Determinants of foreign-owned banks efficiency in New Zealand: a stochastic frontier approach

Abstract

The banking sector in New Zealand is characterised by the dominance of foreign-owned banks, and in particular from Australia. The objective of this study is to examine the efficiency performance of foreign-owned banks relative to domestically owned banks, with major focus on the determinants on the differences of foreign banks’ efficiency. The parametric stochastic frontier approach (SFA) is employed to extend the existing bank efficiency studies that used the non-parametric approach--Data Envelopment Analysis (DEA). Ten major banks which have continuously operated over the period 2002 to 2011 were selected and both industry- and bank-specific characteristics are tested using quarterly data for 40 quarters with the consideration of macroeconomic conditions. The one-step SFA approach of model is used in order to obtain the cost and profit efficiency scores and the inefficiency effects simultaneously to avoid any bias on the results.

The empirical results suggest that the presence of foreign banks in New Zealand has contributed to the efficiency of New Zealand banking system as a whole. The results also support the limited global advantage hypothesis (Berger, DeYoung, Genay, & Udell, 2000) that foreign banks from specific nations (Australia in this study) have operated efficiently due to having less liabilities of foreignness in the host nation. Other distinguishing determinants factors on the differences in cost and profit efficiency between foreign and domestic banks are bank size, the level of equity, asset quality, as well as the market concentration and interest rate and inflation environment in New Zealand.