The implication of economic freedom on bank efficiency an empirical evidence of vietnamese commercial banksevidence of vietnamese commercial banks

MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY - PHUNG THI LAN NHI THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK EFFICIENCY: EMPIRICAL EVIDENCE OF VIETNAMESE COMMERCIAL BANKS MASTER THESIS IN ECONOMICS HoChiMinh City – 2020 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY - PHUNG THI LAN NHI THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK EFFICIENCY: EMPIRICAL EVIDENCE OF VIETNAMESE COMMERCIAL BANKS Major: Banking and Finance (Research Orientation) Major code: 8340201 MASTER THESIS IN ECONOMICS Supervisor: DR LE DAT CHI HoChiMinh City – 2020 DECLARATION This is to certify that this thesis entitled: “the implication of economic freedom on bank efficiency: an empirical evidence of Vietnamese commercial banks” which I submitted to fulfill the requirements for the degree of master in finance This thesis is only my original work and due supervision as well as acknowledgment have been made in the text to material used th Ho Chi Minh City, December 2019 Author Phung Thi Lan Nhi TABLE OF CONTENTS DECLARATION TABLE OF CONTENTS ABBREVIATIONS LIST OF TABLES LIST OF FIGURES ABSTRACT CHAPTER 1: INTRODUCTION 1.1 Research objectives 1.2 Research questions 1.3 Research scope and methods 1.4 Research Structure CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical Literature 2.1.1 Theory of economic freedom 2.1.1.1 The concept of economic freedom 2.1.1.2 Economic freedom Indicators 2.1.2 Theory of bank efficiency 2.1.2.1 The definition of Bank efficiency .9 2.1.2.2 Bank efficiency - financial ratios approach 2.1.2.3 Bank efficiency - Production Possibility frontier (PPF) approach 11 2.1.3 Economic freedom and bank efficiency 15 2.2 Empirical studies 17 2.2.1 Economic freedom 17 2.2.2 Financial freedom 20 2.2.3 Freedom from corruption 20 2.2.4 Government spending 22 2.2.5 Property rights .22 2.2.6 Business freedom 23 2.3 Control variables 24 2.3.1 Bank size .24 2.3.2 Equity/Assets (Bank capitalization) 25 2.3.3 ROAE (Profitability) .26 2.3.4 Loans/ Total assets (Credit risk) 26 CHAPTER 3: DATA AND METHODOLOGY 28 3.1 Research method 28 3.1.1 Data Envelopment Analysis (DEA) 28 3.1.2 The bootstrap DEA method 30 3.2 Model specification 32 3.3 Variables description .34 3.3.1 Variables for DEA 34 3.3.2 Variables for truncated regression 36 3.3.2.1 Dependent variable 36 3.3.2.2 Independent variables .36 3.4 Data source 41 CHAPTER 4: RESULTS AND DISCUSSION .42 4.1 Descriptive statistics .42 4.1.1 Efficiency estimates 42 4.1.2 Truncated regression estimates 44 4.1.3 Vietnam economic freedom overview 46 4.2 Correlation 48 4.3 Result 50 4.3.1 First stage result - Bank efficiency 50 4.3.2 Second stage result - Truncated regression result 53 4.4 Sensitive Test 60 CHAPTER 5: CONCLUSION 65 5.1 Conclusion and policy implication .65 5.2 Limitation 66 REFERENCES APPENDIX ABBREVIATIONS GCC Gulf Cooperation Council BE Bank efficiency EF Economic freedom FF Financial freedom PCBs Private Commercial Banks SOBs State Owned Banks SSA Sub- Saharan African TE Technical efficiency LIST OF TABLES Table 3.1: The overview of input and output variables to estimate bank efficiency scores (DEA) in first stage 35 Table 3.2: The overview of explanatory variables to regress in second stage 40 Table 4.1: A summary statistics of variables used to estimate the bank efficiency (first stage) in Vietnamese commercial banks from 2010 to 2018 42 Table 4.2: A summary statistics of variables used for truncated regression (second stage) to investigate economic freedom effects on bank efficiency during period 20102018 44 Table 4.3: Viet Nam economic freedom index 2010-2018 46 Table 4.4: Correlation matrix among variables in truncated regression 49 Table 4.5: Banking efficiency (TE) scores in the period 2009-2018 50 Table 4.6: the distribution of Vietnamese bank Technical Efficiency scores 201053 Table 4.7: Second stage result - Truncated regression result 53 2018 Table 4.8: Merger and Acquisition in Viet Nam commercial banks 2012-2015 60 Table 4.9: Sensitive Test 61 Table 4.10: Summarize result between second step regression and sensitivity test 64 LIST OF FIGURES Figure 2.1: Technical efficiency (TE) - Allocative efficiency (AE) - Economic efficiency (EE) 12 Figure 2.2: Input- Oriented approach (IO) 13 Figure 2.3: Output- Oriented approach (OO) 14 Figure 3.1: Variable Returns to scale Model (VRS) and constant Returns to scale Model (CRS) 30 Figure 4.1: Graph of average efficiencies of Viet Nam banks 2010-2018 52 THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK EFFICIENCY: AN EMPIRICAL EVIDENCE OF VIETNAMESE COMMERCIAL BANKS Abstract The effect of economic freedom on the economy’s well-being has been widely documented However, it is absent from the literature of empirical evidence about effect of economic freedom on the banking sector This study employs the overall economic freedom index and the index’s components which are derived from Heritage Foundation to examine their effect on Vietnamese commercial bank’s effieciency In first procedure, we obtain efficiency scores of 39 banks in Viet Nam using Data Envelopment Analysis (DEA), over the period 2010-2018 with 299 observations Then second step, the efficiency scores estimated from DEA method will be regressed on economic freedom indexes, applying truncated regression model combined with bootstrapped confidence intervals while controlling for bank specific characteristics Additionally, we carry out a sensitive analysis using a fractional logit estimator as a robustness check We find strong evidence supporting that far greater economic freedom positively impacts the efficiency of banks in Vietnamese banking sector However, the influence of different economic freedom counterparts on efficiency banking sector is not as uniform as economic freedom overall index such as the higher the degree of property rights, business freedom and freedom from corruption, the better the bank’s performance while negative effects of financial freedom on bank efficiency Besides, the empirical findings also show the positive relationship between capitalization and bank efficiency as well as credit risk and bank efficiency Keywords: Banks, economic freedom, bank efficiency, DEA, truncated regression bootstrap, Viet Nam CHAPTER 1: INTRODUCTION Efficiency is the most important aim of most business including banks, and bank efficiency is a widely discussed topic because of its vital roles in creating a stable and profitable banking sector then impact on economic growth in each country As a perspective that individual’s liberty to pursue its own economic goals will lead to efficient outcomes is as instinctive as the economics theory itself, we have seen that most countries trying to close to economic freedom However, most of studies recently just focus on the relationship between economic freedom (EF) and economic growth, less studies have been carried about effect of economic freedom on banking sector, which is one of the most important financial intermediary playing an important role in providing funding sources for economic growth (Ferreira,2015) EF plays a vital role for the banking sector’s development which categorizes of priority for developing nations and improving efficient banking system in a globalized economy Theoretically argued, EF helps to motivate the environment leading to efficiency financial system’s establishment or being innovative ideas and producing capacities, but the relationship between EF and financial activities still remains vague (Terpilih, 2010) For example, one of component in economic freedom is financial freedom, and the effect of financial freedom (FF) in emerging markets of financial markets is not easily determined as it relies on kind of reform and conditions of financial constrains in the market (Ağca et al., 2007) As a study from Kose et al., (2003), the influence of FF and integration on banking sector and economic growth is hard to determine because it could rely on the governance’s quality and institutions They points that the integration in developing countries is lack of experience, and government could create higher uncertainty shocks to banking sector resulting in lower efficiency Lou et al., (2016) find that the openness with high level leads to shrink of bank performance due to the lack of technologies, skills, the high level of competition and knowledge Higher freedom and openness also lead to the higher dependence on each others and fragility of banking sectors in the world such as credit risk, economic and information shock (Anginer and Demirguc-Kunt,2014), which can affect bank efficiency ( BE) On the other hand, Asharf (2017) finds that freedom increases the bank’s development levels by decreasing cost and bank credit risk The author also finds that freedom helps to remove barriers of trading and stimulate lending diversification which creates more bank credit demand and banks’ chances to growth Reducing restrictions in banking activities due to FF provides more potential chances to improve BE and profitability (Chen, 2009) Banks tend to have higher profitability, efficiency in countries that have high economic and freedom (Tennant and Sutherland 2014) A study from Ahamed (2017) also shows that foreign Banks’s entry following freedom policies will improve the host country’s banking system because of the “technology spillover” effects which positively impact on the financial institution’s performance In Viet Nam, particularly this time, the Association of Southeast Asian Nations (ASEAN) banking system has been preparation for the multilateral- liberalization before of the year 2020 and this is basing on the ASEAN Banking Integration Framework (ABIF) in 2014 Therefore, we expect Vietnamese banking system to achieve higher liberalization, freedom and integration level in 2020 This keys on that the importance to understand the impact of EF on BE to have appropriate actions for the aim of maintaining stable and efficient banking system for economic development in the long term This study follows this spirit by examining the impact of economic freedom on the efficiency of Vietnamese commercial banks during the period of 2010 to 2018 1.1 Research objectives - This study measures commercial bank’s efficiency in Viet Nam during the period of 2010-2018 - This study investigates the effects of economic freedom on banking efficiency in Viet Nam during the period of 2010-2018 1.2 Research questions To determine the impact of economic freedom on bank’s efficiency, this study particularly aims to answer the following questions: 89 Table Technical efficiency scores of commercial banks 2018 90 APPENDIX C- TRUNCATED REGRESSION BOOTSTRAP MODELS Table Model 1- Economic freedom overal 91 Table Model 2- Financial freedom 92 Table Model 3- Government spendings 93 Table Model 4- Property rights 94 Table Model 5- Freedom from Corruptions 95 Table Model 6- Business freedom 96 Table 7: Model Economic freedom counterparts (Financial freedom, Government spendings, Property rights, Freedom from corruptions and Business freedom) 97 APPENDIX D - SENSITIVE TEST Table Model 1- Economic freedom overal 98 Table Model 2- Financial freedom 99 Table Model 3- Government spendings 100 Table Model 4- Property rights 101 Table Model 5- Freedom from Corruptions 102 Table Model 6- Business freedom 103 Table 7: Model Economic freedom counterparts (Financial freedom, Government spendings, Property rights, Freedom from corruptions and Business freedom) ... purpose on types of bank The reason is that commercial banks are the only one type in Viet Nam and existing and not yet approval these kinds of Islamic banks, saving banks or investment banks Even that... this thesis entitled: ? ?the implication of economic freedom on bank efficiency: an empirical evidence of Vietnamese commercial banks? ?? which I submitted to fulfill the requirements for the degree of. .. OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY - PHUNG THI LAN NHI THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK EFFICIENCY: EMPIRICAL EVIDENCE OF VIETNAMESE COMMERCIAL