A study on the input efficiency of Korean banks and the role of equity on the banks' efficiency

In this paper, we study the input efficiency of the Korean banking industry and further investigate the role of equity on the industry’s efficiency. Particularly, for a proper inference for the role of equity on the banking efficiency, we focus on a 11-year period from 1992 to 2002 in which a major event of the Asian financial crisis occurred in 1997. By employing a non-parametric approach of data envelope analysis, we construct the reference technology from the sample, and use the input distance function for the measurement of input efficiency. Our results are as follows. Technical and allocative efficiency of the Korean banking industry severely deteriorated during the Asian financial crisis from 1997 to 1998, resulting in further reduction in cost efficiency. The negative impact of the crisis on these efficiencies was greater for regional banks than national ones. Regarding the role of equity on efficiency, the size of equity relative to assets is found to be not a significant factor separating efficient banks from inefficient ones in the pre-crisis and even in the crisis period. However, during the recovery period from 1999 to 2002, higher equity ratios are significantly related to improvement of the Korean banking industry’s efficiency. Our study suggests that it is important to have a proper size of equity in a bank’s capital to enhance operational efficiency of banking inputs, especially in the aftermath of a negative event.