Global Financial Crisis and Productivity Changes of Banks in UAE
To analyze the impact of the 2008 global financial crisis on the banking sector in the UAE and provide recommendations for addressing the challenges faced by the industry.
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This research evaluates the productivity change of the Emirati Banking sector for a balanced panel which covers 10 banks operating in UAE for the period 2006-2010, by estimating a non-parametric approach Data Envelopment Analysis. Input-oriented Malmquist indices of productivity change are estimated with DEA to measure total factor productivity (TFP) change. The TFP changes are decomposed into the product of technological change and technical efficiency change (catch-up).
Global Financial Crisis and Productivity Changes of Banks in UAE
To analyze the impact of the 2008 global financial crisis on the banking sector in the UAE and provide recommendations for addressing the challenges faced by the industry.
Added on 2023-06-15
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International Journal of Business and Society, Vol. 18 S3, 2017, 437-448
GLOBAL FINANCIAL CRISIS AND PRODUCTIVITY
CHANGES OF BANKS IN UAE: A DEA-MPI ANALYSIS
Ammar Jreisat
Al Ain University of Science and Technology
Sameer Al-Barghouthi
Al Falah University
Amer Qasim
Al Ain University of Science and Technology
Khalil Nimer
American University of the Middle East
ABSTRACT
The primary objective of this research is to undertake in-depth evaluation and examination of the productivity
change of the Emirati Banking sector for a balanced panel which covers 10 banks operating in UAE for the
period 2006-2010, by estimating a non-parametric approach Data Envelopment Analysis. Input-oriented
Malmquist indices of productivity change are estimated with DEA to measure total factor productivity (TFP)
change. The TFP changes are decomposed into the product of technological change and technical efficiency
change (catch-up). The era of our sample is very rich with many aspects that influenced the UAE banking system
which cover the global financial crisis era. The empirical results are obtained by running an input-oriented DEA
model using the software package, DEAP Version 2.1 (Coelli, 1996). Our results reveal that the banking sector
in UAE shown a decline after the financial crisis in 2008.
Keywords: Two Stage Data Envelopment Analysis; UAE Banks; Malmquist Productivity Indices; Total Factor
Productivity; Global Financial Crisis.
1. INTRODUCTION
Financial system stability in any country is important for both the overall economic development and
the effectiveness of the central bank monetary policy. Over the last two decades, the UAE government
has undergone consistent and remarkable transformation from a socialist to a capitalist economy.
These changes were introduced mainly to improve the economic efficiency of UAE banking system
especially after the global financial crisis. The banking industry in the United Arab Emirates is one
of the major, and arguably the most important, industry in the United Arab Emirates after the oil and
gas industry. This is mainly due to its role as an intermediary and facilitator for the better allocation
of assets in a country that is seen as the regional hub for international finance, a free zone and
international trade hub, a leader in the development and sale of real estate mega-developments and
centre for a large concentration of net worth individuals with large multibillion dollar conglomerates.
Corresponding author: Dr. Ammar Jreisat, Department of Accounting, Finance and Banking, College of Business, Al Ain University
of Science and Technology, P.O. Box 112612, Abu Dhabi, UAE Email: ammar.jreisat@aau.ac.ae.
GLOBAL FINANCIAL CRISIS AND PRODUCTIVITY
CHANGES OF BANKS IN UAE: A DEA-MPI ANALYSIS
Ammar Jreisat
Al Ain University of Science and Technology
Sameer Al-Barghouthi
Al Falah University
Amer Qasim
Al Ain University of Science and Technology
Khalil Nimer
American University of the Middle East
ABSTRACT
The primary objective of this research is to undertake in-depth evaluation and examination of the productivity
change of the Emirati Banking sector for a balanced panel which covers 10 banks operating in UAE for the
period 2006-2010, by estimating a non-parametric approach Data Envelopment Analysis. Input-oriented
Malmquist indices of productivity change are estimated with DEA to measure total factor productivity (TFP)
change. The TFP changes are decomposed into the product of technological change and technical efficiency
change (catch-up). The era of our sample is very rich with many aspects that influenced the UAE banking system
which cover the global financial crisis era. The empirical results are obtained by running an input-oriented DEA
model using the software package, DEAP Version 2.1 (Coelli, 1996). Our results reveal that the banking sector
in UAE shown a decline after the financial crisis in 2008.
Keywords: Two Stage Data Envelopment Analysis; UAE Banks; Malmquist Productivity Indices; Total Factor
Productivity; Global Financial Crisis.
1. INTRODUCTION
Financial system stability in any country is important for both the overall economic development and
the effectiveness of the central bank monetary policy. Over the last two decades, the UAE government
has undergone consistent and remarkable transformation from a socialist to a capitalist economy.
These changes were introduced mainly to improve the economic efficiency of UAE banking system
especially after the global financial crisis. The banking industry in the United Arab Emirates is one
of the major, and arguably the most important, industry in the United Arab Emirates after the oil and
gas industry. This is mainly due to its role as an intermediary and facilitator for the better allocation
of assets in a country that is seen as the regional hub for international finance, a free zone and
international trade hub, a leader in the development and sale of real estate mega-developments and
centre for a large concentration of net worth individuals with large multibillion dollar conglomerates.
Corresponding author: Dr. Ammar Jreisat, Department of Accounting, Finance and Banking, College of Business, Al Ain University
of Science and Technology, P.O. Box 112612, Abu Dhabi, UAE Email: ammar.jreisat@aau.ac.ae.
438 Global Financial Crisis and Productivity Changes of Banks In UAE: A DEA-MPI Analysis
All of these key industries in the United Arab Emirates require the presence of banks in order to allow
the right allocation of funds through financing the key projects and industries of the country.
In 2010 the UAE banking sector comprising of some 23 local and 26, the banking sector in the UAE
has for quite some time benefitted from being in a very sound and robust position. In the UAE, four
types of banks are seen to be operating simultaneously. They are conventional, Islamic and foreign
banks. Moreover, some commercial banks have started opening Islamic windows and Islamic units
for those clients who do not want to indulge in interest-based transactions. This conviction created an
increased demand for Islamic products in the field of financing, and gave birth to a market where
only Islamic products are acceptable. Thus, banks working under Islamic windows are established to
provide an additional service to Muslim clients or to offer a variety of products for general clientele.
The UAE was the first country in the world to establish an Islamic bank, namely Dubai Islamic Bank,
in 1975. Islamic banking is one of the fastest-growing segments in the financial sector globally.
Assets of UAE's Islamic banks reached $73.1bn at the end of 2010 according to UAE Central Bank
governor. Islamic banks in the UAE target all categories to broaden their reach, through innovative
product offerings including Islamic personal finance, Islamic credit cards and Islamic auto finance,
Shari’a-complaint mortgages, and a growing range of investment funds.
UAE bank shares were slammed by a bear market amid an epic fall in oil prices, a rise in the US
dollar and an exodus of global capital from emerging/frontier markets. The scale of selling on the
Dubai Financial Market and the Abu Dhabi Securities Exchange has eerie echoes with the autumn of
2008, when Lehman's failure led to a seizure in the global interbank and wholesale funding markets,
a $100 a barrel drop in Brent crude, panic flows into the US dollar and a free fall in Gulf property
markets.
The global financial crisis in autumn of 2008 has affected many countries globally and in particular
effect UAE economy in general. The UAE made various actions after the crisis to save their economy
from any impact may affect their economy. Firstly, UAE banks have vastly boosted their capital
cushions since 2008 and Basel Tier one capital for the banking sector is now 16.7 per cent, at least
500 basis points higher than on the eve of Lehman's failure. Secondly, six years of frenetic loan
growth had made loan/deposit ratios in UAE banking excessive at 108 per cent in fall 2008. Banking
sector leverage has also fallen to 7.6, 100 basis points lower than in 2008. Three, UAE banks have
also successfully raised the non-performing loan coverage ratios in the banking system to 113 per
cent, far higher than the coverage ratio during the 2008 global credit crisis. Fourth, the UAE banking
sector was dependent on fickle global wholesale funding markets, which froze after Lehman's failure
triggered an epic crisis of confidence in the international interbank market.
With the above information we should shed the light on measuring the productivity change of the
banking sector during the global financial crisis era, especially the domestic banks, to assess how
each bank performs during and after the global financial crisis. Measuring the efficiency of the United
Arab Emirates banks significant as the UAE has developed rapidly comparing with other Middle
Eastern countries and this will be important for analysts, practitioners and policymakers to be able to
understand the relative performance of banks benchmark the efficiency of the banks against each
other. (Jemrić and Vujčić, 2002).
The primary objective of this paper is to undertake and in-depth evaluation and examination of the
productivity growth in the UAE banking sector. Input-oriented Malmquist indices of productivity
All of these key industries in the United Arab Emirates require the presence of banks in order to allow
the right allocation of funds through financing the key projects and industries of the country.
In 2010 the UAE banking sector comprising of some 23 local and 26, the banking sector in the UAE
has for quite some time benefitted from being in a very sound and robust position. In the UAE, four
types of banks are seen to be operating simultaneously. They are conventional, Islamic and foreign
banks. Moreover, some commercial banks have started opening Islamic windows and Islamic units
for those clients who do not want to indulge in interest-based transactions. This conviction created an
increased demand for Islamic products in the field of financing, and gave birth to a market where
only Islamic products are acceptable. Thus, banks working under Islamic windows are established to
provide an additional service to Muslim clients or to offer a variety of products for general clientele.
The UAE was the first country in the world to establish an Islamic bank, namely Dubai Islamic Bank,
in 1975. Islamic banking is one of the fastest-growing segments in the financial sector globally.
Assets of UAE's Islamic banks reached $73.1bn at the end of 2010 according to UAE Central Bank
governor. Islamic banks in the UAE target all categories to broaden their reach, through innovative
product offerings including Islamic personal finance, Islamic credit cards and Islamic auto finance,
Shari’a-complaint mortgages, and a growing range of investment funds.
UAE bank shares were slammed by a bear market amid an epic fall in oil prices, a rise in the US
dollar and an exodus of global capital from emerging/frontier markets. The scale of selling on the
Dubai Financial Market and the Abu Dhabi Securities Exchange has eerie echoes with the autumn of
2008, when Lehman's failure led to a seizure in the global interbank and wholesale funding markets,
a $100 a barrel drop in Brent crude, panic flows into the US dollar and a free fall in Gulf property
markets.
The global financial crisis in autumn of 2008 has affected many countries globally and in particular
effect UAE economy in general. The UAE made various actions after the crisis to save their economy
from any impact may affect their economy. Firstly, UAE banks have vastly boosted their capital
cushions since 2008 and Basel Tier one capital for the banking sector is now 16.7 per cent, at least
500 basis points higher than on the eve of Lehman's failure. Secondly, six years of frenetic loan
growth had made loan/deposit ratios in UAE banking excessive at 108 per cent in fall 2008. Banking
sector leverage has also fallen to 7.6, 100 basis points lower than in 2008. Three, UAE banks have
also successfully raised the non-performing loan coverage ratios in the banking system to 113 per
cent, far higher than the coverage ratio during the 2008 global credit crisis. Fourth, the UAE banking
sector was dependent on fickle global wholesale funding markets, which froze after Lehman's failure
triggered an epic crisis of confidence in the international interbank market.
With the above information we should shed the light on measuring the productivity change of the
banking sector during the global financial crisis era, especially the domestic banks, to assess how
each bank performs during and after the global financial crisis. Measuring the efficiency of the United
Arab Emirates banks significant as the UAE has developed rapidly comparing with other Middle
Eastern countries and this will be important for analysts, practitioners and policymakers to be able to
understand the relative performance of banks benchmark the efficiency of the banks against each
other. (Jemrić and Vujčić, 2002).
The primary objective of this paper is to undertake and in-depth evaluation and examination of the
productivity growth in the UAE banking sector. Input-oriented Malmquist indices of productivity
Ammar Jreisat, Sameer Al-Barghouthi, Amer Qasim and Khalil Nimer 439
change are estimated with DEA to measure total factor productivity (TFP) change using a balanced
panel data containing 10 banks operating in UAE for the period 2006-2010. The study compares the
productivity change between the domestic banks during the sample period. The empirical results are
obtained by running an input-oriented DEA model using the software package, DEAP Version 2.1
(Coelli, 1996).
The rest of the paper is organised as follows. To put the study in perspective. Section 2 presents a
brief overview of existing literature on productivity changes in the banking industry. Section 3
presents the Malmquist Productivity Index (MPI) Measurement. The Data and the choice of variables
presented in Section 4. The drivers of productivity change are analysis in Section 5. Sections 6
summarises and brings together the main findings.
2. LITERATURE REVIEW
The literature on efficiency and productivity change of banks and how productivity influenced by
changes in regulations, innovation and technological processes and differences of productivity across
countries is vast. Various studies conducted in the US, Europe, Asia and a few in Africa have
measured efficiency and productivity change in banking sector.
Ferrier and Lovell (1990) and Grabowski et al. (1994) used the DEA approach to assess the
productive performance of US banks relative to the best practice frontier, and found that overall the
efficiency of the US banking industry ranges from 65% to 90%. Following this, Richard et al. (2002)
used the DEA model to evaluate the productive efficiency of US commercial banks from 1984–1998.
Strong and consistent relationships between efficiency and independent measures of performance
were found. Seiford and Zhu (1999) examined the performance of the top 55 US commercial banks
using DEA. They used a two-stage [1] production process to measure profitability and marketability,
with inputs and outputs in each stage consisting of eight factors. Their results indicated that relatively
large banks exhibited better performance on profitability, whereas smaller banks tended to perform
better with respect to marketability.
The Middle East studies on measuring efficiency and productivity change of banks are limited.
However, that are a few studies on measuring productivity and efficiency on the Middle East area.
For example, Al-Tamimi and Lootah (2007) investigated the operating and profitability efficiency of
15 branches of UAE-based commercial bank utilizing the DEA method. The results indicate that the
profitability efficiency appears to be higher than operational efficiency. Regarding the financial ratios
analysis, a consistent effect cannot be obtained and it cannot be determined which branch has an
overall position in terms of higher performance. In addition, management should consider major
operational improvement efforts to reduce employees’ expenses and other operating expenses
combined with an increase in the total loans portfolio. Moreover, both interest and non-interest
revenues require improvement to increase profitability efficiency of the whole branch network.
Using the data from the annual reports of individual banks published by Emirates Banks Association
for 1997- 2001, Al–Tamimi (2008) focussed on identifying the relatively best performing banks and
relatively worst performing banks in the United Arab Emirates (UAE). The study used DEA and
some traditional financial ratios such as returns on assets, returns on equity, ratio of loans to deposits
and ratio of loan to total assets to investigate efficiency of banks. The DEA model used interest
expense and non-interest expense as input variable; interest revenue and non-interest revenue as
change are estimated with DEA to measure total factor productivity (TFP) change using a balanced
panel data containing 10 banks operating in UAE for the period 2006-2010. The study compares the
productivity change between the domestic banks during the sample period. The empirical results are
obtained by running an input-oriented DEA model using the software package, DEAP Version 2.1
(Coelli, 1996).
The rest of the paper is organised as follows. To put the study in perspective. Section 2 presents a
brief overview of existing literature on productivity changes in the banking industry. Section 3
presents the Malmquist Productivity Index (MPI) Measurement. The Data and the choice of variables
presented in Section 4. The drivers of productivity change are analysis in Section 5. Sections 6
summarises and brings together the main findings.
2. LITERATURE REVIEW
The literature on efficiency and productivity change of banks and how productivity influenced by
changes in regulations, innovation and technological processes and differences of productivity across
countries is vast. Various studies conducted in the US, Europe, Asia and a few in Africa have
measured efficiency and productivity change in banking sector.
Ferrier and Lovell (1990) and Grabowski et al. (1994) used the DEA approach to assess the
productive performance of US banks relative to the best practice frontier, and found that overall the
efficiency of the US banking industry ranges from 65% to 90%. Following this, Richard et al. (2002)
used the DEA model to evaluate the productive efficiency of US commercial banks from 1984–1998.
Strong and consistent relationships between efficiency and independent measures of performance
were found. Seiford and Zhu (1999) examined the performance of the top 55 US commercial banks
using DEA. They used a two-stage [1] production process to measure profitability and marketability,
with inputs and outputs in each stage consisting of eight factors. Their results indicated that relatively
large banks exhibited better performance on profitability, whereas smaller banks tended to perform
better with respect to marketability.
The Middle East studies on measuring efficiency and productivity change of banks are limited.
However, that are a few studies on measuring productivity and efficiency on the Middle East area.
For example, Al-Tamimi and Lootah (2007) investigated the operating and profitability efficiency of
15 branches of UAE-based commercial bank utilizing the DEA method. The results indicate that the
profitability efficiency appears to be higher than operational efficiency. Regarding the financial ratios
analysis, a consistent effect cannot be obtained and it cannot be determined which branch has an
overall position in terms of higher performance. In addition, management should consider major
operational improvement efforts to reduce employees’ expenses and other operating expenses
combined with an increase in the total loans portfolio. Moreover, both interest and non-interest
revenues require improvement to increase profitability efficiency of the whole branch network.
Using the data from the annual reports of individual banks published by Emirates Banks Association
for 1997- 2001, Al–Tamimi (2008) focussed on identifying the relatively best performing banks and
relatively worst performing banks in the United Arab Emirates (UAE). The study used DEA and
some traditional financial ratios such as returns on assets, returns on equity, ratio of loans to deposits
and ratio of loan to total assets to investigate efficiency of banks. The DEA model used interest
expense and non-interest expense as input variable; interest revenue and non-interest revenue as
440 Global Financial Crisis and Productivity Changes of Banks In UAE: A DEA-MPI Analysis
output variables. The study revealed that most of the UAE Commercial Banks were inefficient. The
national banks were relatively more efficient than the foreign banks. Two traditional ratios namely,
loans to deposits and loans to total assets indicated that the UAE Commercial Banks somehow did
not use the available resources efficiently.
Al-Muharrami (2007) used DEA techniques to estimate technical, pure technical, and scale
efficiency, using an input orientation for GCC banks for ten years. He highlighted several interesting
findings: First, smaller banks exhibited superior performance in terms of overall technical efficiency
than did larger ones. Second, big banks proved to be more successful in adopting the best available
technology, while medium banks proved to be more successful in choosing optimal levels of output.
Third, Islamic banks were more successful in both the adoption of the best available technology and
choosing optimal levels of output. Fourth, banks in Bahrain, Qatar, Oman, UAE, Kuwait and Saudi
Arabia ranked first to sixth, respectively, in terms of technical efficiency.
Miniaoui and Tchanetchan (2010) assessed technical efficiency of 44 top GCC banks over the period
2005-2008 using DEA approach. The results show that only 14 banks are rated as efficient under
CRS and/or VRS assumptions, and indicate that Islamic banks perform slightly better than the other
types of banks (conventional and windowing).
In a more recent , Al Suwaidi (2013), applied DEA method to evaluate and analyze the efficiency of
the national commercial banks in the United Arab Emirates by defining and using different
approaches of Data Envelopment Analysis in order to identify the relatively efficient and relatively
less efficient national commercial banks. This study concentrates on the main approaches of the
operating efficiency and the financial intermediary role efficiency. Through this study they observed
that over the period of 2008 – 2012 that (i) A general and consistent level of high operational
efficiency can be observed in the United Arab Emirates banking Sector; (ii) A general and consistent
level of high intermediary role efficiency can be observed in the United Arab Emirates banking Sector
with the presence of efficiency fluctuations in some banks; (iii) The age of individual banks had little
or no effect on the relative efficiency of the bank; (iv) Compared to previous studies we can observe
a general raise in operating efficiency levels among banks.
To the best of our knowledge, none of these studies have evaluate and analyse the productivity growth
covered pre and post global financial crisis era for the UAE banking sector. The present study
overcomes this limitation by encompassing the entire financial liberalisation period and investigating
the drivers of productivity change in UAE banks. The global financial crisis brought about significat
changes in practices of UAE banks from 2006 to 2010. The study undertaken in this paper will
provide a new perspective about the banking sector of UAE.
3. THE MALMQUIST PRODUCTIVITY INDEX (MPI): DECOMPOSITION AND
MEASUREMENT
The Malmquist TFP index was first introduced in two very influential papers by Caves, Christensen
and Diewert (1982a, 1982b). These authors define TFP index using Malmquist distance functions;
hence the resulting index is known as Malmquist TFP index or simply (MPI). One of the important
features of these distance functions is that these allow description of a multi-input, multi-output
production technology without the need to specifying a behavioural objective such as cost
minimisation or profit maximisation. Distance functions are of two types: the input distance functions
output variables. The study revealed that most of the UAE Commercial Banks were inefficient. The
national banks were relatively more efficient than the foreign banks. Two traditional ratios namely,
loans to deposits and loans to total assets indicated that the UAE Commercial Banks somehow did
not use the available resources efficiently.
Al-Muharrami (2007) used DEA techniques to estimate technical, pure technical, and scale
efficiency, using an input orientation for GCC banks for ten years. He highlighted several interesting
findings: First, smaller banks exhibited superior performance in terms of overall technical efficiency
than did larger ones. Second, big banks proved to be more successful in adopting the best available
technology, while medium banks proved to be more successful in choosing optimal levels of output.
Third, Islamic banks were more successful in both the adoption of the best available technology and
choosing optimal levels of output. Fourth, banks in Bahrain, Qatar, Oman, UAE, Kuwait and Saudi
Arabia ranked first to sixth, respectively, in terms of technical efficiency.
Miniaoui and Tchanetchan (2010) assessed technical efficiency of 44 top GCC banks over the period
2005-2008 using DEA approach. The results show that only 14 banks are rated as efficient under
CRS and/or VRS assumptions, and indicate that Islamic banks perform slightly better than the other
types of banks (conventional and windowing).
In a more recent , Al Suwaidi (2013), applied DEA method to evaluate and analyze the efficiency of
the national commercial banks in the United Arab Emirates by defining and using different
approaches of Data Envelopment Analysis in order to identify the relatively efficient and relatively
less efficient national commercial banks. This study concentrates on the main approaches of the
operating efficiency and the financial intermediary role efficiency. Through this study they observed
that over the period of 2008 – 2012 that (i) A general and consistent level of high operational
efficiency can be observed in the United Arab Emirates banking Sector; (ii) A general and consistent
level of high intermediary role efficiency can be observed in the United Arab Emirates banking Sector
with the presence of efficiency fluctuations in some banks; (iii) The age of individual banks had little
or no effect on the relative efficiency of the bank; (iv) Compared to previous studies we can observe
a general raise in operating efficiency levels among banks.
To the best of our knowledge, none of these studies have evaluate and analyse the productivity growth
covered pre and post global financial crisis era for the UAE banking sector. The present study
overcomes this limitation by encompassing the entire financial liberalisation period and investigating
the drivers of productivity change in UAE banks. The global financial crisis brought about significat
changes in practices of UAE banks from 2006 to 2010. The study undertaken in this paper will
provide a new perspective about the banking sector of UAE.
3. THE MALMQUIST PRODUCTIVITY INDEX (MPI): DECOMPOSITION AND
MEASUREMENT
The Malmquist TFP index was first introduced in two very influential papers by Caves, Christensen
and Diewert (1982a, 1982b). These authors define TFP index using Malmquist distance functions;
hence the resulting index is known as Malmquist TFP index or simply (MPI). One of the important
features of these distance functions is that these allow description of a multi-input, multi-output
production technology without the need to specifying a behavioural objective such as cost
minimisation or profit maximisation. Distance functions are of two types: the input distance functions
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