Sunday, August 10, 2008

Performance Evaluation of Commercial Bank

Performance Evaluation of Commercial Bank Branches Using Data Envelopment Analysis
Journal of Business and Management, 2005 by Yavas, Burhan F, Fisher, Dorothy M



Considerable research has been devoted to using multiple criteria to measure the performance of business units such as bank branches. However, bank managers continue to use traditional methods to evaluate their branch offices. In general, subjective weights for various criteria are used to arrive at a weighted average score to measure the performance of a bank branch. Potential deficiencies in an existing set of weights include bias and inconsistency with organizational objectives. This paper employs Data Envelopment Analysis (DEA) to evaluate the operational performance of a bank branch relative to the performance of its peer branches. Utilizing data from 31 branches of a major bank located in Southern California, the use of DEA yields the following: 1) rankings of bank branches using efficiency scores, 2) identification of areas of deficiency and 3) establishment of the reference group against which a branch is evaluated. Twenty-two of the 31 branches were found to be in need of improvements in various areas. In addition to identifying best-practice branches and those that are out-of-line with the best practice branches, DEA also points to the specific changes that must be made in the less productive branches in order for them to catch up with their best-practice peer group. The findings of this study should help management in identifying the strengths and weaknesses of their bank branches.

Discussion
Banks operate in a volatile environment that constantly requires them to alter their products and services. As indicated earlier, the trend is more revenues coming from such non-traditional offerings as insurance and financial services, while traditional banking revenues have declined. In fact, since World War II, the share of depository institutions in total assets held by the industry has declined from 55.9 percent to 35.6 percent between 1948 and 2000 (Saunders & Cornett, 2003). On the other hand, investment companies that give savers cheaper access to securities markets have seen their share of that business increase reflecting savers' shifting preferences toward securities markets over those products offered by commercial banks. In addition, information technology and a changing regulatory environment have resulted in consolidations in the commercial banking industry (Saunders & Cornett, 2003). In such an environment, banks compete with one another by developing new financial products and devising new ways of delivering these products to customers. Online banking and smart debit cards are two examples of new products in the banking industry. Equity and bond mutual funds are among the more recent offerings. Earlier examples of innovation included Automated Teller Machines (ATMs) and credit and debit cards.
Along with seriously considering and analyzing domestic trends, commercial banks must now also compete with foreign banks and other financial intermediaries. Against this background, it is clear that the future performance of commercial banks will be based largely on the extent to which they adopt the newest technologies and offer new, competitively priced products, such as mutual funds and insurance. In such a highly competitive environment, performance evaluation of bank branches assumes greater importance. The challenges brought about by this environment may require new operating principles that in turn make changes necessary at the bank branch level as the mix of product offerings changes. Regardless of the sources of these changes, bank managers must know whether their banking policies have improved productivity and whether the changes and the new initiatives affect some branches differently than others.
Instead of using traditional techniques such as ratio analysis and observation, the management of the bank studied here decided to use DEA to identify areas where improvement could be made in the performance of the branches while maintaining service quality and also pinpointing opportunities where savings could be achieved.
The identification of bank branches that are functioning efficiently in contrast to inefficient branches is one of the most important outcomes of a DEA assessment. This is so because both efficient and inefficient bank branches typically use a similar set of resources (inputs) in producing a similar mix of services (outputs) in a similar environment. Therefore, inefficient branches can learn from and emulate their efficient peers regarding what needs to be done to improve. Furthermore, operational practices identified as contributing to efficiency may be studied, and information gathered may be disseminated throughout the entire organization that seeks to investigate, improve and grow.
Suggestions for further use of DEA include development of a DEA-based index (Fare et al., 1994) that measures productivity change and can be used to investigate the changes in productivity resulting from changes in product offerings and/or operating principles. In addition to measuring the impact of new offerings, such analyses could help address the questions of how to allocate operating budgets to units, how to minimize financial risks at branch levels, and how to use inter-branch data to monitor a bank's performance vis-Ã -vis other branches as well as other banks in the industry.


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