Economies of scale and input costs efficiency of commercial banks in vietnam, 2006 2014

University of Economics

International institute of Social Studies

Ho Chi Minh
City, Vietnam

Erasmus
University
of
Rotterdam

The
Neth
erlan
d

VIETNAM- THE NETHERLANDS
PROGRAMME FOR M.A. IN
DEVELOPMENT ECONOMICS

ECONOMIES OF SCALE AND
INPUT COSTS EFFICIENCY OF

COMMERCIAL BANKS IN
VIETNAM, 2006-2014
By Dang Tri Dung
Supervisor

Dr. Vo Hong Duc

Thesis submitted for the
Degree of Master of Art in
Development Economics

Vietnam Netherlands
Programme,
November 2013


University of Economics
Ho Chi Minh City, Vietnam
VIETNAM- THE NETHERLANDS PROGRAMME FOR
M.A. IN DEVELOPMENT ECONOMICS

ECONOMIES OF SCALE AND INPUT COSTS EFFICIENCY
OF COMMERCIAL BANKS IN VIETNAM, 2006-2014
By Dang Tri Dung

A thesis submitted in Partial fulfillment of the Requirements for the
Degree of Master of Art in Development Economics

Under the supervision of Dr. Vo Hong Duc

Vietnam - Netherlands Programme, November 2015


DECLARATION
I hereby declare that the thesis "Economies Of Scale And Input Costs
Efficiency Of Commercial Banks In Vietnam, 2006-2014" was made by myself

under the supervision of Dr. Võ Hồng Đức.
I also hereby declare that all the data and the results of this thesis are
collected and calculated by me. In addition, the conclusions and recommendations
are not copied by any research.

Đặng Trí Dũng

...........................................

..............................................

The above declaration is affirmed

Dr. Võ Hồng Đức

..........................................

i

............................................


ABSTRACT
This study is conducted to determine and quantify the performance of the
commercial banks in Vietnam in relation to their economies of scale and the
possibility of substitute of inputs in their operations. Data used in this study were
collected from 32 commercial banks in Vietnam for the period from 2006 to 2014.
The Iterate Semmingly Unrelated Regression (ITSUR) with the support of STATA
software is used in this study. The findings from this study provide empirical
evidence to confirm that the operation scale of the commercial banks in Vietnam is

increasing return to scale. This means that increasing the scale of operations from
the commercial banks in Vietnam may result in an increase of their profitability.
This finding appears to be consistent with a merger and acquisition taking place in
the Vietnam’s banking system at the moment with the lead of the State Bank of
Vietnam.
In addition, the commercial banks in Vietnam have demonstrated that cost
inefficiencies during operations are problematic. The three key inputs of
commercial banks during their operations are labor, financial capital and fixed
assets are all inelastic and as such, they may be substitute for one another. As such,
controlling labour costs appears to be essential for the efficient operations of the
commercial banks in Vietnam.
Empirical findings from this empirical study are drawn to provide some
implications for both the commercial banks and the State Bank Vietnam in relation
to the scale efficiency of operations for the commercial banks and the leading roles
of the central banks in providing guidance and assistance for the entire banking
system to grow further.
Keywords: Ecnomies of scale; Financial capital; Labor; Fixed assets;
Elasticity; Commercial banks; Vietnam.

ii


ACKNOWLEDGMENT
I sincere thanks to my supervisor Dr. Vo Hong Duc. He was enthusiastically
helped and gave me advice during the research process. Dr. Vo Hong Duc suggested
useful ideas for my research.
In addition, I am also wish to thank to all the lecturer of the VietnamNetherlands program. The lecturers helped me to get the knowledge of development
economics. Furthermore, the teachers helped me to know the research methods in
the economic field.

iii


DECLARATION
ABSTRACT ..............................................................................................................
ACKNOWLEDGMENT.........................................................................................
CONTENTS .............................................................................................................
LIST OF TABLES .................................................................................................
LIST OF FIGURES ..............................................................................................
ABBREVIATIONS .................................................................................................
CHAPTER 1 INTRODUCTION .............................................................................
1.1.

Problem Statements ........................................

1.2.

Research Objectives ........................................

1.3.

Research Questions ........................................

1.4.

The Scope of this Research .............................

1.5.

Methodology ..................................................

1.6.

The Structure of the Study .............................

CHAPTER 2 LITERATURE REVIEW .................................................................
2.1.

Overview of the Commercial Banking System

2.2.

Studies On The Scale Economies Of Commerc

2.3.

Studies On The Price Elasticity Of Inputs In B

2.4.

Translog Cost Function Theory .......................

2.5.

The Estimation Method Of The Scale Econom

2.5.1 Estimation Method Of The Scale Econ

2.5.2 The Own-Price Elasticity And Cross-P
CHAPTER 3 RESEARCH METHODOLOGY ...................................................

3.1.

The Hypothesis Testing ..................................

3.2.

Identification Of Variable ...............................

iv


3.3. Data Collection And Expected Results ..........

3.4. The Research Methodology ...........................

CHAPTER 4 EMPIRICAL RESULTS ................................................................

4.1. Descriptive Statistical Analysis ......................

4.2. Regression Results .........................................

4.2.1. The Results From Translog Cost Func

4.2.3. The Result Of The Scale Economies ...

4.2.4. The Own-Price Elasticity and Cross-P
CHAPTER 5 CONCLUSIONS AND POLICY IMPLICATIONS ....................

5.1. Conclusions ....................................................

5.2. Policy Implications .........................................

5.3. Limitations And Future Research ...................
APPENDIX A ..........................................................................................................
APPENDIX B ..........................................................................................................
APPENDIX C ..........................................................................................................
APPENDIX D ..........................................................................................................
APPENDIX E ..........................................................................................................
APPENDIX F ...........................................................................................................
APPENDIX G ..........................................................................................................
APPENDIX H ..........................................................................................................
APPENDIX I ............................................................................................................

v


APPENDIX J......................................................................................................... 79
APPENDIX K........................................................................................................ 80

vi


LIST OF TABLES
Table 1

The Variables Of Equation System That Analyzes The Relationship
Between Financial Capital And Labor. 15

Table 2

The Variables Of Equation System That Analyzes The Relationship
Between Financial Capital And Fixed Assets. 16

Table 3

The Variables Of Equation System That Analyzes The Relationship
Between Labor And Fixed Assets. 16

Table 4

The Dependent Variables................................................................... 21

Table 5

The Independent Variables................................................................ 22

Table 6

Statistics Of Variables In The Equation System (9)..........................32

Table 7

Statistics Of Variables In The Equation System (10)........................33

Table 8

Statistics Of Variables In The Equation System (11)........................33

Table 9

The Correlation Matrix Of Variables In The Equation System (9). 34

Table 10

The Correlation Matrix Of Variables In The Equation System (10).
34

Table 11

The Correlation Matrix Of Variables In The Equation System (11).
35

Table 12

The Results Of The Equation System (09)......................................... 36

Table 13

The Results Of The Equation System (10)......................................... 37

Table 14

The Results Of The Equation System (11)......................................... 38

Table 15

The scale economies of Vietnam Commercial banks in 2006-2014. .. 41

Table 16

The scale economies of Joint stock commercial banks and State
commercial banks in 2006-2014. 41

Table 17

The Own-Price Elasticity And Cross-Price Elasticities From Two
Outputs Model.
44

Table 18

The Own-Price Elasticity And Cross-Price Elasticities From Models
Including Loan.
45

Table 19
Models

The Own-Price Elasticity And Cross-Price Elasticities From
Including Deposits. 46

Table 20

The Relationship Between The Inputs.............................................. 47


vii


LIST OF FIGURES

Figure 1 Total Assets And Return On Total Assets Of Commercial Banks In
Vietnam 2013-2015 6

viii


ABBREVIATIONS
IPO:

Initial Public Offering

NPLs:

Nonperforming loans

ROA:

Return On Total Assets

Agribank:

Bank For Agriculture And Rural Development

Vietinbank:

Bank For Industry And Trade

BIDV:

Bank For Investment And Development

VCB:

Bank For Foreign Trade of Vietnam

OLS:

Ordinary Least Squares

FGLS:

Feasible Generalized Least Squares

ix


CHAPTER 1
INTRODUCTION
This chapter presents problems statements that the author will solve in this
thesis. The problem statements of study will be interpreted through detailed research
objectives and research questions. Next, the scope of research and research methods
will be presented in order to clarify the research objectives of the thesis.
1.1. Problem Statements
In recent years, the total assets of the commercial banks in Vietnam have
increased continuously. Monthly Report 5-2015 from the State Bank of Vietnam
(SBV) showed that the total assets of the State Commercial Bank System was
2,896,430 billion VND and total assets of the Joint Stock Commercial Bank System
1

is 2,715,910 billion VND. In addition, the average growth rate of the total assets of

the State Commercial Bank System from 1/2013 to 5/2015 is 1.14%/month and the
Joint Stock Commercial Bank System is 0.89%/month. These data showed that the
commercial banks Vietnam were always trying to increase their scale. The increase
of scale creates conditions for using more inputs such as labor, capital and fixed
assets. However, the increase of scale does not always bring the expected profits
that the commercial banks desire. The increase of the scale have to be in accordance
with capability of the management of the commercial banks. Therefore, the
commercial banks can find a best way that combines the inputs to maximize the
outputs. If the scale of the banks is less than the one, the increase of scale will
facilitate to increase profitability as expected. However, if their scale is currently
larger than one, the increase of scale would increase costs and as such, reduce
profits.
The research of Akhigbe and McNulty (2003) with data of the commercial
banks in the US concluded that small banks will be more profitable than large
1The data collected from the central bank

1


banks. Pasiouras and Kosmidou (2007) study for European banks also provided
evidence that the increase of scale would increase their cost and it has a negative
impact on bank profitability. In contrast, research by Williams (1998) in the case of
foreign branches in Australia concluded that the profitability of branches will have a
positive impact from the increase of scale of their parent bank. In the study
conducted for Indian banks, Das and Ghosh (2009) also reached a similar view
when they concluded that the increase of scale will have positive impact on bank
profitability.
In the case the commercial banks of in Vietnam, banks always put effort to
increase their scale. However, the return on assets (ROA) appears to decrease.
Therefore, it is argued that the authentic approach to determine the scale efficiency

of Vietnam’s the commercial banks is an essential issue. The economies of scale
condition of the Vietnam the commercial banks should be determined. Therefore, it
is expected that findings from this empirical study will provide further evidence for
the commercial banks to make their decisions.
1.2. Research Objectives
This study is conducted to provide the quantitative evidence in relation to the
scale economies of the commercial banks Vietnam in terms of profit maximization.
In addition, this research also considers the ability of the commercial banks in
Vietnam to change the amount of inputs for the purpose of increasing their
profitability.
In short, this study aims to achieve two key objectives: (i) determining the
economies of scale of the commercial banks; and (ii) considering the possibility of
varying inputs in order to achieve the operate efficiently.

2


1.3. Research Questions
In accordance with research objectives, the two relevant research question
should be answered are:




The first question: Are the economies of scale of Vietnam commercial banks
increasing return to scale, decreasing return to scale or constant return to
scale?
The second question: Are the inputs substitutable?

1.4. The Scope of this Research

The purpose of the study is to establish the quantitative evidence about the
scale economies of the commercial banks in Vietnam. Therefore, data from 32 the
commercial banks in Vietnam in the period from 2006 to 2014 were collected. The
research covers the period of 2006-2014 mainly because the commercial banks in
Vietnam disclose their information relatively sufficient during this period. Some
commercial banks are removed in the process of collecting data because they do not
provide enough information or their operations were terminated during the research
period.
1.5. Methodology
The quantitative approach is used in this study to estimate the scale economies
of the commercial banks in Vietnam. Using the translog cost functions adopted in
various relevant previous empirical studies, this study uses quantitative approach to
determine the impact of factors such as the input prices and control variables to the
cost of the commercial banks in Vietnam. The Iterate Semmingly Unrelated
Regression (ITSUR) method is used in this research with the support of STATA
software.

3


1.6. The Structure of the Study
This study includes five chapters with the key contents included in each
chapter can be summarized below.


The first chapter presents an overview of this study including the Problem
Statement, Research Method and Data.



Chapter two presents the literature reviews. This chapter firstly describes the
overview of the commercial banking system and the process that the
commercial banks in Vietnam increase their scale. Then, this chapter presents
relevant previous studies in relation to estimating the scale and elasticity of the
inputs. This chapter ends with theoretical model of translog cost function and
estimation method about the scale economies and the elasticity of the inputs.
These theory will be used to model in detail in the next chapter.



Chapter three present the research method. The theoretical model will be
detailed into the three systems of equations that they are appropriate with the
research objectives. Chapter three will also show how this research estimates
variables in the model using the collected data. Finally, this chapter ends with
appropriate regression methods to estimate for system of equations.



Chapter four presents the results estimated using the model adopted in chapter
three. In addition, this chapter also presents results from the scale economies
and the elasticity of the input of the commercial banks in Vietnam during the
research period from 2006-2014. Finally, the results from the model will be
explained in detail.



The final chapter presents the conclusions which are drawn from this study.
On the ground of these empirical findings, policy recommendations for the
State Bank are formed. Finally, this chapter will present the limits of this
research and ways for future research.

4


CHAPTER 2
LITERATURE REVIEW
2.1.

Overview of the Commercial Banking System in Vietnam

By the end of July 2015, Vietnam commercial banking system consists of 40
banks. Banking system is classified as Joint stock commercial banks and state
commercial banks.
The State commercial banks are Bank For Agriculture And Rural Development
(Agribank), Bank For Industry And Trade (Vietinbank), Bank For Investment And
Development (BIDV) and Bank For Foreign Trade (VCB). Vietinbank has the
largest charter capital in State commercial banks with 37,234 billion VND charter
capital. Whereas, Saigon Thuong Tin Commercial Joint Stock Bank has the largest
charter capital among Joint stock commercial banks with 12,425 billions VND
charter capital. In 2006, the State Bank has requested commercial banks to increase
2

their chartered capital .
In 2015, many bank mergers happened, they increased the scale of banks.
Some large mergers such as Petrolimex Bank merged into Vietinbank; Housing
Bank of Mekong Delta merged into Bank For Investment And Development. Saigon
Thuong Tin Commercial Joint Stock Bank merged into Southern Bank. The purpose
of this merger is to modernize commercial banking system in Vietnam and improve
the effectiveness of the system in the integration context. Total Assets and ROA of
commercial banking system is represented by Figure 1.

2Decree of gorvement 141/2006/NĐ-CP

5


Figure 1 Total Assets And Return On Total Assets Of Commercial Banks In
Vietnam 2013-2015
Total Assets and Return on total assets of Vietnam
Commercial banks in 2013-2015

Total as ets of State
Tổng tài sản NHTM CP NN

commercial bank

ROANHTMofStateCPcommercialNN
bank

Note:
- Data were collected from the State Bank of Vietnam
- Total assets is shown in the left column chart with units million billion VND.
- ROA is shown in the right column chart with units percent.

2.2.

Studies On The Scale Economies Of Commercial Banks
Jagtiani and Khanthavit (1996) studied with the US Commercial banks in the

period 1984-1991. Results achieved from this research showed that the major US

banks have achieved efficiency on scale, but these banks have continued to increase


6


their scale. The studies of Isik and Hassan (2003) for Turkish banks have shown that
there is no consistency in the performance of commercial banks. The banks do not
have the scale efficiency and they are inefficiency due to the greater impact of
technological inefficiencies than the impact of the allocation of resources. And then,
these banks have become ineffective on the scale due to the impact of minimum
regulation about risk based capital level. However, the research by Bos and Kolari
(2005) is based on the data of US and European banks in the period from 1995 to
1999 showed that banks had not yet reached the optimum scale and they may
increase their profit by increasing their products.
Several studies have been conducted to compare the scale efficiency of
domestic banks and branches of foreign banks. Havrylchyk (2006) studied on
domestic banks and branches of foreign banks in Poland. Author suggested that the
domestic banks and branches of foreign banks did not improve the scale efficiency
for the period 1998-2001. However, this research also concludes that the branches
of the banks that joined later have better scale efficiency of domestic banks. In
addition, the efficiency of foreign bank branches is not improved when competing
with domestic banks.
Research by Valverde, Humphrey, and del Paso (2007) was performed in the
context of banking consolidation in Europe. The results showed the banks in 10
European countries have a similar efficiency, the business environment of each
country does not affect the operation efficiency of the bank. Therefore, banks have
improved their efficiency by merging and expanding markets.
2.3.

Studies On The Price Elasticity Of Inputs In Banking

Research by Noulas, Ray, and Miller (1990) for the large US the banks has
shown that the elasticity of input factors has changed monotonically with changes in
scale. The fund will increasingly substitute for labor and deposits with the increase
of bank scale, while degree of substitution between deposits and fixed assets

7


become weaker and weaker. The importance of capital will be increasing, when
banks want to increase their scale, because financial capital can easily be reserved
and converted into other inputs.
Hughes and Mester (1998) also showed that banks may easily substitute labor,
fixed assets by financial capital, but objective of minimizing costs and increase
profits are not made in a simple way, it also depends on the ability of risk
management and portfolio management of banks. Banks can set a target to reduce
costs or increase profits by changing outputs. Research by Humphrey and Vale
(2004) used data of the US banks in 1988-1997, the results showed that banks want
to expand output products such as business loans will cost less than the consumer
loans. The cause of this difference is the price elasticity of businesses loans is
smaller than consumer loans. However, banks have increased their scale by
merging, this will not affect the cost of businesses loans and consumer loans. This
suggests that the scale economies of banks depends on not only the ability to
combine inputs but also the choice of the appropriate output with ability to manage
risk.
However, other studies for microfinance institutions have different results.
Hartarska, Shen, and Mersland (2013) researched on the microfinance institutions
from 69 countries in 1998-2000. The research results shown that the inputs such as
labor, fixed assets and financial capital is inelastic. The large of the change in the

labor price will be substituted by other inputs such as financial capital or fixed
assets. Similarly, significant changes of the financial capital will make using more
fixed assets. In addition, this research also showed that when the microfinance
institutions could increase their scale, their costs will decrease and increase profits.
2.4.

Translog Cost Function Theory

Methods efficiency scale analysis for financial intermediation are usually Cost
function and Profit function. However, Bos and Kolari (2005) suggested that there

8


is a homogeneous result while using Cost function and Profit function. The cost
function analyzes the cost effectiveness that now is achieved through the production
process, the cost effectiveness is understood as the minimum cost of the business
when they combine different inputs (Camanho & Dyson, 2005). Ferrier and Lovell
(1990) shown that when the banks increased the scale, this will affect the cost
efficiency of banks.
Cost effectiveness is evaluated by a Translog Cost Function. Binswanger
(1974), Ferrier and Lovell (1990), Kumbhakar (1997), Hartarska et al. (2013)
shown that translog cost function may be presented:
lnC = α

+∑α
0

∑δ

∑ γimlnqizm + lnv

With C is total cost; and are the outputs; and are the input prices; zm are the control variables; α, β, δ, and γ are the coefficients ; lnv are the residual of
Model 1.

Follow Darrough and Heineke (1978) and Berndt and Christensen (1973),
Model 1 and Model 5 must be homothenticity. Model 1and Model 5 must satisfy
conditions:
∑ βk = 1; ∑ βlk = 0 ; (2)

∑ δjk = 0 with any qj; (3)
∑ γkm = 0 with any zm (4)

According to Berndt and Wood (1975), the cost share of inputs can be
quantified by using the derivative of the Shepherd's Lemma from Model 1:

9


∂lnc
s=

(5)

sk = βk + ∑ βlklnpl + ∑ δjklnqj + ∑ γkmzm + lnvk

2.5.

The Estimation Method Of The Scale Economies and The Elasticity

2.5.1 Estimation Method Of The Scale Economies
The scale economies is determined by taking the derivative of the model with
respect to the logarithm of output.
∂lnC

Scale=
∂lnqj

The scale efficiencies are analyzed on the condition that businesses will have
the same management capabilities and technologies. However, in reality, the scale
efficiencies of businesses are different, so some businesses will have lower costs
and higher profits (Hartarska et. al., 2013).
Begg, Fischer, and Dornbusch (2005) shown that there are three reasons for
the scale efficiencies. First, the businesses can not divide the production process.
When the business begins manufacturing, they need a minimum quantity of inputs,
whether the businesses have produced or not. These factors are usually fixed and do
not change over output. Second, the businesses can specialize in the manufacturing
process. When the scale of the businesses is expanded, employers will have to hire
more employee, each employee will be able to focus on different jobs, so they will
work better. Finally, when the scale of the businesses is increased, the input will be
arranged closer together. At that time, manufacturing time and transport costs of
inputs will decrease. A business is increasing return to scale when scale economies
of bussiness is less than one. On the other hand, a business is decreasing return to
scale when scale economies of bussiness is larger than one. Finally, a business is
constant return to scale when scale economies of bussiness is equal to one.

10


2.5.2 The Own-Price Elasticity And Cross-Price Elasticities

The combination of inputs also affects the operational efficiency of the bank.
Because inputs have different costs, different combinations of inputs will produce
different outputs and profits.
This study estimates the price elasticity of inputs such as The own-price
elasticity and cross-price elasticities. The own-price elasticity should be understood
as a percentage change of the input demand if its price changes one percentage.
Meanwhile, The cross-price elasticity should be understood as percentage change of
the input demand if its price of other one changes one percentage (Ollinger, Ralston,
& Guthrie, 2011).
According to Uzawa (1962), Berndt and Wood (1975) The Allen partial
elasticities between k input and l input:
σ

lk

=

CClk
ClCk

With
For σlk = σkl. The Allen partial elasticities according to translog cost function was estimated:

σ =
ll

σ =
lk

βlk + sl

slsk

According to R. G. D. Allen (1938) The Own-price elasticity and The Crossprice elasticity:

11