After financial liberalization, the opening of private banks, and revisions to financial regulations, competition in the domestic banking industry and for domestic bankers has become increasingly fierce, with an increasingly harsh business environment. This has reduced bank spreads and loosened credit conditions, thereby increasing non-performing loans (NPL) ratios, causing low asset quality, and further placing banks in danger of financial collapse. In this study, we investigate the influence of NPL ratios on bank performance. Our case subject is the Taiwan Business Bank, which was restructured as a private bank in 1998. The research period is from one year prior to privatization to 2010 to determine whether NPL ratios influenced this bank’s performance.
In this study, we use data envelopment analysis, which has had high credibility for assessing banking efficiency in recent years, to measure the performance of the case bank. We also employ the Charnes, Cooper, and Rhodes (CCR) and Banker, Charnes, and Cooper (BCC) models and the Malmquist productivity index to analyze cross-sectional operational efficiency and longitudinal productivity changes and investigate the correlation between reasons for inefficiency and NPL ratios. We adopt an intermediate approach to select input and output variables. The input variables are deposits and equity. The output variables are NPL ratios and loans. We employ relative efficiency, reference set, and slack variables analyses to distinguish relatively efficient years and to understand areas that require improvement from the inputs and outputs of the relatively inefficient years.
The results of this study indicate that NPL ratios influenced the performance of Taiwan Business Bank substantially during the research period. Regarding the bank’s long-term business objectives, reducing NPL ratios is a top priority. Banks have numerous methods for reducing NPL ratios, such as setting current surpluses against bad debt losses and increasing loan volume to increase denominator numbers. However, these methods all have negative effects on bank performance, such as profit derogation and increases in NPL ratio risk. Thus, to reduce the influence of NPL ratios on operational risk, banks should continue to start with credit policies, or strengthen available capital to adjust risky asset ratios. These are more sound practices.