks are used to measure the efficiency of banks and using the annual reports to get some valuable information to calculate the ratios. 4 ratios were used to measure the efficiency of those banks. Those ratios are –

1. Total Equity to Total Asset: It means that how much equity is available against 1 BDT total asset.

2. Liquid Asset to Total Asset: It means that how much liquid asset or cash or money is available against 1 BDT total asset.

3. Total Non-earning Asset to Total Asset: It means that how much non-earning asset is available against 1 BDT total asset.

4. Cost Efficiency: It means that how much expense against 1 BDT revenue they earned.

5. Data and Construction of Variables:This study is based on secondary data. For this report data are collected from annual reports of Bangladesh Bank and other related websites. Moreover, the journals, articles, and reports have been used.

5.1 Data:

For constructing the report data were crucial. Ms excel is the place where all the data are arranged in orderly manner. An appendix is best suited to place all the Ms excel. To construct the report 3 foreign & 3 local banks were taken. For data, year 2011-2014 were used.

5.2 Variables:

To analyze the financial performance of banking sector different variables are included in this study, they are as follow:

Equity- Equity is very important for banks. In banking sectors, shareholder’s equity is mainly used as total equity. It shows the ownership of assets.

Assets- Assets includes all fixed asset and other current assets, long-term assets.

Deposits-Deposits are considered as banks‟ main source of funding and are the lowest cost of funds. The more deposits are transformed into loans, the higher the interest margin and profit. Hence, deposits generally have

4 | P a g e

positive impact on profitability of the banks. But if a bank can’t transform its deposits into loans efficiently it may bring negative impact on profitability also.

Capital Adequacy- Capital adequacy is a measure of the financial strength of a bank, usually express as a ratio of its shareholders‟ fund to total assets. The ratio reflects the ability of a bank to withstand the unanticipated losses. This ratio has a positive relationship with the financial soundness of the bank.

5.2.1 Bank Efficiency measure:

Local Bank:

1. City Bank:A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.1540.139

0.123

0.047

Total Equity to total Asset


B. Liquid Asset to Total Asset: LIQUID ASSET/TOTAL ASSET

5 | P a g e

2011 2012 2013 20140

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.065 0.0650.071

0.046

Liquid Asset to Total Asset


C. Total Non-earning asset to total asset: TOTAL NON EARNING ASSET/TOTAL ASSET

2011 2012 2013 20140.042

0.044

0.046

0.048

0.05

0.052

0.054

0.052

0.046 0.046 0.046

Total non-earning asset to total asset

D. Cost Efficiency: EXPENSE/REVENUE

6 | P a g e

2011 2012 2013 20140

0.2

0.4

0.6

0.8

1

1.2

1.4

1.205

0.330000000000001

0.630000000000001

0.763000000000001

Cost Efficiency

Cost Efficiency

2. Dutch Bangla Bank Ltd. :A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140.064

0.065

0.066

0.067

0.068

0.069

0.07

0.071

0.072

0.073

0.0740.073

0.07

0.068

0.067




7 | P a g e

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.086

0.121 0.1170.109

Liquid Asset to Total Asse



2011 2012 2013 20140

0.005

0.01

0.015

0.02

0.025

0.03

0.0350.032

0.03

0.0220.02



8 | P a g e

2011 2012 2013 20140.6

0.62

0.64

0.66

0.68

0.7

0.72

0.74

0.76

0.78

0.661000000000001

0.714000000000001

0.771000000000001

0.743000000000001

Cost Efficiency

Cost Efficiency

3. Southeast Bank Ltd. :A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.140.123

0.103 0.0990000000000001

0.00400000000000001




9 | P a g e

2011 2012 2013 20140

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.1

0.057 0.057 0.058

0.092




2011 2012 2013 20140

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

0.045

0.050.046

0.04

0.0350.033



10 | P a g e

2011 2012 2013 20140

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

0.848000000000001

1.117

1.517

1.045

Cost Efficiency

Cost Efficiency

Foreign Bank:

1. HSBC Bank:A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.134

0.165 0.162 0.162




11 | P a g e

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.112

0.089

0.130.119




2011 2012 2013 20140

0.001

0.002

0.003

0.004

0.005

0.006

0.005

0.004

0.003

0.005



12 | P a g e

2011 2012 2013 20140

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.432 0.444

0.675000000000001

0.588

Cost Efficiency

Cost Efficiency

2. Woori Bank Ltd. :A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.291

0.173

0.3910.374




13 | P a g e

2011 2012 2013 20140

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.303

0.116

0.377 0.374




2011 2012 2013 20140

0.002

0.004

0.006

0.008

0.01

0.012

0.014

0.001 0.001

0.009

0.013



14 | P a g e

2011 2012 2013 20140

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

4.351

0.3210.646

1.016

Cost Efficiency

Cost Efficiency

3. Standard Chartered Bank:A. Total Equity to total Asset: TOTAL EQUITY/TOTAL ASSET

2011 2012 2013 20140.095

0.1

0.105

0.11

0.115

0.12

0.125

0.13

0.108 0.1070.105

0.125




15 | P a g e

2011 2012 2013 20140

0.02

0.04

0.06

0.08

0.1

0.12

0.1

0.0830000000000001 0.082

0.074




2011 2012 2013 20140

0.001

0.002

0.003

0.004

0.005

0.006

0.007

0.008

0.007

0.006

0.005 0.005



16 | P a g e

2011 2012 2013 20140

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.517

0.428

0.503

0.588

Cost Efficiency

Cost Efficiency

5.2.2 Bank Regulation and Supervision:

The study used three key regulatory and supervisory variables. The variable RESTRICT measures the extent of bank regulations that restrict activities that generate non-interest income. This variable indicates if bank activities in the securities, insurance, and real estate markets and bank ownership and control of nonfinancial firms are unrestricted, permitted, restricted or prohibited. Higher values indicate a higher level of restrictions.

The bank supervision variables are represented by the intensity of private monitoring (MONITOR) and official supervision of banks (OFFICIAL). Both variables were derived as given in Barth, Caprio and Levine (2004, 2006). The MONITOR index contains information regarding the external auditing of banks, ratings by international agencies, the availability of an explicit deposit insurance scheme, and the disclosure of risk-management procedures to the public. The OFFICIAL index provides information regarding the extent to which regulators have the authority to take regulatory actions. Higher values for MONITOR and OFFICIAL indicate greater private oversight and more official supervisory power, respectively.

5.2.3. Specific characteristic of banking financial institutions:

We used several variables to capture specific banking activities that could directly affect the productive performance of banks. Several studies have highlighted the importance of capital requirements. Higher capital requirements will have a direct impact on the risk-taking activities of the owners of the bank. To capture this effect, we introduced the total equity to total assets ratio. To capture the liquidity effects of the banks we used loan loss

17 | P a g e

reserve to total loans ratio, liquid assets to total assets ratio, and non-earning assets to total assets ratio. To account for the off-balance sheet activities of banks, we used off-balance sheet to total assets ratio.

The impact of foreign ownership and partnership on bank performance is given by a dummy variable, FOREIGN, which represents majority foreign ownership of more than 50 percent equity ownership of the banks. We also show whether the bank is a public bank (PUBLIC), wherein the government has more than 25 percent ownership. To capture the moral hazard issues related to banks taking ownership of banks and private companies taking ownership of banks, we introduce the dummy variable SUBSIDIARY that indicates if the bank is a subsidiary or if it has a subsidiary. We also introduce dummy variables to capture the types of banking activities of the bank.

6. Result:

Total Equity to Total Asset:

In general, higher equity ratio is good for a bank. Higher ratio shows that the potential investors are willing to invest in this company.

i. Local Bank:1. City Bank Ltd.: In 2011, they got highest equity ratio (15.4%) between

consecutive last 4 years (2014-2011). But this was very unhealthy ratio for this bank. The equity ratio 15.4% means that 15.4% of company’s shares are owned by shareholders and not creditors.

2. Dutch-Bangla Bank ltd.: In 2011, they got highest equity ratio (7.3%) which was not good. It is decreased on year to year. So they are not in a favorable position in that case.

3. Southeast Bank Ltd.: They also got highest ratio in 2011 (12.3%). But in 2014, they got very unfavorable equity ratio (4%).

ii. Foreign Bank:1. HSBC Bank: In 2012, they got highest equity ratio (16.5%) and also

their equity are well balanced in year to year. Ratio is not fluctuated frequently.

2. WOORI Bank: They got highest ratio in 2013 (39.1%) which is more favorable. And all 4 years ratios are good for this bank.

3. Standard Chartered Bank: In 2014, they have got highest equity ratio (12.5%). But it’s not favorable for an organization.

When the comparison comes between local bank and foreign bank in case of equity ratio, the foreign banks are more efficient.

Liquid Asset to Total Asset:

In general, liquid asset or liquid cash is considered as an idle asset or cash for an organization. But there has some conflict about the specific liquid asset or cash portion. But experts say that the liquid asset ratio is 0.25 or less than 0.25 favorable for an organization.

i. Local Bank:

18 | P a g e

1. City Bank: in 2014, they have got lowest liquid asset ratio (0.046). It is favorable condition for city bank because they don’t have excess idle money or asset. But the

2. Dutch-Bangla Bank: DBBL liquid ratios are also in favorable position. 3. Southeast Bank ltd.: They are also in a good position.

ii. Foreign Banks:1. HSBC Bank: HSBC Bank also maintains their liquidity ratio in a good

manner. Last 4 years they have got less than 0.25 liquid asset or cash against total asset.

2. WOORI Bank: They have got more liquid asset or cash than any other local and foreign banks in last 4 years. But in general, liquid asset is considered as an idle asset or money or cash. So this is not favorable for WOORI Bank.

3. Standard Chartered Bank: They are maintaining a favorable liquidity ratio in last 4 years. And it’s very good to see that the liquid asset is being decreased year to year. So their asset or cash are generated more money rather than idle asset or cash or money.

When the arguments are raised between local banks and foreign banks in case of liquid asset to total asset, all banks are more or less same in efficiency level. But local banks are efficient than foreign banks in case of liquidity. The ratio positions are good for the local banks.

Total Non-earning Asset to Total Asset:

If the non-earning asset is more, the banking efficiency is good.

i. Local Bank:1. City Bank: in 2011, they got highest non- earning asset ratio. But it

decreased a lot after 2011. So the situation is not favorable for city bank.

2. Dutch-Bangla Bank: Nor-earning Asset ratio is decreased year to year since 2011 for DBBL which is not favorable.

3. Southeast Bank: They got good non-earning asset ratio since 2011. But its decreased year to year.

ii. Foreign Bank:1. HSBC Bank: They got very balanced non-earning asset ratio. But its

little bit poor for the bank. Because they have less branches.2. WOORI Bank: They also got lower non-earning asset ratio. But recent

year 2013 and 2014, they were improved. Because they increased their fixed asset.

3. Standard Chartered Bank: They were more or less same to HSBC bank.

Cost Efficiency:

Cost efficiency means that how much expense is occurred against revenue earned.

i. Local Bank:

19 | P a g e

1. City Bank: In 2011, they had good cost efficiency ratio. But the ratio was fluctuated. Although it’s fluctuated, they were in a favorable position.

2. Dutch-Bangla Bank: They had cost efficiency ratio less 1. So it’s not so favorable.

3. Southeast Bank: SEBL is in a very good position. Their cost efficiency ratio more than 1.

ii. Foreign Bank: 1. HSBC Bank: They got less 1 in cost efficiency ratio. So they are not in

favorable position after all.2. WOORI Bank: They were in a very good position in 2011. But in 2012

and 2013, they had less than 1. But 2014 they were improved.3. Standard Chartered Bank: They had less than 1 in efficiency ratio.

They are not in a favorable position.

7. Conclusion:

By analyzing the data and variables it has found that foreign banks are efficient than the

local banks. For better economy both the foreign and local banks have to be efficient. Banks are just one part of the world of financial institutions, standing alongside investment banks, insurance companies, finance companies, investment managers and other companies that profit from the creation and flow of money .Bank is a financial institution and intermediary. It collects money from surplus economic units as different types of deposits and lends money to deficit economic units as different types of loans. Mainly Banks collects money from individual/group who have abundant of money and lends the money to individual/group who in need for money. Bank is a multi-work institution. As banks are profit -earning concern; they collect deposit at the lowest possible cost and provide loans and advances at higher cost. The differences between two are the profit for the bank. With the pace of financial market liberalization, financial institutions are facing increasing competition and greater volatility from external shocks. In such an environment, efficient banks and financial institutions will have greater competitive advantage. The reason behind choosing banking sector for this study is that it plays an important role in our economy. After the liberation war, the government of Bangladesh put in a constant effort to booster our country’s banking sector. Banks have grown so extensively that it now plays a significant part in the economy. With the opening up of the economy of Bangladesh, dramatic change has been observed in the banking sector in Bangladesh.

8. References:

20 | P a g e

[1] Claessens, S., Demirgüc-Kunt, A., Huizanga, H., How does foreign entry affect domestic banking markets, Journal of Banking and Finance, Volume 25, Issue 5, , Pages 891–911, May 2001.

[2] Aktaş, H., Kargın, M., A Comparison of Financial Ratios of Foreign and Domestic Banks in Turkish Banking Sector, CBU Yönetim ve Ekonomi (Journal), Volume: 14, Issue: 2, page:25-44, Manisa, 2007.

[3] Jha, S, and Hui, X., A comparison of financial performance of commercial banks: A case study of Nepal, African Journal of Business Management, Vol. 6(25), pp. 7601-7611, 27 June, 2012.

[4] San, O., T., Theng L., L., Heng, T., B., A Comparison on Efficiency of Domestic and Foreign Banks in Malaysia: A DEA Approach, Business Management Dynamics, Vol.1, No.4, pp.33-49, Oct 2011.

[5] Ally, Z., Comparative analysis of financial performance of commercial banks in Tanzania, Research J. of Finance and Accounting, Vol.4, No.19, pp:133-143, 2013

[6] Ansari, S. and Rehman, A., Financial performance of Islamic and conventional banks in Pakistan: A comparative study, 8th International Conference on Islamic Economics and Finance, page:1-19,December 2011.

[7] Doğan, M., Comparison of financial performances of domestic and foreign banks: The case of Turkey, International Journal of Business and Social Science, Vol. 4, No. 1., pp:233-240, January 2013.

[8] Safiullah, Md., Superiority of Conventional Banks & Islamic Banks of Bangladesh: A Comparative Study, International Journal of Economics and Finance, Vol.2, No.3.,pp:199-207, August 2010.

[9] Moin, M., S., Performance of Islamic Banking and Conventional Banking in Pakistan: A Comparative Study, Master Degree Project in Finance, University of Skövde, School of Technology and Society, Master Thesis, 2008.

[10]

Goel, C. and Rekhi, C.B., A Comparative Study on the Performance of Selected Public Sector and Private Sector Banks in India, Journal of Business Management & Social Sciences Research, ISSN No: 2319-5614, Vol.2, No.7, pp:46-56, 2013.

[11 Samad, A., Hassan, M., K., The performance of Malaysian Islamic bank during 1984-

21 | P a g e

] 1997: An exploratory study, International Journal of Islamic Financial Services, V:1, N:3, pp:1-14,199.

[12]

Samad, A., Glenn, L., M., Miah, F., Inter-temporal performance: Does bank-size matter? An analysis of Utah banks, Banks and Bank Systems, Volume 1, Issue 2, page 137-144, 2006

[13]

Tarus, D., Chekol, Y., B., Mutwol, M., Determinants of Net Interest Margins of Commercial Banks in Kenya: A Panel Study, Procedia Economics and Finance, Vol:2, pp: 199–208, 2012.

Appendix:

1.

22 | P a g e

2.

3.

4.

23 | P a g e

5.

6.

24 | P a g e

25 | P a g e

group 05 efficiency on local and foreign bank in bangladesh

Economy & Finance