Assessing the performance of the Latin American and Caribbean banking industry: Are domestic and foreign banks so different?

Abstract

This paper studies the relative performance of domestic and foreign banks in the Latin American and Caribbean banking industry. Data Envelopment Analysis is used to compute technical efficiency scores for the years 2001 and 2013. Our main contribution is twofold. On the one hand, we assess performance at the level of the management of specific production factors. On the other hand, we distinguish program efficiency from managerial efficiency, which allows us to evaluate whether the differences in technical efficiency between national and foreign banks are due to the use of different technologies (program efficiency) or, conversely, differences in the managerial capacities of managers in both categories of banks (managerial efficiency). The results show that foreign banks are more efficient than domestic ones, and provide evidence that the greater efficiency of foreign banks is mostly due to the superior technology they use.

Keywords:

• Latin American and Caribbean banking industry
• efficiency
• foreign capital

Public Interest Statement

The financial crises experienced by the Latin American and Caribbean region in the 1980s and the first half of the 1990s boosted reforms in the banking system aimed at adapting banks to international solvency standards, liberalizing their operational capacity, opening to international competition, and increasing their efficiency and productivity. Foreign banks were encouraged to enter these countries and were also meant to play a leadership role in the process of modernization; however, the role they actually played still remains a cause for debate. This paper contributes to this ongoing debate by analyzing performance in the regional banking industry. Our results show that foreign banks are managed more efficiently than their domestic counterparts; furthermore, this superiority is determined to a great extent by the use of more efficient technologies. Accordingly, our results appear to support the opening up of the Latin American industry, and the positive role of foreign banks in its modernization.

Acknowledgments

We would like to acknowledge the constructive comments of two anonymous referees. Francisco J. Sáez-Fernández would like to acknowledge the support of the David Rockefeller Center for Latin American Studies and Real Colegio Complutense (Harvard University).

Notes

1. Compared to domestic banks, the large size of foreign banks allows them better access to international financial markets, e.g. reducing liability costs and investing in superior technology. Foreign banks can also develop the same marketing policy for different national markets and centralize bureaucratic tasks in international centers, thus reducing unit costs.

2. Although our analysis covers the period 2001–2013, the latest available information in the Global Financial Development Database of the World Bank used in Table 1 corresponds to 2011.

3. In addition to DEA techniques, Stochastic Frontier Analysis (see Aigner, Lovell, & Schmidt, 1977; Meeusen & van Den Broeck, 1977) is a parametric technique widely employed to assess efficiency. However, we have decided in favor of DEA because it allows the calculation of input-specific efficiency scores that account for slacks, which are an important source of inefficiency in our case study. Moreover, DEA techniques facilitate the modeling of production processes with multiple outputs, as is the case of the banking industry.

4. In the case of non-profitable assets, results from these two tests are, however, contradictory.

5. The entry of new banks in the LAC banking industry from 2001 and the exit of others means that there are differences between the 2001 and 2013 samples. Additionally, observations on banks in both data-sets also belong to different moments of time.

Additional information

Funding

Funding. We would also like to gratefully acknowledge the financial support of the Spanish Ministry of Economy and Competitiveness [grant number ECO2012-32189], [grant number ECO2011-30260-C03-01].

Notes on contributors

Francisco Javier Sáez-Fernández

Francisco Javier Sáez-Fernández, PhD in Economics (University of Granada), is a lecturer at the University of Granada. He has focused part of his research on the field of water economics, where he has published in international journals, and more recently, in banking and finance, with particular interest in the study of the Latin American banking industry.

Andrés J. Picazo-Tadeo

Andrés J. Picazo-Tadeo, MSc in Economics (London School of Economics and Political Science) and PhD in Economics (University of Valencia), is a professor at the University of Valencia. One of his main areas of research is the analysis of efficiency and productivity, a field in which he has published numerous methodological and empirical papers in international journals.

Mercedes Beltrán-Esteve

Mercedes Beltrán-Esteve, PhD in Economics (University of Alicante), is a lecturer at the University of Valencia and her research focuses on the field of efficiency and productivity measurement, an area in which she has recently published in top-rated journals.