Cost efficiency and the effect of mergers on the Taiwanese banking industry

Abstract

This study addresses the cost efficiency, economies of scale and scope of the Taiwanese banking industry, specifically focusing on how bank mergers affect cost efficiency. Adopting stochastic frontier analysis, we employ a translog cost function for efficiency estimation. Composite error terms are used to account for managerial inefficiency and environmental effects. Empirical results suggest that economies of scale and scope exist at small and medium-sized banks. Meanwhile, government-owned or -controlled banks are the most cost efficient. Non-performing loans increase the inefficiency of the banking sector by just under 10 per cent. Further analysis reveals that bank merger activity is positively related to cost efficiency. Mergers can enhance cost efficiency, even though the number of bank employees does not decline. The banks involved in mergers are generally small and were established after the banking sector was deregulated.