The effect of economic freedom on commercial banks efficiency, does economic freedom enhance bank’s efficiency?
List of Authors
  • Ahmad Shakhashiro , Fakarudin Kamarudin

Keyword
  • bank’s efficiency, economic freedom, DEA, European countries, technical efficiency

Abstract
  • Generally the main objective of commercial banks is to increase shareholders’ wealth via profit maximization or cost minimization. The profitability of banks is associated with the stage of bank’s efficiency. To achieve a greater efficiency level, the banks have to be aware to their profits and costs levels. Additionally, the main elements of economic freedom are individual selection, voluntary exchange, freedom to compete, and protection of person and property. Nevertheless, some essential foundations of economic freedom normally those related to property rights, regulatory restrictions and government regulations are difficult to capture with objective processes. Therefore, the degree of economic freedom is playing a vital role in financial institutions’ profitability and banks’ efficiency specifically. This study contains two stages of analysis in order to examine the efficiency of the European banking system. In the first stage, will use the “bootstrap Data Envelopment Analysis (DEA)” method to measure the efficiency of particular banks in the period 2010-2018. Then use panel data regression “(Pooled OLS, Random effect RE and Fixed effect FE)” to examine the impact of economic freedom on bank efficiency. The findings show that a strong positive connection between some indicators of the economic freedom index such as overall economic freedom, business freedom and financial freedom and the efficiency of the bank under this study. On the other hand, this study has found that property right indicator negatively affecting bank’s efficiency. Similarly tax burden indicator has a strong negative relationship with bank’s efficiency.

Reference
  • 1. Altman, Morris. (2007). How much Economic Freedom is Necessary for Economic Growth? Theory and Evidence..Economics Bulletin 15(2), 1-20.

    2. Ariff, M. and Can, L. (2008). Cost and profit efficiency of Chinese banks: A non- parametric analysis. China Economic Review 19:260-273.

    3. Avkiran, N.K. (1999). The evidence on efficiency gains: the role of mergers and the benefits to the public. Journal of Banking and Finance 23:991-1013.

    4. Banker, R.D., Charnes, A. and Cooper, W.W. (1984). Some models for estimating technical and scale inefficiencies in data envelopment analysis. Management Science 30:78-92.

    5. Bauer, P.W., Berger, A.N., Ferrier, G.D. and Humphrey, D.B. (1998). Consistency conditions for regulatory analysis of financial institutions: a comparison of frontier efficiency methods. Journal of Economics and Business 50:85-114.

    6. Berger, A. N. and Humphrey, D. B. (1997) Efficiency of financial institutions: International survey and directions for future research. European Journal of Operational Research. 98,175 212.

    7. Caminal. R. (2003). "Taxation of Banks: Modeling the Impact" European Journal of Operational Research. 149(2).

    8. Canals, J., (1993). Competitive Strategies in European Banking. Oxford University Press.

    9. Chortareas, G., C. Girardone, and A. Ventouri, (2012), “Bank Supervision, Regulation, and Efficiency: Evidence from the European Union,” Journal of Financial Stability, 51. 173–172.

    10. Chortareas, G., C. Girardone, and A. Ventouri, (2013), Financial freedom and bank efficiency: Evidence from the European Union, “Journal of Banking & Finance”, 37. 1223–1231.

    11. Chronopoulos, D.K., Liu, H., McMillan, F.J., & Wilson, J.O.S. (2015). The dynamics of US bank profitability. The European Journal of Finance, 21(5), 426-443.

    12. Coelli, T., Prasada, R. and Battese, G. (1998). An introduction to efficiency and productivity analysis, Kluwer Academic Publishers, Boston, MA.

    13. De Haan, J., and J. E. Sturm, (2000), “On the relationship between Economic Freedom and Economic Growth,” European Journal of Political Economy, Elsevier, 16(2), pp. 215-241.

    14. Demirguc-Kunt, A., L. Laeven, and R. Levine, (2004), “Regulations, Market Structure, Institutions and the Cost of Financial Intermediation,” Journal of Money, Credit, and Banking, 36(3), pp. 593-622.

    15. Farrell, M. J. (1957). The measurement of productive efficiency. Journal of Royal Statistical Society Association 120:253-281.

    16. Feldmann, H., (2009). The unemployment effects of labor regulation around the world. Journal of Comparative Economics 37, 76–90.

    17. Garza-Garciajesus G. (2012a)."Determinains of Bank Efficiency in Mexico:A Two-Stage Analysis." Applied Economics Letters 19 (12): 1679-1682.

    18. Greene, W., (1993). “The Econometric Approach to Efficiency Analysis,” in The Measurement of Productive Efficiency, H. Fried, K. Lovell, and S. Schmidt, eds., Oxford University Press, Oxford.

    19. Gujarati, D. (2002). Basic Econometric, 6th Ed., New York. Macgraw Hill.

    20. Gwartney, D. J., (2009), “Institutions, Economic Freedom, and Cross-Country Differences in Performance,” Southern Economic Journal, 75(4), pp. 937-956.

    21. Hauner, D., (2005). Explaining efficiency differences among large German and Austrian banks. Applied Economics 37 (9), 969–980.

    22. Holmes, K. R., Feulner, E. J., & O'Grady, M. A. (2008). 2008 index of economic freedom (Heritage Foundation).

    23. Jones, S. K., and M.D. Stroup, (2010). “Closed-end Country Fund Premiums and Economic Freedom,” Applied Financial Economics, 20(21), pp.1639-1649.

    24. Keen, M. (2011) The Taxation and Regulation of Financial Institutions. IMF Working Papers. WP 11/206.

    25. Levine, Ross (1998). “The Legal Environment, Banks, and Long-Run Economic Growth.” Journal of Money, Credit and Banking, 30: 3 (August, Part 2), 596-613.

    26. Lin, C., Ma, Y. and Song, F.M. (2010). Bank competition, credit information sharing and banking efficiency. Sixth Annual Asia-Pacific Economic Association Conference, Hong Kong.

    27. Love, I. (2003). Financial development and financing constraints: international evidence from the structural investment model. The Review of Financial Studies 16:765-791.

    28. Milton Friedman, (1962), Capitalism and Freedom Chicago: University of Chicago Press, p. 9.

    29. Mirzaei, A., Moore, T., & Liu, G. (2013). Does market structure matter on banks’ profitability and stability? Emerging vs. advanced economies. Journal of Banking & Finance, 37(8), 2920 2937.

    30. Olson, M., Sarna, N. and Swamy, A.V. (2011). Governance and growth: a simple hypothesis explaining cross-country differences in productivity growth. Public Choice 102:341-364.

    31. Roychoudhury, S., Lawson, R.A., (2010). Economic freedom and sovereign credit ratings and default risk. Journal of Financial Economic Policy 2, 149–162.

    32. Scully, Gerald, and Daniel J. Slottje. (1991). Ranking Economic Liberty Across Countries. Public Choice 69, no. 2: 121–52.

    33. Sufian, F and Habibullah, M.S. (2010). Does economic freedom fosters banks’ performance? Panel evidence from Malaysia. Journal of Contemporary Accounting and Economics 6:77-91.

    34. Sufian, F. and Habibullah, M., S. (2009a). Bank specific and macroeconomic determinants of bank profitability: empirical evidence from the China banking sector. Frontiers of Economics in China 4:274-291.