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Social and Economic Studies 60: 3 & 4 (20 1 1): 10 J- 126 ISSN: 0037-766 1
Lisa-Kaye Wallace
ABSTRACT
1 Bank examiners generally evaluate a bank's health using an overall rating system
called CAMEL, based on Capital adequacy, Asset quality, Management quality,
Earnings ability and Liquidity positions, but assessing management is more
difficult and is considered a subjective matter.
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1 02 SOCIAL AND ECONOMIC STUDIES
ally, Seballos and Thompson (1990) noted that the ultimate deter-
minant of whether or not a bank fails is the ability of its man-
agement to operate the institution efficiently as well as to evaluate
and manage risk.
In light of the recent failure of a number of financial
institutions globally, the need for more effective prediction models
that incorporate management quality has become evident. How-
ever, Barr and Siems (1996) noted that an early warning system
cannot replace the on-site examination, which allows for personal
interaction with the bank's management and employees and
permits first-hand evaluation of operating procedures, levels of
risk-taking and long-range strategic planning. In this context, an
effective early warning system that incorporates management
quality can complement the on-site examination process by
identifying troubled institutions that need early examination or
possible intervention, thereby, minimizing the risk of costly
bailouts.
2 The inputs used in this model were: full-time equivalent employees, salary
expenses, fixed assets, non-interest expense, total interest expense and purchased
funds. Correspondingly, the outputs included deposits, earning assets and
interest income.
3 Technical efficiency measures the maximum possible output that a given number
of inputs can produce.
4 A score of 1.0 signifies that a bank is technically efficient and a score less than 1.0
implies technical inefficiency.
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Quantifying Management's Role in Bank Survival 103
5 The inputs included number of employees, labour costs, number of branches and
funding costs. The outputs on the other hand were deposits, savings and interest
income.
6 The input variables used by Jackson (2000) include number of employees, non-
labour operating expense and direct expenditure on buildings and amortization
expense whereas the outputs are loans, demand deposits and time deposit.
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1 04 SOCIAL AND ECONOMIC STUDIES
7 After the crisis period three commercial banks were merged (Citizen Bank, Eagle
Commercial Bank and Workers Bank) to form Union Bank and subsequently
RBTT.
8 See Green (1999), Foga et al. (1997) and Panton (1998) for further details with
respect to the macroeconomic and regulatory weaknesses that contributed to the
crisis.
9 Foga et al. (199 7) highlighted the fact that there is the view that the problems that
emerged in the Jamaican financial sector over the middle part of the 1990s have
been more related to factors such as poor risk assessment and unsound
management techniques on the part of financial institutions.
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Quantifying Management's Roie in Bank Survival 105
the major factors which led to the growth in the banks' bad debt
portfolio. In the case of collaterals, many real estate based collaterals
were overvalued, signalling that loans could not be liquidated in the
event that they went bad. This was compounded by the dilution of
skills, which accompanied a too-rapid expansion of the industry
and which saw inexperienced loan officers failing to conduct
appropriate risk assessments. Panton (1998) also alluded to the fact
that, occasionally, larger clients were not pressured to service loan
obligations on a regular basis, pointing to inherent deficiencies in
the credit management policies and procedures in some commercial
banks.
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1 06 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Role in Bank Survival 107
10 Technical efficiency measures the maximum possible output that a given number
of inputs can produce.
11 Essentially, Barr (1993) identified a number of variables as surrogates for
managerial performance of banks and argued that "these variables, while not
directly measuring managerial ability, do nevertheless capture the ex-post
consequences of managementes decisions".
12 Over time, production technology can change, causing shifts in the best practice
technical frontier. These shifts could be due to more experience as time passes,
increased knowledge, innovations in management or in production processes,
financial liberalisation or deregulation and increased competition.
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1 08 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Roie in Bank Survival 109
EVALUATION TECHNIQUE
/=i
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subjected to js!
m
i- 1
13 The CCR model is based on the work of Chames, Cooper and Rhodes (1978).
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1 1 0 SOCIAL AND ECONOMIC STUDIES
T
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Quantifying Management's Role in Bank Survival 1 1 1
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1 1 2 SOCIAL AND ECONOMIC STUDIES
The variables selected for the purpose of this paper focus on bank
management's basic allocation, control and product mix decisions.14
Hence, the model includes variables that are most descriptive of
management's decision-making role in a bank's intermediation
process. Because of the multitude of functions performed and
decisions made by management, a descriptive model of bank
management quality must contain several inputs and outputs. The
model utilizes semi-annual balance sheet and income statement
data obtained from the Bank of Jamaica over the period June 1989 to
December 1998, and June 2002 to December 2008 for commercial
banks. The performance measure describes five input and five
output variables (see Table 2).
In essence, the input-output variables were selected based on
the premise that the most efficient banks allocate resources and
control internal processes by effectively managing salary expenses,
facilities, non-interest expense, interest expense and purchased
funds while working to maximize deposits, loans, other earning
assets and interest income.15 Moreover, given that, the operations of
all bank activities involve labour, materials, machines and
buildings, management certainly has a great deal of discretion con-
cerning the allocation of these resources. For instance, management
determines the number of employees needed to perform a desired
function at a desired level of service. They also establish salary
levels and they determine the types of facilities to build, where to
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Quantifying Management's Role In Bank Survival 113
build and how to furnish and operate them (see Table 3 and Table
4).16
Furthermore, management also decides what other non-
interest expenses to incur, such as legal assistance and adminis-
trative expenditures related to maintaining and liquidating fore-
closed real estate and other assets. The five inputs and five outputs
essentially reflect the key activities of management. Another input
associated with acquiring deposits in stage one is total interest
expense. Management establishes the types of deposits and the
interest rate levels offered to depositors. While interest rates are
influenced by market forces and monetary policy, management
decisions regarding the composition of deposits which directly
affect total interest expenditures are primarily influenced by
endogenous factors such as the risk premium on bank loans,
competition and administrative costs.
In terms of loans, there was a sharp average decline of 5.9% in
loans by failed banks during the financial crisis period relative to
average growth of 17% during the pre-crisis period.17 Non-failed
institutions experienced positive growth in their loan portfolio
during the crisis period, albeit lower than in the pre-crisis period.
The negative growth experienced by failed institutions during the
crisis period may have reflected an inability to lend given liquidity
problems.
Average growth in non-interest income and interest income
declined for both failed and non-failed banks during the crisis
period relative to the pre-crisis period.18 However, during the crisis
period, the pace of decline in the growth of interest income was
16 Table 3 and Table 4 provide a list of the inputs and outputs used in this study and
also give the average growth rates of these variables for failed and non-failed
banks for the sample periods 1989-1995 (pre-crisis) and 1996-1998 (crisis),
respectively. The first six columns of each table present the average input and
output growth rates of banks that survived and the latter six columns present the
rates for the institutions that failed.
17 Failed banks refer to those institutions that were declared insolvent by the
regulatory authority at some point between 1996 and 1998.
18 It must be noted that the decline in non-interest income for failed banks during
the crisis period relative to the pre-crisis period was due principally to the
operations of one institution which recorded a sharp decline in its net interest
income. Additionally, during the period 1996-1998, Century National Bank (CNB)
ceased operations, thus resulting in a lower number of failed banks relative to the
pre-crisis period.
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1 1 4 SOCIAL AND ECONOMIC STUDIES
slower for failed banks relative to banks that survived. This could
19 Notably, during the latter half of 1996, both domestic and foreign currency
deposits increased sharply for NCB, possibly due to depositors moving funds
from troubled institutions to banks that they had deemed profitable and efficient
at the time (NCB failed in 1997).
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Quantifying Management's Role in Bank Survival 1 15
EMPIRICAL FINDINGS
20 The mean efficiency scores for the institutions that failed (CNB, ECB, WSLB, NCB
and CBL) during the mid-1990s crisis in some instances exceeded the efficiency
scores of institutions (BNS, CBNA, CIBC and TCB) that survived the crisis.
Institutions that failed refer to institutions that either ceased operations or were
taken over by the Government of Jamaica.
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1 1 6 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Role in Bank Survival 1 1 7
REFERENCES
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1 1 8 SOCIAL AND ECONOMIC STUDIES
Barr, Richard and Thomas Siems. 1996. "Bank failure prediction using DEA
to measure management quality". Financial Industries Studies
Working Paper 7: 1-20.
Barr, Richard, Lawrence Seiford and Thomas Siems. 1993. "An
envelopment-analysis approach to measuring the management
quality of banks". Annals of Operations Research 38: 1-13.
Coelli, Tim. 1996. A Guide to DEAP version 2.1: A Data Envelopment Analysis
(computer) Program. Annidale: Centre for Efficiency and Productivity
Analysis.
Foga, Camille, Robert Stennett, and Pauline Green. 1997. "Stabilization and
the Jamaican Commercial Banking Sector 1991-1997". Paper
presented at the Annual Monetary Studies Conference, Paradise
Island, Bahamas, October 26-30.
Forsund, Finn and Nikias, Sarafoglou. 2002. "On the Origins of Data
Envelopment Analysis". Journal of Productivity Analysis 17 (1-2): 23-40.
Langrin, Brian R. 2005. "The Role of Foreign Banks in the Recent Jamaican
Financial Crisis". Social and Economic Studies 54 (1): 1-42.
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Quantifying Management's Role in Bank Survival 1 19
Meyer, Paul and Howard Pifer. 1970. "Prediction of Bank Failures". Journal
of Finance 25: 853-868.
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1 20 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Role in Bank Survival 121
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1 22 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Role in Bank Survival 123
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1 24 SOCIAL AND ECONOMIC STUDIES
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Quantifying Management's Role in Bank Survival 125
2/NB: After the 1996-1998 financial sector crisis, several institutions were
merged and others renamed. Notably after the crisis period, Eagle Commercial
Bank, Workers Saving & Loan Bank and Citizens Bank were merged to form
RBTT, while Canadian Imperial Bank of Commerce (CIBC) and Trafalgar
Commercial Bank were renamed First Caribbean International Bank (FCIB)
and First Global Bank (FGB), respectively. Additionally, Century National
Bank ceased operations altogether.
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1 26 SOCIAL AND ECONOMIC STUDIES
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