FINANCES-UAE: Small banks more cost efficient, says study

By IPS Correspondents Reprint | | Print |

Att.Editors: The following item is by the United Arab Emirates news agency (WAM)

DUBAI, Feb 14 2003 (IPS) - A recent research study on 35 commercial banks operating in the United Arab Emirates (UAE) found that small banks were more cost efficient than large ones. The study further discovered that small banks improved their returns in the year 2000, while large banks maintained constant returns during that period.

The study, carried out by Dubai University College and sponsored by Dubai Chamber of Commerce and Industry (DCCI), looked at 35 commercial banks operating in the UAE during 1998 – a weak year for banks, as the oil prices were lowest – and in 2000 – a relatively good year for banks, with higher oil prices.

According to ‘Gulf News’, which reported the story in its issue of today, the study estimated the cost efficiency, scale and scope measures and cost productivity growth rates of banks using stochastic cost frontiers. The findings were presented in the European Conference of Financial Management Association International in Copen-hagen on June 6, last year.

On an average, all the banks in general exhibited increasing returns to scale in 2000 compared with 1998. When compared with the best-practicing banks, cost productivity rate of medium-sized banks increased between the two periods. This increase in cost productivity rate was contributed, to a major extent, by the improved practices in cost functions adopted by these banks and changes in business conditions.

"With the entry of the UAE into the fold of the World Trade Organization, these findings appear to be especially important for the future of the banking industry, since the over-banking situation in UAE has resulted in increased competition, reduced margins and limited lending opportunities for banks," says the report.

It suggested that further efforts are needed to increase their productivity and reduce cost-inefficiency through efficient asset-liability management.

The study has found that management teams of small banks were capable of managing their portfolio more effectively and were able to exploit the improved business conditions during 2000 in their favor, to face competitive pressure and to ward off potential threats of consolidation by larger banks in the coming years through mergers and acquisitions.

As for the gross change in cost productivity growth rates between the two periods, the study revealed that cost changes were rising at an annual growth rate of 1.24 percent between 1998 and 2000, meaning that the overall costs had increased by 24 percent when compared with the best-practice banks.

In the Gulf, the UAE has the second highest branch density, with each branch serving almost 12,000 people in 2000. The report says such an over-banked situation has resulted in increased competition, reduced margins, limited lending opportunities for banks and, hence, efforts are needed to increase their productivity.

With this in mind, it is important for the industry to research the level of cost inefficiency in the banking industry and its implications. If inefficient banking firms have a tendency to remain inefficient, it would be of interest for the policy makers to investigate how these banks can remain economically viable and not be driven out of the banking market, says the report.

Further, the policy makers and regulators would be concerned about whether inefficient banking firms pose additional risks to the banking system and its safety net. Because a key role of a country’s bank regulators is to limit systematic risk, which is the risk that problems in a few banks could spread to many other banks, that are otherwise liquid and solvent.

Although the study was intended to lay a foundation for cost inefficiency analysis in UAE banks using the recent research developments in the area in other countries, the findings have certain limitations. The study also says that all banks do not practice uniform accounting and reporting standards, although there are directives to this effect from the UAE Central Bank.