Chapter 3 Does Financial Regulation Enhance or Impede the Efficiency of China’s Listed
2. CBRC’s Regulation of China's Banking Industry
3.2 Tobit Regression Model
Each term in square brackets of (4) expresses the efficiency of the term tas measured by the relative slacks of inputs and links, and it is equal to unity if all slacks are zero. It is units-invariant and its value is between 0 and 1.
),
Hence, (4) is the weighted average of term efficiencies over the whole terms which we call the input-oriented overall efficiency and it is also between 0 and 1.
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3.2 Tobit Regression Model 3.2.1 Model and Variable
We applied Tobit regression model to study the relationship between financial regulation and static efficiency of China’s listed commercial bank. We only analyzed similar significant results between Tobit regression models. The study selected static efficiency estimated by the SBM model as the explained variable. The efficiency scores (as the explained variable) from DEA are limited to value between 0 and 1. Because the explained variable in the regression equation cannot be expected to have a normal distribution, we cannot expect the regression error to also meet the assumption of normal distribution. The OLS method often leads to biased and inconsistent parameter estimates (Greene, 1981). We therefore used Tobit estimation (Coelli, Prasada Rao and Battese, 1998; Fried, Schmidt and Yaisawarng, 1999;
Wang, Tseng and Weng, 2003; Lin, 2002) in this study.
To investigate the relationship between financial regulation and the static efficiency of listed commercial banks, we divided the financial regulation variable into two categories. The first category looks at financial regulation indicators for measures already implemented in accordance with the provisions of the CBRC – for example, capital adequacy ratios and loan to deposit ratios. The other category looks at financial regulation indicators for measures expected to be implemented under the new Basel III regulations – for example, leverage ratios and loan-loss provision ratios.
According to the CBRC, we divided the financial regulation variable into four categories, asset quality, benefit and efficiency, liquidity and capital adequacy. For each category, we selected the provision coverage, loan-loss provision ratio, cost to income ratio, loan to deposit ratio, current ratio, capital adequacy ratio, tier 1 CAR and leverage ratio as the explanatory variables. We finally used bank size and establishment time as control variables to level their effects on financial regulation. Table 3-3 lists the definitions for these variables. We used technical efficiency as the dependent variable explained by each of the financial regulation variables. Our estimated models are shown as follows.
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Model 1：
Yt = bXt +εt ， εt ~ N(0,σt
2 )…... (8) Y(static efficiency) = ao +b1×RES_NPL +b2×CI+b3×LD +b4×LIQ+b5×CAR
+b6×Size +b7×Time +εt
Model 2：
Yt = bXt +εt ， εt ~ N(0,σt
2 )…...(9) Y(static efficiency) = ao +b1×RES_NPL +b2×CI +b3×LD +b4×LIQ+b5×Tier_1
CAR+b6×Size+ b7×Time +εt
Model 3：
Yt = bXt +εt ， εt ~ N(0,σt
2 )…... (10) Y(static efficiency) = ao +b1×RES_Loan+b2×CI +b3×LD+b4×LIQ+b5×Leverage
+b6×Size +b7×Time +εt
Table 3-3 Definition of explanatory variables Variable code Variable name Description
1. Asset Quality
RES_NPL provision coverage ratio
loan-loss reserves to non-performing loans RES_Loan loan loss provision
ratio
loan-loss reserves to loan outstandings 2. Benefit and Efficiency
CI cost to income ratio operating costs to operating income 3. Liquidity
LD loan to deposit ratio loans to deposits
LIQ current ratio current assets to current liabilities 4. Capital Adequate
CAR capital adequacy ratio
net capital to risk weighted assets Tier 1_CAR tier 1 CAR tier 1 capital to risk weighted assets
Leverage leverage ratio Basel III definition：
core capital to the adjusted on-and off-balance sheet assets of the relevant bank
Our study definition：
tier 1 capital to total asset
It is difference in the definition of denominator.
The ratio in our study is only for estimation and may be deviation from the actual level.
5. Control Variables
Size bank size It is the natural logarithm of total assets.
Time establishment time It is the cumulative year of the establishment time
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between static efficiency and the financial regulation. As shown in Table 3-4.Table 3-4 Hypotheses
Hypothesis Description Related literature
H1 The provision coverage ratio has no effect on the technical efficiency of a bank.
Aasset Quality
H2 The loan-loss provision ratio has no effect on the technical efficiency of a bank.
H3 The cost to income ratio has no effect on the technical efficiency of a bank.
Xiong and Sun (2009), the technical efficiency of a bank.
Liquidity
H5 The current ratio has no effect on the technical efficiency of a bank.
Tochkov and Nenovsky (2011), Athanasoglou, Delis and Staikouras (2006), Ayadi and Pujals (2005)
H6 The capital adequacy has no effect on the technical efficiency of a bank.
H7 The tier 1 capital adequacy has no effect on the technical efficiency of a bank.
Capital Adequacy
H8 The Leverage ratio has no effect on the technical efficiency of a bank.
Zhong (2007)
Assets Quality: ‘Loan Loss Reserve’ for loan impairment is the amount that reduces the recorded investment in a loan portfolio to the carrying amount on the balance sheet. The ratio estimates the portion of total loans that may prove to be bad loans and acts insurance reserves for potential problem loans. It provides an indication of the extent to which the bank has made provisions to cover credit losses, and in turn to impair net interest revenue on the income statement. The higher the ratio, the larger is the amount of expected bad loans on the books, and the higher are the risks despite having been provisioned (Ayadi and Pujals, 2005). On the other hand, a higher ratio also indicates the improvement in asset quality management. The share of loan loss provisions in total loans had an adverse effect on technical efficiency (Tochkov and Nenovsky, 2011)
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Benefit and Efficiency: The cost income ratio, defined by operating expenses divided by operating income, can be used for benchmarking by the bank when reviewing its operational efficiency. Lower is better. Francis (2004) observes that there is an inverse relationship between the cost income ratio and the bank's profitability. Ghosh, Narain, and Sahoo (2003) also find that the expected negative relation between efficiency and the cost-income ratio seems to exist. Xiong and Sun (2009) pointed that the cost to income ratio had a significant negative effect on efficiency of bank. Zhou and Wong (2008) showed that the cost to income ratio has a negative sign, which shows that the efficiency of management is quite important in determining interest margins, and that poor management lowers the interest margin.
Liquidity: A liquidity problem usually arises from the possible inability of a bank to accommodate decreases in liabilities or to fund increases on the assets’ side of the balance sheet (Athanasoglou, Delis and Staikouras 2006) The higher this ratio is, the stronger is a position of a bank to absorb liquidity shocks (Ayadi and Pujals, 2005). Liquidity had a positive effect on cost efficiency and allocative efficiency. Keeping a larger share of liquid assets seems to be more efficient because it minimizes the costs of borrowing (Tochkov and Nenovsky, 2011). However, since liquid assets tend to be low yielding, a higher ratio implies lower earnings. As a measure of liquidity, the ratio may reflect how well the funding sources match the funding uses.
Capital Adequacy: Capital Adequacy is a measure of a bank’s financial strength, in terms of its ability to withstand operational and abnormal losses. Adequate bank capital can function to reduce bank risk by acting as a buffer against loan losses, providing ready access to financial markets in turn to guards against liquidity problem and limiting risk taking but also constraining growth (Zhong, 2007). Most banks regulators see capital adequacy regulation as a means of strengthening the safety and soundness of the banking industry. In China, with the establishment of the CBRC in 2003, the 8% minimum capital adequacy ratio. As a supplement to capital adequacy ratios, a leverage ratio is introduced. If the ratio is set too low, it will not effectively constrain the banks’ rapid expansion
4. Empirical Analysis