Cost efficiency and banking performances in a partial universal banking system: a panel smooth threshold model

Abstract

This paper studies the cost efficiency of bank in a partial universal banking system (PUBS), Taiwan. Instead of assuming one common technology in the bank cost function, two technologies are assumed to be imbedded in the cost function. We use fee revenues as threshold to divide the banks into two technologies. A bank's fee revenues exceeding the threshold is designated as German technology while falling below the threshold is designated as U.S. technology. The panel smooth transition model is adopted, which allows banks to smoothly adjust between the two technologies. We suggest two criteria, overbanking and the trend-toward-fee revenues, to assess the new model's performances. With respect to scale economies, our results do find a panel smooth transition model yield more reasonable results than the conventional OLS and random effect of panel data approach. Based on the panel smooth transition model, the optimal fixed asset size is around 10 billion New Taiwan dollars. Furthermore, our estimated X-efficiency yielded by a panel smooth transition model exhibit the strongest correlation with a non-performing loan and with return on equity, followed by the random effect model and then by OLS. Adding risk into the cost function typically generates counter-intuitive results