Keywords

Efficiency, Data Envelopment Analysis, Performance, CRS, VRS

Citation Information

Osuma, G.S., Ikpefan, O.A., & Omankhanlen, A.E. (2021). Exploring the relationship between efficiency and profitability of listed deposit money banks in Nigeria. Journal of Management Information and Decision Sciences, 24(S1), 1-14.

Introduction

An efficient banking sector's importance cannot be over-emphasized because of its importance in promoting sustainable economic growth, which would lead to the financial system development and a dynamic economic system (Fagge, 2019). Performance measurement has become a pivotal issue in the finance sector that has helped to identify efficient and inefficient companies (Jaloudi, 2019). The Nigerian financial sector has experienced tremendous growth since the 2007-2008 global financial crisis, and this development isbecause ofthe global policy measures to restore stability to the financial sector (Osuma, Babajide, Ikpefan, Nwuba & Jegede, 2019). An example of such global policy measures includes the introduction of the Basel III by members of the Basel committee in 2010 to strengthen the banking sector's supervisory, regulatory, and risk management system. However, this development in the financial sector called for continuous monitoring of the performances of this sector. In Nigeria, banks have thrived under different economic conditions which covered technological, political, cultural, and socio-economic changes to be abreast of one another and this competition has enabled banks to adopt methods of containing cost, rebranding their product, and deepening customers' relationship (Abel, Khobai & Roux, 2017; Worimegbe, Abosede & Worimegbe, 2018; Worimegbe, Oladimeji & Eze, 2019).

There are two main approaches used in the evaluation of bank performance, these include the frontier technique (approach) and financial ratio analytical approach. The financial ratio approach bases its measurement on financial indices such as liquidity ratios, profitability ratios, and the banks' credit quality (Samad, 2004). The financial ratio approach has a drawback of its lack of consensus from academics about the portent combination of financial ratios and their weighting in the bank efficiency analysis (Yang, 2012). The frontier analysis involves both the parametric and non-parametric approaches, which are used to determine an efficiency frontier of the various decision-making units after the assignment of relative efficiency scores. Chen (2001), as cited in (Olanrewaju & Obalade, 2015) stated that efficiency could be measured in three phases, which include scale, scope, and operational efficiency. Scale efficiency ensures that the bank maintains its constant rate of returns, while scope efficiency deals with how it increases its location. However, operational efficiency deals with the efficient utilization of people and material resources. The level of growth in the banking industry's efficiency can be attributed to the advent of technology, improved managerial competencies, style, and knowledge. The need to continuously evaluate efficiency levels in the banking sector is a result of competitive pressure within the sector and the investors as well as the customers' expectations.

Over the years, financial ratios have been used by regulators to measure and/or evaluate the overall efficiency, performance and soundness of financial institutions, as it is believed that after the financial evaluation of deposit money banks and other financial institutions with the CAMELS rating which is an acronym for capital adequacy, asset quality, management efficiency, earnings capacity, liquidity and market risk sensitivity, the sector ought to move from a striving sector to a thriving sector but, the reverse seems to be the case because these sectors have shown to be highly subjected to contagion effect otherwise known as systemic risk where little or huge financial shock poses a systemic threat to the Nigerian financial system with the banking sector being the most hit from the shock. Thus, financial ratios do not measure the managerial capacity of converting inputs into outputs in the same organization. How more efficient can a bank be if it cannot withstand both internal and external shocks that tend to pose a systemic threat to its financial system thus the rationale for this study in examining both efficiency and profitability in DMBs performance. This paper consists of the introduction, literature review, methodology and theory, data analysis and presentation of results, conclusion and recommendation, acknowledgement, and references.

Literature Review

Ali and Bahram (2020) examined how technological performance and total factor output is affected by various aspects of board diversity. The analysis assessed the board's composition from two dimensions: the partnership dimension (gender and age) and the mission dimension (expertise, education, and tenure) usage of balanced panel data for eight hundred and six (806) Chinese non-financial companies over the 2009 to 2017 period. For research, they used a two-stage technique. In the first point, to measure the technological efficiency and factor productivity ratings, which made use of the non-parametric frontier technique. The study reduced the ratings on board diversity attributes in the second level (task-related diversity and relation-related diversity). The study found that board diversity increases technological performance and total factor competitiveness by using two-step method GMM and Tobit regression. Our studies demonstrate that corporate board diversity (in terms of ethnicity, age, tenure, expertise, and experience) positively affects corporate performance. According to Abiola & Olaniyan (2020), financial services have encountered a diverse and challenging climate and Islamic banking is one of the fastest developing sectors. They further opined that there are few established studies on Islamic banks productivity in Nigeria, considering the significant growth of the Islamic banking sector. The research analyzed Nigeria's Islamic banking system's efficacy compared with the conventional or traditional banking using the DEA approach. The study findings showed that, with an efficiency score of 98.25 percent and 73.18 percent for pure technical efficiency and total technical efficiency, the chosen Islamic bank is efficient. The Islamic bank has also appeared on an efficient frontier, showing that their financial resources have been handled effectively for many years. The findings showed that the Islamic bank selected (JAIZ bank) was successful in the face of close competition from other traditional banking counterparts. The study proposed that Islamic banking be included in Nigeria's search for global financial stability.

In Indonesia, Yumna (2020) examined the x-efficiency of fifteen commercial banks consisting of seven (7) syariah and eight (8) traditional banks. Three (3) phases of data processing were used in this research: non-parametric Data Envelopment Analysis (DEA) method, t-test, and multiple regression methodology. The findings showed that both the syariah as well as traditional banks in Indonesia did not achieve an optimum level of productivity in the span of this analysis. However, traditional banks, relative to syariah banks, obtain a higher degree of allocative and absolute efficiency. Instead of technological challenges, the inefficiency of Islamic banks derives from allocative inefficiency. The X-efficiency of the bank is greatly impacted by the scale rather than the amount of banking outlets and employees' expense. Fukuyama, Matousek & Tzeremes (2020) developed a two-stage model to examine Turkish banks' cost inefficiencies from 2007 through 2016. To analyze the approximate Nerlovian cost inefficiency to the sum of slack based technological and allocative inefficiency amounts, the analysis used Koopmans notion of input efficiency. In addition to the conventional inputs, outputs and intermediates used to model the banks efficiency calculation, the analysis also applied the efficiency element of labor education as a non-discretionary variable. This facilitated the simulation of how human capital considerations impact the revenue generation stage of a bank. The study's outcome showed that the levels of cost inefficiency are influenced particularly by a bank's capacity to monitor allocative inefficiency level. Empirically shown by the improved performance of international banks, this suggested that the calculation of cost performance was important for bank ownership structures. Conclusively, the global financial crisis of 2008 revealed that it had anadverse effect on the bank’s capacity to minimalize their cost inefficiency rate. Nonetheless, the aftermath of the crisis showed that Turkish banks have begun to rebound from the adverse consequences, primarily through better allocation efficiency.

Wasiaturrahma, Raditya, Shochrul, Cahyaning & Ahmad (2020) evaluated the performance efficiency ofIslamic rural banks and traditional banks in Indonesia, particularly Bank Pembiayaan Rakyat Syariah (BPRS) and Bank Perkreditan Rakyat (BPR). The research used efficient data envelopment analysis technique. From the study findings, it indicated that both Bank Perkreditan Rakyat and Bank Pembiayaan Rakyat Syariah are efficient in terms of production while inefficient in terms of the intermediation role. Subsequently, the Tobit estimation showed that these 2 efficiencies results are positively affected by the Capital Adequacy Ratio (CAR) and location. Rural banks working in cities have also been shown to appear to have a higher degree of productivity than elsewhere. Moreover, in terms of development and intermediation, the greater the money, the more productive both Islamic and traditional rural banks are. Although the banking sector's absolute performance has always been a foremost concern to the regulators, it is now of utmost significance to researchers, the public, and policymakers alike. Managers of banks and other financial institutions such as insurance companies seek ways to improve efficiency and profitability since it is the core of banking industry goals globally. It comes in different phases (Worimegbe et al., 2019).

Evaluation of banks and other financial institutions performance efficiency varies depending on the evaluator's perspective. Some evaluators may be more concerned about the bank's potential loan loss, profit after tax, capital adequacy ratio, net interest margin, and so on. Bank’s shareholders are more concerned about the bank's profitability and dividend payment, while depositors are more concerned about the banks' solvency, liquidity, and safety. Although each category of evaluators has their specific motivation, they are all moved by the general motivation to evaluate the banks' performance. By evaluating a bank's performance, the internal structure of the bank is explored, which helps identify the root cause of poor performance (Shah, Wu & Korotkov, 2019). Duncan & Elliot (2004), averred that efficiency aims to increase financial performance by reducing cost, increasing customers' satisfaction, and earning, which in the long run, improves banks' financial performance. Alshammari (2017) study found that the 2008 global financial crisis from the subprime lending affected commercial banks' performance, but not the Islamic banks in Kuwait, Saudi Arabia and United Arab Emirate.

Mollah, Hassan, Farooque & Mobarek, (2017) investigated whether governance structures differences influence the performance of Islamic banks' than commercial banks. The study used a sample of a hundred and four (104) conventional banks and fifty-two (52) Islamic banks in fourteen (14) countries from 2005 through 2013. The study concluded that Islamic banks governance structure plays a crucial role in their financial performance and helped Islamic banks to achieve better performance when compared to the conventional banks. Olweny & Shipho (2011) considered the CAMELS approach to determine the relationship between bank’s performance and capital adequacy. The study found that banks get more efficient as they increased their capital base. The study of Aguenaou, Lahrech & Bounakaya (2017) evaluated the CAMELS approach's six components to Moroccan bank performance. For this study, emphasis is given to the capital adequacy which stands for "C" in the acronym. The capital adequacy ensures meeting a substantial part of the minimum of the capital requirement will enhance efficiency and the inability to meet the minimum requirement causes inefficiency since the owner's control over the management is not secure. The study accessed from the Moroccan context the determinant of the financial efficiency of Six (6) listed banks on the Casablanca stock exchange for the period of eleven years spanning from 2004 through 2014. They used the CAMEL framework as the independent variable. The study found that only “M,” which stands for management efficiency from all the acronyms, had a positive and significant influence on the selected banks. The other acronyms had a negative influence on the banks performance. The study of Eriki & Osifo (2015) carried out a different study from their 2014 research by examining the determinants of efficiency in the Nigerian Banking industry, considering nineteen (19) banks in Nigeria. Their findings revealed that the independent variables, such as bank size and age, positively influence the efficiency of Nigerian banks. In contrast, board independence and the ownership structure had a negative impact on banks' performance in Nigeria. Their study recommended that an efficient and robust management of risk policies should be put in place. Also, the regulatory and supervisory functions of monetary policies should be rigorously pursued.

Omankhanlen & Adegbite (2018) examined the post-2005 consolidation effects on the Nigerian banking sector's efficiency from the year 2005 through 2009. The study showed that none of the study's banks produce up to fifty (50) percent total efficiency in any of the years under study. Even after the consolidation era, many of the banks did not record full efficiency. Therefore, there is a need to formulate and put in use better monetary policies that will improve these banks' performances, including their efficiencies. Osadume & Ibenta (2018) investigated some selected banks' financial performance in Nigeria for fourteen (14) years spanning from 2001 through 2014. The study considered net profit as the dependent variable. In contrast, capital adequacy, liquidity and assets quality as independent variables on short-term and long-term basis revealed that the proxies for independent variables had a significant effect on the selected deposit money banks' financial performance. Therefore, net profit should not be the only basis for assessing the banks performance. The study recommended that necessary regulatory standards and framework be adhered to in evaluating banks' performance in Nigeria.

Fakarudin, Fadzlan, Annuar, Nazratul & Hafezali (2019) investigated the Malaysian Islamic banking sector's sales performance. The study explored the possible bank-specific (internal) and macroeconomic (external) determinants influencing Malaysian domestic Islamic banks' revenue performance. In analyzing the possible determinants of sales performance, a panel regression analysis was adopted. As opposed to their international Islamic bank counterparts, the results revealed that Malaysian domestic Islamic banks' level of revenue efficiency is lesser. The strength, liquidity, and management quality of the bank sector also significantly affect the improvement in Malaysian domestic Islamic banks' income performance during the time under review. For the first time, this research presented empirical data covering all three (3) efficiency principles, including expense, benefit, and benefit efficiency. The measurement of these efficiency principles can observe the efficiency standards of domestic and global Islamic banks. The effect of sales performance on banks' profitability can be definitively defined by comparing both cost and benefit efficiency. as shows in Table 1.

Table 1 Various Types Of Efficiency
Efficiency Type	Definition Relating to Banking
Transactional Efficiency	Using banks as a case study, transactional efficiency measures bank-client relationships which means how productive these new distribution channels are, such as Automated Teller Machine (ATM), Mobile banking, Internet banking and the Point of Sale (POS) channels of the bank. However, the transactional efficiency output measures the level of customer's patronage of these distribution channels and the amount of income generated through these channels. Transactional efficiency aims to ensure that the customers switch to these new distributional platforms of payment and settlement to avoid or reduce human errors in payment processes. The more financial institutions achieve transactional efficiency, the more competitive advantage they realize just as banks that are more technologically inclined often times have more customer base than their competitors.
Operational efficiency	Operational efficiency measures performance and productivity in terms of sales. It estimates how a firm's product has been produced, stored and distributed efficiently (Portela & Thanassolious, 2007; Olanrewaju & Obalade, 2015). Without operational efficiency, an organization can find it difficult to survive the evolving economic conditions since its major objective is to maximize profit and shareholder wealth. Operational efficiency is crucial for a bank's survival, which calls for the evaluation of banks' input and output since many organizations from different sectors rely solely on banks for survival. According to Olanrewaju & Obalade (2015), operational efficiency involves tactical planning that helps to balance the cost and productivity of an organization. Operational efficiency ensures that cost and wastages are minimized to improve revenue and benefits to improve customer satisfaction. Operational efficiency occurred when the right set of people, processes, materials, and technology are combined to enhance business operations' value and productivity. Operational efficiency identifies the areas of wastages in an organization that can impede profit and organizational resources. It enhances cost reduction to improve production or maintains the same level of production.
Technical efficiency	A financial institution is said to be technically efficient when it can achieve maximum output from a given combination of inputs or when it can use the minimum level of inputs to produce an equivalent level of output (Asmare & Begashaw, 2018). A bank is technically efficient if it produces maximum outputs from a minimum quantity of inputs, capital, labor or technology.
Profit Efficiency	This is a macroeconomics concept that assesses a firm's financial performance on how its actual profits would be compared with certain best-practice (benchmarking) frontiers. Specifically, profit efficiency is the overall form of efficiency, in such a way that once a bank or company is efficient in its profit, it would also be efficient in its costs and production scale (Fitzpatrick & McQuinn, 2008) as cited in (Pilar, Marta & Antonio, 2018) Get the App