Analyzing for profit efficiency of banks with undesirable output

Abstract

The primary objective of commercial banks is to maximize profit, but the usual ratio approach may encounter a problem when observed profit equals zero. This study uses the Nerlovian profit indicator, based on the difference rather than the ratio approach, to measure a profit efficiency indicator. We further decompose the profit efficiency indicator into technical and allocation efficiencies. The dataset consists of commercial banks from 1999 to 2007 in Taiwan. The empirical results show: (1) the shadow price affects the profit efficiency; (2) profit efficiency mainly comes from allocation efficiency; (3) the profit efficiency and allocation efficiency is better in old banks than in new ones; (4) the profit efficiency and allocation efficiency of banks belonging to a financial holding company are significantly higher than those not belonging to a financial holding company; (5) the diversification is really suitable for banking service in Taiwan.