A Qualitative Index of Risk Management of Chinese Banks as an Intermediate Input in Network DEA

Kent MatthewsCardiff Business SchoolGlobal Science and Technology Forum, 23-24 May 2011, Singapore

Research Design

Obtain survey information on risk management practice and organisation of individual banks.

Compare the responses from Chinese bank risk managers with foreign bank risk managers (benchmark).

Questionnaire – 3 areas of risk management. First – Loan approval decision (large enterprises,

SMEs, consumers). Second – quantitative and qualitative tools used in risk

management. Third – organisation, training and staffing. Chinese and foreign bank risk managers score various

questions on a 1 – 5 scale. 1 is worst and 5 is best.

Sample frame

24 bank executives interviewed over the period 2007-2008.

3 foreign banks, Big-4, 9 joint stock banks, 2 city commercial banks – 15 Chinese banks.

Interviews in - Beijing, Shanghai, Tianjin, Dalian, Guangzhou, Shenzhen.

While the numerical scores provided by the Risk Managers was the primary objective much useful soft information was also provided.

Lending Decision – median response (15 factors)

RISK

0

1

2

3

4

5

X1

X2

X3

X4

X5

X6

X7

X8X9

X10

X11

X12

X13

X14

X15

BENCHMARK

MEDIAN

Individual Factor Wilcoxon* (p<.05)

X1 – Credit Record (SOE) 信誉记录 （国有企业） .014*

X2 – Cash Flow (SOE) 现金流动（国有企业） .022*

X3 – Account profitability (SOE) 账目盈利能力（国有企业） .059

X4 – Collateral or Guarantee (SOE) 抵押担保（国有企业） .078

X5 – Know Your Customer (SOE) 相识客户（国有企业） .006*

X6 – Credit Record (SME) 信誉记录（中小型企业） .022*

X7 – Cash Flow (SME) 现金流到（中小型企业） .008*

X8 – account profitability (SME) 账目盈利能力（中小型企业） .227

X9 – Collateral or Guarantee 抵押担保 （中小型企业） .008*

X10 – Know Your Customer (SME) 相识客户 （中小型企业） .022*

X11 – Credit Record (Mortgage) 信誉记录 （抵押贷款） .036*

X12 – Personal Income (Consumer loan) 个人收入（消费贷款） .170

X13 – Credit score (personal loans) 信誉评分（个人贷款） .003*

X14 – Net worth of borrower (personal loan) 净价值（个人贷款） .754

X15 – deposit account (personal loan) 存款帐户 （个人贷款） .002*

Risk Management Organisation

ORGANISATION

0

1

2

3

4

5X17

X18

X19

X20

X21

X22X23

X24

X25

X26

X27

BENCHMARK

MEDIAN

X17 – Risk Management Training .001*

X18 – Staffing levels .002*

X19 – Organisation of workloads .036*

X20 – Internal Recruitment .177

X21 – External Recruitment .001*

X22 – University background .286

X23 – Foreign University Training .530

X24 – Experience .100

X25 – Professional qualification .009*

X26 – Higher degree .038*

X27 – Retention Policy .834

Benchmarking

Foreign bank manager responses used as benchmarks.

Negative scores – Chinese bank risk manager score less than benchmark.

Positive score – Chinese bank risk manager score greater than benchmark.

Negative scores are penalised but positive scores are not penalised.

CB=Chinese bank responseFB=Foreign bank response

1001)(13

212

23

xx

xf

ForBChBx

Asymmetric loss function

F(X)

40

50

60

70

80

90

100

110

-4 -2 0 2

X

F(X

)

Principal Component Analysis

Construct two measures using PCA.First principal component.(1) Risk Practice (2) Risk Organisation.

Black Box DEA

Input 1

Input 2

Input 3

Black Box

Output 1

Output 2

Output 3

Network DEA

Recognises there are stages in the production process

Each stage has an intermediate output which is an intermediate input to a further stage.

Three Stages

Stage 1 - Primary inputs: Operational costs and fixed assets

Stage 2 - Intermediate inputs/outputs: Labour costs, non-labour costs, interest costs, branches, (Later we add Risk Management Practice, Risk Management Organisation). Deposits as a primary input.

Stage 3 - Final output: Interest earnings, non-interest earnings and NPL as a bad output

Output is Revenue or Profit Efficiency

Three Exercises conducted

Exercise 1 - Black Box DEA where there are only two stages – 3 inputs and 2 outputs

Exercise 2 – 3-stage DEA without measures of Risk Practice and Risk Organisation but NPL is a bad output.

Exercise 3 - Repeat exercise 2 but use risk organisation index and risk practice index in the process.

Primary Input OC

Primary Input FA

Stage 1 - intermediate outputs

PERS OTHER

Stage 2 - intermediate outputs

INTCOST BR

Stage 3 – final outputs

INT

Stage 2 - Intermediate inputs

Stage 3 Intermediate inputs

Stage 2 Primary input DEP

NPL (bad output = primary input)

ORGPCA

Stage 3 Primary input RISKPCA

Stage 2 Final output OBS

Network framework

The network additions

RISKORG is an intermediate output at stage 2 and an intermediate input at stage 3

RISKPCA is an external input at stage 3 determined by the culture of the bank and political and/or other pressures it faces.

Contribution of Risk Measures

Accounting measure of bank performance is return on assets (ROA) = profits/assets.

Efficiency score from DEA is a measure of efficiency relative to best practice. Efficiency is revenue or profit efficiency.

Correlation between ROA and DEA score should be high if it is a good measure.

Profit and efficiency

0 0.2 0.4 0.6 0.8 1 1.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Profit and efficiency

score

RO

A

Contribution of Risk Measures

Black box DEA Network DEA – without risk measures

Network DEA – with Risk Measures

Intercept 0.328(.197)

0.704***(.000)

0.625***(.000)

NPL_RATIO -.037***(.002)

-.032***(.005)

-.035***(.001)

SCORE 0.911***(.007)

0.877***(.003)

.725***(.000)

R2 .6378 .6755 .7803

MSE .2040 .1931 .1589

F(2,12) 13.33 15.57 25.86

Conclusion

The indices constructed from interviews provide insights into the risk function in Chinese banks relative to best practice

The combination of the risk practice and risk organisation with the other inputs and outputs of the banks in a NDEA framework can be used to measure bank performance.

NDEA provides information to the manager about the stages of production between inputs and outputs.