Cost Efficiency Credit Risk-taking And Capital Adequacy An Empirical Study On Ethiopian Commercial Banks

The purpose of this study is twofold, first to investigate the cost efficiency level of Ethiopianrncommercial banks; and second, to analyze the relationship between cost efficiency, credit risk-rntaking and capital adequacy based on the notion of causality. Balanced panel data from samplesrnof eight banks which have data for the period 2000 to 2014 have been used. The study appliedrnStochastic Frontier Analysis (SFA) techniques provided by Battese and Coelli (1995) torninvestigate the banks‟ cost efficiency level and Granger causality techniques to analyze causalrnrelationship among cost efficiency, credit risk-taking and capital adequacy. The findings of thernstudy highlight that the average cost efficiency level of the studied commercial banks is 89rnpercent. At individual bank level, Ethiopian Commercial Bank (CBE) is the most cost efficientrnwhile Construction and Business Bank (CBB) is the least cost efficient. State ownership hasrnnegative impact on cost efficiency due to the averaging effect of the two studied state ownedrncommercial banks. Bank size has positive impact on cost efficiency indicating that large banksrnon average tended to be more cost efficient than small banks. With regard to the causalrnrelationship, the results of the Granger model show that negative and bidirectional causalityrnexists between cost efficiency and credit risk-taking supporting both the “luck” and “badrnmanagement” hypotheses. The study also shows that improvement in cost efficiency Grangerrncause increase in capital adequacy level. Capital adequacy and credit risk-taking also havernbidirectional causality supporting both “luck” and “moral hazard” hypothesis. Overall, thernresults of the Granger model indicate that the severity of one of the three variables may increasernunless the other is carefully managed.rnKey words: Cost efficiency; Credit risk-taking; Capital adequacy; Granger causality; StochasticrnFrontier Analysis; System GMM

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