Research on Chinese Banks Risk Management Efficiency

1. A Qualitative Index of Risk
Management of Chinese Banks as an
Intermediate Input in Network DEA
Kent Matthews
Cardiff Business School
Global Science and Technology Forum, 23-24
May 2011, Singapore

2. 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.

3. 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, Sh
enzhen.
 While the numerical scores provided by the Risk
Managers was the primary objective much useful
soft information was also provided.

4. Lending Decision – median
response (15 factors)
R ISK
X1
5
X15 X2
4
X14 X3
3
2
X13 X4
1
BENCHMARK
0
MEDIAN
X12 X5
X11 X6
X10 X7
X9 X8

5. 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*

6. Risk Management
Organisation
ORGANISATION
X17
5
X27 X18
4
3
X26 X19
2
1
BENCHM ARK
0
M EDIAN
X25 X20
X24 X21
X23 X22

7. 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

8. 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.

9. CB=Chinese bank response
FB=Foreign bank response
x ChB ForB
2 3 1
3 1
2 x 2 x
f ( x) 1 100

10. Asymmetric loss function
F(X)
110
100
90
80
F(X)
70
60
50
40
-4 -2 0 2
X

11. Principal Component
Analysis
 Construct two measures using PCA.
 First principal component.
 (1) Risk Practice
 (2) Risk Organisation.

12. Black Box DEA
Input 1 Output 1
Output 2
Input 2 Black Box
Output 3
Input 3

13. 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.

14. 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

15. 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.

16. Network framework
Primary Primary
Input OC Input FA
Stage 1 - intermediate outputs
Stage 2 - Stage 2
PERS Intermediate inputs OTHER Primary input
DEP
Stage 2
Final Stage 2 - intermediate outputs
output
OBS
Stage 3 Intermediate ORG
INTCOST inputs BR PCA
Stage 3
Primary input Stage 3 – final outputs NPL (bad output =
RISKPCA primary input)
INT

17. 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.

18. 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.

19. Profit and efficiency
Profit and efficiency
1.6
1.4
1.2
1
ROA
0.8
0.6
0.4
0.2
0
0 0.2 0.4 0.6 0.8 1 1.2
score

20. Contribution of Risk
Measures
Black box DEA Network DEA – without Network DEA – with Risk
risk measures Measures
Intercept 0.328 0.704*** 0.625***
(.197) (.000) (.000)
NPL_RATIO -.037*** -.032*** -.035***
(.002) (.005) (.001)
SCORE 0.911*** 0.877*** .725***
(.007) (.003) (.000)
.6378 .6755 .7803
R2
.2040 .1931 .1589
MSE
F(2,12) 13.33 15.57 25.86

21. 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.