Assessing the efficiency of South African medium-sized banks

Abstract

The economic growth and stability of any country is strongly dependent of the performance and efficiency of its financial sector, of which the banking industry forms an integral part. South Africa's financial sector is one of the most developed on the African continent, especially the banking industry in which advanced credit and management systems have been implemented. However, as is expected of a developing economy, the country's banking industry is highly concentrated, due to the dominance of the five major banks. Many authors argue that a concentrated banking industry contributes to greater financial instability, which raises concerns regarding the performance and efficiency of the smaller banks. While the efficiency of the large banks in South Africa has been analysed, little is known about the efficiency of the of the medium and small-sized banks in the country. The focus of this study was to estimate the technical and scale efficiency of the medium-sized banks of South Africa over a 13-year period from January 2004 until December 2017, which consisted of four different business cycle phases. A multi-stage Data Envelopment Analysis (DEA) model was applied using the intermediation approach with an input-oriented measure under the constant returns to scale and variable returns to scale model specifications to determine the efficiency levels of the medium-sized banks. Total deposits, central bank and money, total equity, and South Africa (SA) group and finance were used as inputs, while other liabilities, deposits, loans and advances, and investments and bills were used as the outputs in the analysis. The hierarchal cluster analysis, using the single linkage method was applied to identify the medium-sized banks, which were namely: African Bank Ltd. (AB), Capitec Bank (CB), Deutsche Bank AG (DB), Investec South Africa (IB), JP Morgan Chase Bank (JPM), and The Hongkong and Shanghai Banking Corporation Ltd.-Johannesburg Branch (HSBC). IB was identified as the most technical efficient bank, followed by JPM and DB as the $2^{\mathrm{th}}$ and $3^{\mathrm{rd}}$-most technical efficient banks. AB was ranked $4^{\mathrm{th}}$, followed by HSBC and CB that were ranked $5^{\mathrm{th}}$ and $6^{\mathrm{th}}$ respectively. In contrast, JPM was identified as the medium-sized bank that generally exhibited the highest scale efficiency, followed by DB as the $2^{\mathrm{th}}$-most scale efficient, and AB and HSBC collectively $3^{\mathrm{rd}}$. CB was ranked $4^{\mathrm{th}}$, followed by IB which exhibited the highest level of inefficiency. It is concluded that the medium-sized banks show some signs of technical and scale inefficiency, especially in terms of central bank and money, and SA group and finance as inputs. This is somewhat concerning, since inefficient banks are more likely to experience higher levels of exposure to risks. Various recommendations are therefore made that can be considered by the banks to improve their respective efficiencies. It was also found that the technical and scale efficiency scores did not display a clear correlation with the upward and downward business cycle phase. Often, upward phases correlated with suppressed efficiency scores, while increased efficiency scores were noted for the downward phases, especially during Phase 2 in which the global financial crisis occurred. This behaviour, especially during Phase 2, was also found in other studies on the efficiency levels of the major South African banks and is thought to be due to conservative banking practises that are supported by strict regulatory frameworks that limits foreign risk.