Year

2011

Degree Name

Doctor of Philosophy

Department

School of Economics, Faculty of Commerce

Abstract

The productivity and efficiency of the banking system is pivotal to the attainment of economic growth and development in both developed and developing economies, and is of particular interest in the wake of financial sector reform and restructuring. Over the last decade the Iranian banking industry has undergone substantial changes due to increased government regulation and technological advances, all of which have resulted in an extensive restructuring of the industry. Changes in policy have affected both state-owned banks (including commercial and specialised banks) and private banks in Iran. The existing literature lacks any rigorous empirical analyses of the impact of these reforms on the efficiency of financial institutions in Iran. The main aim of this study has been to conduct an empirical investigation of financial institutions in Iran during 2003 to 2008, with a view to assessing their technical efficiency and productivity. By investigating technical efficiency and productivity among financial institutions in Iran, this study addressed the following four questions: a) What is the mean efficiency score of financial institutions in Iran; b) What is the total factor productivity change for Iran’s financial institutions; c) Have financial reforms been successful in improving the performance of the banking sector, and has the performance of Iranian banks become more efficient after the regulatory changes; and d) and what are the major sources of inefficiency in the context of Iran’s financial institutions. Data envelopment analysis, which is a non-parametric approach, was employed in this study to analyse empirically the technical efficiency and productivity changes of financial institutions in Iran. For the first time in a developing country, this study employed a Bootstrapped Malmquist technique under Variable Returns to Scale assumptions proposed by Simar and Wilson (1999) to analyse efficiency and productivity changes in the banking industry. The bootstrap approach demonstrates that the majority of estimates obtained in this study are statistically significant. A comprehensive decomposition of the Hicks-Moorsteen TFP index, developed by O’Donnell (2010b), is applied in this thesis for the first time in a banking context to analyse efficiency and productivity changes. Based on our empirical results, from the intermediation perspective, it is found that the industry efficiency level improved over the period 2003-2006, but declined considerably after 2006. The findings also show that, while the state ownership of public banks helped to reduce the extent of their inefficiency by providing banking services to government-specified areas, the lack of independence of public banks, in particular specialised banks, from government controls led to their considerable scale and mix inefficiency particularly after the regulatory measures were introduced in 2005. From a revenue point of view public banks were significantly more mix- and technically inefficient than private banks, suggesting that the profitability maximization is the highest priority of all private banks. Finally, the empirical results indicate that no matter which approach is taken into consideration, scale inefficiency was a major source of inefficiency among the Iranian banks, in particular public banks, indicating significant room for scale optimization to facilitate higher levels of revenue and services. The industry showed negative changes in productivity over the period 2007-2008. The poor overall productivity performance of Iran’s financial sector after 2007 is a cause for concern, as it is likely to constrain the growth and development of the overall economy. As a consequence, the authorities will need to rethink their reform measures to deal with the objective of stimulating more competition in the marketplace. In order to improve scale and mix efficiency levels of public banks, the government needs to redesign their reform measures with the objective of increasing public banks’ independence. This thesis has made four significant contributions to the analysis of efficiency in financial institutions. First, this is the first study to address the issue of efficiency and productivity in Iran’s financial institutions using DEA and TFP indices for a period after 2003. After conducting an inclusive review, all previous studies of Iranian banks suffer from neglect of the importance of market structure (all have been conducted under constant returns to scale), productivity changes over time and the entry of new private banks. Thus, this study conducts an in-depth assessment of the banking sector efficiency and productivity by means of adopting different techniques. This study has employed a larger category of financial institutions than have other studies. The sample data included in this study comes from commercial banks, specialised banks and private bank. All these categories were homogenous in terms of inputs and outputs and hence it was possible to apply DEA methodology. Second, this is the first study to analyse Iranian banking efficiency over a period riddled with significant financial reforms or government interventions. Third, for the first time in a developing country, this study employed a Bootstrapped Malmquist technique under Variable Returns to Scale assumptions to analyse efficiency and productivity changes of a banking industry. Finally, this study is the first to use the new decomposition of the Hicks-Moorsteen TFP index to analyse efficiency and productivity changes in a banking context.

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