The implication of economic freedom on bank efficiency an empirical evidence of vietnamese commercial banks

However, the influence of different economic freedom counterparts on efficiency banking sector is not as uniform as economic freedom overall index such as the higher the degree of proper

MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS HOCHIMINH CITY

-

PHUNG THI LAN NHI

THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK

EFFICIENCY: EMPIRICAL EVIDENCE

OF VIETNAMESE COMMERCIAL BANKS

MASTER THESIS IN ECONOMICS

HoChiMinh City – 2020

MINISTRY OF EDUCATION AND TRAINING

UNIVERSITY OF ECONOMICS HOCHIMINH CITY

-

PHUNG THI LAN NHI

THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK

EFFICIENCY: EMPIRICAL EVIDENCE

OF VIETNAMESE COMMERCIAL BANKS

Major: Banking and Finance

(Research Orientation)

Major code: 8340201

MASTER THESIS IN ECONOMICS

Supervisor: DR LE DAT CHI

HoChiMinh City – 2020

DECLARATION

This is to certify that this thesis entitled: “the implication of economic freedom

on bank efficiency: an empirical evidence of Vietnamese commercial banks” which I submitted to fulfill the requirements for the degree of master in finance This thesis is only my original work and due supervision as well as acknowledgment have been made in the text to material used

Ho Chi Minh City, 6th December 2019

Author

Phung Thi Lan Nhi

TABLE OF CONTENTS

DECLARATION

TABLE OF CONTENTS

ABBREVIATIONS

LIST OF TABLES

LIST OF FIGURES

ABSTRACT

CHAPTER 1: INTRODUCTION 1

1.1 Research objectives 2

1.2 Research questions 2

1.3 Research scope and methods 3

1.4 Research Structure 3

CHAPTER 2: LITERATURE REVIEW 4

2.1 Theoretical Literature 4

2.1.1 Theory of economic freedom 4

2.1.1.1 The concept of economic freedom 4

2.1.1.2 Economic freedom Indicators 5

2.1.2 Theory of bank efficiency 9

2.1.2.1 The definition of Bank efficiency 9

2.1.2.2 Bank efficiency - financial ratios approach 9

2.1.2.3 Bank efficiency - Production Possibility frontier (PPF) approach 11

2.1.3 Economic freedom and bank efficiency 15

2.2 Empirical studies 17

2.2.1 Economic freedom 17

2.2.2 Financial freedom 20

2.2.3 Freedom from corruption 20

2.2.4 Government spending 22

2.2.5 Property rights 22

2.2.6 Business freedom 23

2.3 Control variables 24

2.3.1 Bank size 24

2.3.2 Equity/Assets (Bank capitalization) 25

2.3.3 ROAE (Profitability) 26

2.3.4 Loans/ Total assets (Credit risk) 26

CHAPTER 3: DATA AND METHODOLOGY 28

3.1 Research method 28

3.1.1 Data Envelopment Analysis (DEA) 28

3.1.2 The bootstrap DEA method 30

3.2 Model specification 32

3.3 Variables description 34

3.3.1 Variables for DEA 34

3.3.2 Variables for truncated regression 36

3.3.2.1 Dependent variable 36

3.3.2.2 Independent variables 36

3.4 Data source 41

CHAPTER 4: RESULTS AND DISCUSSION 42

4.1 Descriptive statistics 42

4.1.1 Efficiency estimates 42

4.1.2 Truncated regression estimates 44

4.1.3 Vietnam economic freedom overview 46

4.2 Correlation 48

4.3 Result 50

4.3.1 First stage result - Bank efficiency 50

4.3.2 Second stage result - Truncated regression result 53

4.4 Sensitive Test 60

CHAPTER 5: CONCLUSION 65

5.1 Conclusion and policy implication 65

5.2 Limitation 66 REFERENCES

APPENDIX

PCBs Private Commercial Banks

LIST OF TABLES

Table 3.1: The overview of input and output variables to estimate bank efficiency

scores (DEA) in first stage 35

Table 3.2: The overview of explanatory variables to regress in second stage 40

Table 4.1: A summary statistics of variables used to estimate the bank efficiency (first stage) in Vietnamese commercial banks from 2010 to 2018 42

Table 4.2: A summary statistics of variables used for truncated regression (second stage) to investigate economic freedom effects on bank efficiency during period 2010- 2018 44

Table 4.3: Viet Nam economic freedom index 2010-2018 46

Table 4.4: Correlation matrix among variables in truncated regression 49

Table 4.5: Banking efficiency (TE) scores in the period 2009-2018 50

Table 4.6: the distribution of Vietnamese bank Technical Efficiency scores 2010-2018 53

Table 4.7: Second stage result - Truncated regression result 53

Table 4.8: Merger and Acquisition in Viet Nam commercial banks 2012-2015 60

Table 4.9: Sensitive Test 61

Table 4.10: Summarize result between second step regression and sensitivity test 64

LIST OF FIGURES Figure 2.1: Technical efficiency (TE) - Allocative efficiency (AE) - Economic efficiency (EE) 12

Figure 2.2: Input- Oriented approach (IO) 13

Figure 2.3: Output- Oriented approach (OO) 14

Figure 3.1: Variable Returns to scale Model (VRS) and constant Returns to scale Model (CRS) 30

Figure 4.1: Graph of average efficiencies of Viet Nam banks 2010-2018 52

THE IMPLICATIONS OF ECONOMIC FREEDOM ON BANK EFFICIENCY:

AN EMPIRICAL EVIDENCE OF VIETNAMESE COMMERCIAL BANKS Abstract

The effect of economic freedom on the economy’s well-being has been widely documented However, it is absent from the literature of empirical evidence about effect of economic freedom on the banking sector This study employs the overall economic freedom index and the index’s components which are derived from Heritage Foundation to examine their effect on Vietnamese commercial bank’s effieciency In first procedure, we obtain efficiency scores of 39 banks in Viet Nam using Data Envelopment Analysis (DEA), over the period 2010-2018 with 299 observations Then second step, the efficiency scores estimated from DEA method will be regressed on economic freedom indexes, applying truncated regression model combined with bootstrapped confidence intervals while controlling for bank specific characteristics Additionally, we carry out a sensitive analysis using a fractional logit estimator as a robustness check

We find strong evidence supporting that far greater economic freedom positively impacts the efficiency of banks in Vietnamese banking sector However, the influence

of different economic freedom counterparts on efficiency banking sector is not as uniform as economic freedom overall index such as the higher the degree of property rights, business freedom and freedom from corruption, the better the bank’s performance while negative effects of financial freedom on bank efficiency Besides, the empirical findings also show the positive relationship between capitalization and bank efficiency as well as credit risk and bank efficiency

Keywords: Banks, economic freedom, bank efficiency, DEA, truncated regression

bootstrap, Viet Nam

CHAPTER 1: INTRODUCTION

Efficiency is the most important aim of most business including banks, and bank efficiency is a widely discussed topic because of its vital roles in creating a stable and profitable banking sector then impact on economic growth in each country As a perspective that individual’s liberty to pursue its own economic goals will lead to efficient outcomes is as instinctive as the economics theory itself, we have seen that most countries trying to close to economic freedom However, most of studies recently just focus on the relationship between economic freedom (EF) and economic growth, less studies have been carried about effect of economic freedom on banking sector, which is one of the most important financial intermediary playing an important role in providing funding sources for economic growth (Ferreira,2015) EF plays a vital role for the banking sector’s development which categorizes of priority for developing nations and improving efficient banking system in a globalized economy Theoretically argued, EF helps to motivate the environment leading to efficiency financial system’s establishment or being innovative ideas and producing capacities, but the relationship between EF and financial activities still remains vague (Terpilih, 2010)

For example, one of component in economic freedom is financial freedom, and the effect of financial freedom (FF) in emerging markets of financial markets is not easily determined as it relies on kind of reform and conditions of financial constrains in the market (Ağca et al., 2007) As a study from Kose et al., (2003), the influence of FF and integration on banking sector and economic growth is hard to determine because it could rely on the governance’s quality and institutions They points that the integration

in developing countries is lack of experience, and government could create higher uncertainty shocks to banking sector resulting in lower efficiency Lou et al., (2016) find that the openness with high level leads to shrink of bank performance due to the lack of technologies, skills, the high level of competition and knowledge Higher freedom and openness also lead to the higher dependence on each others and fragility

of banking sectors in the world such as credit risk, economic and information shock (Anginer and Demirguc-Kunt,2014), which can affect bank efficiency ( BE)

On the other hand, Asharf (2017) finds that freedom increases the bank’s development levels by decreasing cost and bank credit risk The author also finds that freedom helps to remove barriers of trading and stimulate lending diversification which creates more bank credit demand and banks’ chances to growth Reducing restrictions

in banking activities due to FF provides more potential chances to improve BE and profitability (Chen, 2009) Banks tend to have higher profitability, efficiency in countries that have high economic and freedom (Tennant and Sutherland 2014) A study from Ahamed (2017) also shows that foreign Banks’s entry following freedom policies will improve the host country’s banking system because of the “technology spillover” effects which positively impact on the financial institution’s performance

In Viet Nam, particularly this time, the Association of Southeast Asian Nations (ASEAN) banking system has been preparation for the multilateral- liberalization before of the year 2020 and this is basing on the ASEAN Banking Integration Framework (ABIF) in 2014 Therefore, we expect Vietnamese banking system to achieve higher liberalization, freedom and integration level in 2020 This keys on that the importance to understand the impact of EF on BE to have appropriate actions for the aim of maintaining stable and efficient banking system for economic development

in the long term

This study follows this spirit by examining the impact of economic freedom on the efficiency of Vietnamese commercial banks during the period of 2010 to 2018

- How are the Vietnamese commercial bank’s efficiency scores between 2010 and 2018?

- Whether and how economic freedom affects on bank’s efficiency?

1.3 Research scope and methods

The data sample of this study includes 39 commercial banks in Viet Nam between 2010 and 2018 They are both listed and unlisted banks This study employs quantitative analysis method with using a two-step approach:

- First step: Estimation of efficiency scores by using DEA (Data envelopment analysis), these efficiency scores are measured by technical efficiency (TE)

- Second step: Bank efficiency scores are regressed against an array of economic freedom variables and other bank specific factors in truncated regression model combined with bootstrapped confidence intervals

The data is unbalanced over 9 years examining: the dependent variable is bank’s efficiency which is measure by Technical efficiency (TE) with DEA method, and independent variables are bank specific factors and economic freedom indexes derived from The Heritage Foundation 2018

1.4 Research Structure

The study contains five chapters:

Chapter 1: Introduction

Chapter 2: Literature Review

Chapter 3: Data and Methodology

Chapter 4: Result and Discussion

Chapter 5: Conclusion

CHAPTER 2: LITERATURE REVIEW

This chapter provides theories about economic freedom and bank efficiency as well as previous researches the relationship between them

2.1 Theoretical Literature

2.1.1 Theory of economic freedom

2.1.1.1 The concept of economic freedom

Freedom (Liberalization) thinking and capitalism ideal have been generated since classical economics like Adam smith, John Locke and recently Milton Friedman Since Adam smith, economists have believed that freedom to choose demand and supply, competitive in business and trade with other countries and ensure the property right which is essential components for economic advances (North and Thormas, 1973) Moreover, Adam Smith, in the book “ The wealth of Nations”, who had emphasized that the invisible hand role in a free market to help an economy comparatively work and function well , then increasingly wealth of nations Milton Friedman (1962) said “I believe that freedom society exists because of economic freedom bringing more efficiency than other solutions in controlling economic activities”

Hayek foresaw decades ago in the book the road to Serfdom:“the guiding principle in any attempt to create a world of free man must be this: a policy of freedom for the individual is the only truly progressive policy” (F.A.Hayek, 1944) Furthermore, in “ The constitution of Liberty “ (1960) of Friedrich Hayek, he analyses that economic freedom should be understood as freedom under government’s law, and freedom does not mean that absence of all government actions Therefore, economic freedom is not an absolute freedom, whereas government actions must have Freedom requires forces, violence and fraudulent to be prevented, except using government forces to make sure best situations with aim for individual efficiency If the government’s coercion is exceed limits, economic freedom will be hurt

In The Heritage Foundation 2014 “A comprehensive view of economic freedom encompasses all liberties and rights of production, distribution, or consumption of goods and services The highest forms of economic freedom should provide an absolute right of property ownership; full freedom of movement for labor, capital and good; and an absolute absence of coercion or constraint of economic activity beyond that which is necessary for the protection and maintenance of liberty itself Individuals are free to work, produce, consume, and invest in any way they choose under the even-handed application of laws, with their economic freedoms at once both protected and respected by the state” According to Gwartney and Lawson 2002, EF means the extent

to which a market economy is in place, where the central components are voluntary exchange, free competition and protection of person and property

In conclusion, following The Heritage Foundation (2014): “economic freedom

is the condition in which individual can act with maximum autonomy and minimum obstruction in the pursuit of their economic livelihood and greater prosperity However, the goal of economic freedom is not simply an absence of government coercion or constraint, but the creation and maintenance of a mutual sense of liberty for all As individuals enjoy the blessings of economic freedom, they in turn have a responsibility

to respect the economic rights and freedoms of others within the rule of law Governments are instituted to ensure basic protections of one citizen over another Positive economic rights such as property and contracts are given societal as well as individual defense again the destructive tendencies of others At the end, economic freedom enhanced and secured by the rule of law, government size, regulatory efficiency, and market openness, is a vital element of human dignity, enabling individuals plan and direct their lives in ways that maximize their happiness as they see fit Therefore, economic freedom is the key to achieve the broad-based economic dynamic that ensures lasting growth and increases prosperity for society as a whole”

2.1.1.2 Economic freedom Indicators

There are four indicators of economic freedom: The Fraser Institute, The Heritage Foundation, Freedom house, and Scully & Slottje (1991) They differ in the

methodswhich they have been constructed, and purposes and the conception of economic freedom embodying The first two Indicators (Fraser Instituteand The Heritage Foundation) have been using up to now

 The Fraser Institute: This indicator was produced by Hames Gwartney and Robert

Lawson, and it has been more widely used than any measures of economic freedom

It covers the time period data from 1980 to 2008 It is different with the index created by the Heritage Foundation that is constructed by third party information The cornerstones of economic freedom include personal choice, voluntary exchange, freedom to compete and security of privately owned property In fact, the index measures : Size of government ( expenditures, taxes, and enterprises); Legal structure and security of property rights; access to sound money; freedom to trade

internationally; regulation of credit, labor and business

 Freedom House: First published in 1996 of economic freedom, but then this

publication has been discontinued They defined economic freedom through two different dimensions: lack of state infringements on citizen’s right to exchange goods and services, and the second one is the state establishmentof the rules governing contracts, property rights and other institutional prerequisites required for the product of economic affairs The Freedom house includes six indices (freedom

to hold property, freedom to earn a living, freedom to operate a business, freedom to invest one’s earnings, freedom to trade internationally and freedom to participate in

the market economy)

 Scully and Slottje (1991): This was an effort to build the first measures of Freedom

House This data is only available in 1980, including 141 countries and having fifteen different characteristics: exchange rate system freedom, freedom from military draft, property freedom, movement freedom, information freedom, civil freedom index of Gastil, classify Gastil – Wright for economy system, printing and press freedom, broadcast freedom, freedom to travel inside, freedom to travel outside, peace freedom, working permit freedom, freedom to seek without

permission, freedom to hold real estate

 The Heritage Foundation: This index is a series of twelveeconomic measurements

produced by the Heritage Foundation and Wall street Journal This index has an advantage like The Fraser Institute as continuous data, and this has been constructed since 1995, including 161 countries and public every year The Index of economic freedom takes a broad and comprehensive view of a country performance, measuring twelve separate areas of economic freedom Some of the aspects of economic freedom are concerned with a country’s interactions with the rest of the world such the extent of an economy’s openness and trade However, mostly assessing the liberty of individuals to use their labor or finances without undue restraint and government interference Each of the economic freedom plays a vital role in developing and sustaining personal and national prosperity Every economic freedom is individually scored on a scale of 0 to 100 An overall economic freedom score is a simply average of its scores on the twelve individual freedoms For presentational clarity, the twelve economic freedoms are classified into four widely categories: Rule of law (property rights; freedom from corruption; judicial effectiveness); Government size (fiscal freedom, government spending; tax); Regulatory efficiency (business freedom, labor freedom, monetary freedom); Market openness (trade freedom, investment freedom, financial freedom) Besides the overall economic freedom index, we have selected these indicators below (in four categories above) which are closely related to the banking sector in order to carry on

this study

- Financial Freedom: The index is a measure of banking security as well as

independence from government control Being to access and function well in a formal financial system that ensures the availability of payment and investment services to individuals, diversified savings, credit.By extending financing chances and promotingentrepreneurship, an open banking environment encourages competition to bring the most efficient financial intermediation Banking and financial regulators by the state that is over the assurance of

transparency and honesty in financial markets can decrease efficiency

- Government spending: The cost of excessive government is a central issue in economic freedom Excessive government spending eventually will be financed

by higher taxationor run a great risk of crowding out private economic activity Even worse, a government’s insulation from market discipline often leads to bureaucracy; lower productivity and inefficiency then undermine economic

freedom

- Property rights: The ability to accumulate private property and wealth is

understood to be a central motivating force for workers and investors in a market economy The protection of private property requires and judicial system that is available to all equally and without discrimination And the transparency and effectiveness of the judicial system have proven to be key determinants of a

country’s prospects for long term economic growth

- Freedom from corruption: In the perspective of EF, corruption can be expressed

as the integrity’s failure in the economic system or a distortion when special groups or individuals are able to take at the expenses of the whole Then a country imposes numerous burdensome barriers on conducting business, higher

transaction costs or bribery

- Business freedom: this index expresses the degree of freedom of entrepreneurs

are able to start businesses or in order to obtain licenses and the ease for closing

a business Obstacles to any of these three activities are able to be deterrents to

business and then to job creation

Accordingly to many studies, the best indicator is Heritage Foundation because

it has been mostly based on the policies which governments can control actually (Heckelman, 2000) On the other hand, the index by Fraser institute is mostly ambiguous efforts to measure economic freedom, and updating by each five years will

be hard to consider economy measurement in short term In this study, we consider economic freedom index provided by Heritage Foundation which is updated by every year

2.1.2 Theory of bank efficiency

2.1.2.1 The definition of Bank efficiency

The definition of efficiency in general or particularly BE are common terms in the literature of economic discipline Productivity and efficiency are normally used for each other In economics, a firm is considered efficient if it can maximize its output

using a given certain inputs, or it reaches the Pareto optimal (Pareto efficiency as a

measure of social welfare is used by many scholars as their efficiency goal A situation

is optimal only if no individuals can be made better off without making someone else

worse off)

An economic system is said to be more efficient than another (in relative terms)

if it can provide more goods and services for society without using more resources Or

we can consider total factor productivity (TFP) which is productivity estimation including all factors of production, mean efficiency can be seemed as productivity and

be measured by the ratio output/input

Productivity (Efficiency) = 𝑂𝑢𝑡𝑝𝑢𝑡

𝐼𝑛𝑝𝑢𝑡

Out: such as revenues, profit …

In: costs, fixed assets,

Efficiency is one kind of economy perspective, it has been measured by comparing between the actual values and optimal value of cost, revenues and profit or any expenses which a firm pursues (Daraio and Simar, 2007)

In general terms, for the definition of efficiency in banking sector, a bank could

be called as efficient only if it is able to produce an expected result with a minimum provided effort of resources

In particularly, there are two approaches to measure the bank efficiency – Financial ratio and production possibility frontier (PPF)

2.1.2.2 Bank efficiency - financial ratios approach

The approach from financial ratio can be understood as measuring bank efficiency from financial ratios which are counted from financial statements In

banking sector, many researchers measured operating efficiency ratio by counting percentage between overhead to total assets The lower ratio is the higher efficiency of the bank Nowadays, the operating efficiency ratio accordingly to international standard is 0.6, this means any banks which has below this ratio, will be efficient operating and vice versa Besides, other financial ratios has been preferred such as ROA, ROE (Chen and Liao, 2009)

In common, there can be considered into four groups of financial ratios to measure bank efficiency: Profitability rates (ROA, ROE, ROS, C/I), margin rates(Net interest margin), weighted result rates, employment efficiency rates

 Profitability rates

- ROA: (The rate of Return on Assets): is a ratio to measure the ability of management to utilize the actual financial resources of a bank to create returns This ratio is widely used to evaluate bank’s performance

- ROE: ( The rate of Return on Equity) is a ratio of financial result to a bank’s owner fund

- ROS: (The rate of Return on Sales): is a ratio of financial result to a bank’s income

- C/I: ( Costs ratio to incomes)

 Margin rates

- Net interest margin: a ratio of interest to assets, and interest spread which can

be understood as a difference between the average interest bearing assets and the average expenses of interest bearing liabilities

 Weight result rates: reserves balance which is shown as a difference between the building up and dissolution of reserves

 Employment efficiency rates

- Assets/ Number of employees

- Result/ Number of employees

Based on analyzing financial ratios and comparing with other banks and time varying, we conclude about the bank efficiency However, this approach has few

drawbacks, such as financial ratios have to be compared with a consensus standard, while constructing this standard is hard Or different financial ratios has different conclusion about efficiency, perhaps this bank can be concluded that efficiency using ROA whereas inefficiency in capital (Chen and Liao, 2009)

2.1.2.3 Bank efficiency - Production Possibility frontier (PPF) approach

However, in the production economics, the definitions of efficiency and

productivity are two different concepts While the “productivity” is considered as the entire elements that decide the output’s level achieved with the input provided,

efficiency has a different meaning in comparison with productivity

Efficiency has been approached by the production frontier, which shows output’s level which can be reached a peak with the same level of input’s level That is clarified as the ideal relationship between input and output, related to a process to gain the greatest level of outputs with lowest input’s level And the company producing on this frontier definitely will be seemed as efficiency There is inefficient producing if this is below the frontier and further distance, more inefficiency it is

In 1957 Farrell took the efficiency’s measurement into the higher degree by establishing the functions of distance between efficiency and producing practically point Academically, he is remembered largely for the celebrated non- parametric measure of productive efficiency

There are three kinds of efficiency: Technical efficiency – TE; allocative efficiency –AE; economic efficiency- EE

TE: The ability of a firm to obtain maximal output from a given set of inputs orientation) or the ability of a firm to minimize input from a given set of outputs (Output-orientation)

(Input-AE: the ability of a firm to use the inputs in optimal proportions, given their prices and can be defined as an optimal utilization for the cost minimizing combination of inputs EE: AE multiply with TE expressing the overall efficiency of the company – Economic efficiency

EE= TE*AE

Assume a model with 2 inputs (x1 and x2) and 1 output (q) as the figure below

Figure 2.1: Technical efficiency (TE) - Allocative efficiency (AE) - Economic efficiency (EE)

TE = 0Q/0P

AE = 0R/0Q

EE= 0R/0P

The figure above demonstrates three kinds of efficiency with input orientation Where:

SS’: Technical efficiency frontier

AA’: Cost line

The TE measured 0Q/0P must lay between 0 and 1, at the value of one means that the firm is fully efficient Reduction in cost if production is at Q’, so at the point Q the TE firm is efficient but AE is inefficient The economic efficiency EE = TE*AE (or equal to 0R/0P)

Furthermore, the PPF’s theory can be processed with two approaches: Input- Oriented approach and Out-put- Oriented approach The firm with IO is to measure the lowest input’s amount to create a given set of outputs, whereas OO one is in order to predict the maximum output’s level from a provided input’s level

 Input- Oriented approach (IO):

Below Figure 2 illustrates a company with x1 and x2 (2 inputs), and 1 output y , SS’ is a frontier which demonstrates each input’s lowest level that can be used to create

a provided output (Technical efficiency frontier) If a company works on this frontier,

it will be technical efficiency in an input-oriented one because of minimizing the input’s amount The frontier AA’ (cost line) (which can be built when we already know the input-price ratio) defines the optimal input’s level to archive the lowest cost

Figure 2.2: Input- Oriented approach (IO)

 Out-put- Oriented approach(OO) :

Figure 3 demonstrates that the case in which a company has one input (x) and two outputs (y1, y2) The ZZ’ curve defines that the highest output level can be reached by using given input’s level x (Technical efficiency frontier) The company is

TE only if it works on this frontier DD’ is the price information The distance CB’ can

be interpreted in terms of cost reduction

There measures in this case also are bounded by zero and one

Figure 2.3: Output- Oriented approach (OO)

TE = 0A/0B

AE = 0B/0C

EE= 0A/0C = TE*AE

There are exceptional ones by applying both sides (Beccalli et al., 2006) and not consensus on the proper results of IO and OO in BE measurement up to now Actually, the foundation of theories about efficiency and BE has been established well long time ago and attracted a variety of academic researches carried on such Berger and Deyoung (1997) with different method of evaluation

Inclusion, efficiency concepts are various and diversified, depending on which purpose we can consider as different perspectives However in this study, Technical Efficiency (EF) is used to measure BE (TE) of bank that focuses on the ability of bank

to reach outcomes with minimum set of inputs To reach the desired output, we make

an effort to minimize the inputs, and then the technological innovations in the banking industry will be reflected on the production frontier That means if a bank operates on this frontier, this could be considered as technically efficient (TE) And further distance, more inefficient the banks are Besides, we apply efficiency with input-orientation because it seems that IO method is almost preferred to the OO as banks can

focus on managing the input level (costs) ,better than basing on the outputs level.(Dipasha et al., 2012) The measurements and analysis of TE are conducted by Data Envelopment Analysis (DEA), the next section methodology will discuss further

2.1.3 Economic freedom and bank efficiency

This section lays out the relevant theories as well as literatures on BE and EF related to financial sector performance, while we derive the hypotheses below

In fact, there are no existing models of theory to analyze explicitly the impact of

EF on BE developed yet, while as far as we have known that few related economic theories are likely to have impact on the banking sector:

- Classical economics theory: Classical economics is a broad term that refers to

the dominant school of thought for economics in the 18th and 19th centuries Mostly considering Scottish economist Adam Smith is the progenitor of the classical economic

theory Adam Smith (1776) release of the Wealth of Nations highlights some of the

most prominent developments in classical economics His revelations centered

surrounding free trade and a concept called the "invisible hand" which served as the

theory for the beginning stages of domestic and international supply and demand regulating democracies and capitalistic market developments form the basis for classical economics The classical economists were pragmatic liberals (economic liberalism), advocating freedom of the market, though they saw a role for the state in providing for the common good Smith acknowledged that there were areas where the market is not the best way to serve the common interest, and he took it as a given that the greater proportion of the costs supporting the common good should be borne by those best able to afford them He warned repeatedly of the dangers of monopoly, and stressed the importance of competition To be related to banking sector, an environment of banking and finance in which a lowest government’s level interference and less dependent on central bank as well as financial institutions supervision; especially regulations are limited to enforce contractual obligations and prevent from fraudulence, this will improve bank efficiency

Self Economic theory: Suggestions from Economic theories that EF tends to affect

productive encourages, efforts, and the resource using’s effectiveness Arguments from economic historians that the central components for economic growth are free to supply or choose resources, trade freedom with others, competing in business and ensure property rights (North and Thomas 1976) In addition, the intuitional issues like lacking investment or weak systems to protect property right and avoid corruption go

on defeating the total EF and economic potential (North and Thomas, 1976), so it is easy to link with the relationship between bank performance and economic freedom under economic theory This can be indicated that a link EF and BE, in particular, the higher the level of EF, the bank’s benefit in terms cost advantages and overall efficiency

- Helping hands (Pigou, 1938): However, another theory considers the role of

supervision and less freedom as an appropriate policy such helping hands The helping hand theory implies that a government’s helping hand will be strong and effective to offset or even ameliorate the failures of market in case of external power, monopoly power and informational asymmetries In banking perspective, this role of government seems as a bank’s official supervision to limit on bank’s activities as well as restrict on bank entries and insurance of bank deposit scheme as proper policies that alleviate failures of market or help to allocate resources (Barth at al., 2006) This can make bank efficient as much as possible to their roles

- The theory of property rights: Coase (1937); Alchian (1969); Demsetz

(1967) are pioneers for this theory Basing on encourages to direct individuals and organization’s economic behavior, an investor has ability to take return of most efficient choices, then he or she can consider and take each alternative choices, compared with net gain among each choice alternative one Finally, choosing a choice

in which can produce the highest benefit for her Obviously, this makes the economy operating efficiently The incentives behind that direct behavior of investor are based

on property rights of the investor’s decision Property rights theory carries on the impact of right assignments on investor’s decision by allocating resources and efficiency This analysis is assumed in the terms of efficient market’s neoclassical

model in which this does not have information issues; zero transaction cost and agent behavior is perfect to maximize the profit from all participants existing in the market (Furubotn & Pejovich, 1972) Besides, each investor who has this right will employs these rights to gain its wealth By implication in banking sector, such protection provides incentive for borrowers and lenders, and decreases protection costs as well as ensures property rights, then borrowers, investor and lenders can devote fewer resources with no hesitant

2001 to 2009 The author uses the DEA method to estimate technical efficiency scores

of banks in the first stage, then second stage using truncated regression model combined with bootstrapped to regress the efficiency scores with economic freedom variables This paper finds that a positive significance effects of economic freedom on bank efficiency in term of cost advantages: higher the level of an economy’s financial, higher the benefits for banks Especially, it tends to be clearer in which countries with more freedom political systems and governments with higher quality governance Investigating the effects of low-liberalized policies on banks, Sun and Chang (2011) find that if the openness is lower degree, it can go up the liquidation costs or switching costs which may seriously decrease bank performance and get case of bank’s loss Bank can improve the profit efficiency as a result of the liberalization of Technology

spill-over effect (Chen, 2009) Further argument, banks in a country with higher freedom’s level tend to have more chances to extent their business to obtain economies

of scale and scope leading to be higher bank efficiency EF brings more chances for banks to approach credit market and customers from oversea which may improve BE, technology, and develop strategies and globalization experience, thus enhancing overall bank profitability (Prasad et al., 2003) Baggs and Brander (2006) also show a proof that an association from higher level of freedom with bank credit to private sectors and higher performance Other studies argue that more openness in the banking markets in terms of increasing foreign penetration, reduces bank margins and improves the efficiency of banking system (Claessen et al., 2001) Similarly, Glick et al., (2006) report that the relationship between deregulation and banks usually relates with more banks taking risk’s measurement, transparency and lending efficiency These positive effects could enhance bank’s performance Same idea as that, Flannery (1984) considering the restrictions faced on US commercial banks in establishing more than one full service office location observes that constraints preventing free entry to the banking industry may force unit banks to operate with a socially inefficient combination of inputs

b) Un-supporting evidences:

Of course, others can argue that freedom with excessive degree might make banks to take greater and more risks then in turn might have a bad performance and even worse, causing to the recent global crisis There are lots of studies find that EF or liberalization can direct banks to take more risks and destroy bank performance For example, Sufian (2014) explores the impact of EF on the efficiency of banks in Malaysia With the two stage approach, computing efficiency score from DEA method then bootstrap regression to examine the impact of EF on BE, the author finds that the greater business freedom tend to reduce the efficiency of bank’s operation The finding suggests the policy makers and regulators taking action by setting more limits on activities which banks might take

Baggs and Brander (2006) suggest that liberalization period time, obviously banks tend to increase their operation scale then make them take more risk exposures causing of failure of managing their operations This is associated with the weak governance’s corporation impeding bank performance A data with higher frequency of Aebi et al (2012) shows that after the introduction of liberalized policies but lack of technology, experiencing and competition advantages in emerging countries, normally banks in these countries are easy to take more risk and have a low-return period As Viet Nam banking system is still weak in perspective of technology, performance, efficiency, size, and power of competitive, perhaps banks in Viet Nam would have lower performance due to the deregulations and economic freedom Furthermore, Klomp and Haan (2015) find that not proper EF within period of the credit boom can have relation with higher probability of economic recession Lou et al (2016) documents that emerging economy’s banking systems do not have enough technology, transparency, power of competitive and financial specialty to compete with oversea banks, therefore association with lower efficiency In addition to this, Gulamhussen et al., (2014) argue that banks depend on each other (co-dependence) happening with liberalization among emerging countries with exposure more systemic risk as well as insolvency risk An evidence of Chortareas et al., (2012) implies that the banking regulation and supervision’s impact on bank performance seem to depend on the regulation’s type Government intervention is usually mentioned in justification to avoid the monopoly power’s development or bank’s taking risk excessively (Freixas and Santomero, 2004) Evidences suggest that regulation in economy plays an especial role in the efficiency of bank operation among banking sectors in different countries (Barth et al 2006) Freixas and Jorge (2008) find that the monetary policy’s changes because of policies becoming liberalized and more freedom can bring some uncertainty shocks, then negatively affect on bank financial performance

Based on these arguments above, the hypothesis can be expressed as follow:

H1: Economic freedom increases bank efficiency

In order to test the hypothesis we also capture the economic freedom counterparts inside this Economic freedom index including Economic freedom overall; Financial freedom, Government spending, Property rights, Freedom from Corruption, Business freedom For the purpose of capturing a country’s boarder environment within

economic activities we control other freedom counterparts

2.2.2 Financial freedom

Chortareas (2013) investigates the dynamics between financial freedom counterparts of the economic freedom index and bank efficiency in European Union, which finds the higher degree of financial freedom the higher benefits for bank overall efficiency Carrying out properly the financial openness’s process can considerably lower the probability of failure of banks because banks could take advantages from more chances and diversifying risks, leading to the higher bank performance (Abiad et al., 2008) Ağca et al., (2007) find that FF is positive effect on bank lending and performance as well because it encourages firms to go up their leverage’s level with more long-term loans More interestingly, examining Vietnamese banking system’s liberalization policies, Vu and Turnell (2010) find that that FF would decrease constraints of regulatory and enhance bank cost efficiency which results in improving

BE A data with 12 Asian economies, Lin et al (2016) find that an increase in the presence of foreign ownership as under effect of FF and then may enhance bank cost efficiency turning to the higher performance

In contrast, Sufian (2014) investigates the relationship between economic freedom and bank’s efficiency which finds the impact of financial freedom is negative, implying that higher financial freedom reduces the efficiency of banks operating in Malaysian banking sector Viet Nam is in trend of multi- integration and liberalization;

we expect the financial freedom level will have positive effect on bank efficiency

H2: Financial freedom will increase bank’s efficiency

2.2.3 Freedom from corruption

Corruption freedom where corruption is defined as dishonesty or decay, in the context of governance, it can be defined as the failure of integrity in the system, a

distortion by which individuals are able to gain personally at the expenses of the whole Freedom from corruption is expected to promote equitable treatment and greater regulatory efficiency (Miles et al., 2006)

Sufian and Habibullah (2010) find a significant and positive sign of the relationship between corruption freedom and bank performance Additionally, Demirguc-Kunt and Huizinga (1999) suggest that exist of corruption will affect negatively the efficiency of banks This result supports that government should impose more solutions to control the corruption, then enhance financial performance of the banking sector A paper examining the influences of corruption on bank lending in Africa indicates that corruption adversely impacts bank lending (Charles I Anaere, 2014) and agent cost problem

In contrast, few studies provide opposite findings to support corruption having a positive impact on bank performance such as Khemaies (2017) finds an important proof that bank can take advantages from corruption because allowing banks to approach potential customers under political relationship, as a result bank can increase their performance Therefore, based on this assumption, a negative relationship between freedom from corruption and BE is expected A factor from corruption that redirects banks to correct pre-existent government issues to get benefits from their advantage financial trades (Zheng et al., 2013) Faccio (2010) finds that because the administrative procedures is complicated and consumes a lot of time, corruption could help bank to save time and opportunity costs for bribing money, thereby improving BE The author also suggests that banks which has a relationship with politicians can avoid troubles and get advantages to take external and priority funds when using corruption effectiveness

Despite the conflicting findings of recent literature on the impact of freedom from corruption on bank efficiency, we expect more freedom from corruption will improve bank lending and thus, improve the bank efficiency in Viet Nam

H3: More freedom from corruption will improve bank efficiency

2.2.4 Government spending

Though government spending is an effective tool to stimulate economic growth, Easterly and Rebelo (1993) point out that productive government spending on transportation or infrastructure brings higher productivity In fact, Viet Nam is a transitioned economy, which indicates that whether it is over necessity Government expenditure has played the basic stimulation and leverage for economy growth However, government expenditure comprises a signal of coercion that distorts the market mechanism’s forces Further arguments, government expenditure planned project may “crowd out” private sector which normally have more profitability and efficiency than public sector one Based on Chortareas et al 2013, the government spending which is a form of government involvement in the economy tends to be negatively linked to the efficiency in banking sector

H4: Higher level of government spending will reduce bank efficiency

2.2.5 Property rights

Measurement of property rights index is the extent of protection of property rights in a country by law and how the government executes those laws The corruption’s level, and individuals and businesses are able to enforce contracts that are also reflected in this index With regard to banking sector efficiency, the legal framework’s quality relates to enforcement of contracts and how protection of property rights plays a crucial role for banks (Chen, 2009) The property rights which reflects to which collateral and bankruptcy laws protect the rights of borrowers and lenders, and thus facilitate lending Higher property right protection and quality of collateral could effectively ensure the bank performance due to lenders and those borrowers could be protected their rights and deposits in bank and vice versa Thereby, higher efficiency in executing contracts could decrease bank’s costs, hence can improve bank efficiency The bureaucratic control of banks along with lack of healthy competition renders banking services highly inefficient and removes accountability mechanism in the sector A study investigates the effect of judicial efficiency on banks’ lending spreads (Luc Laevena and Giovanni Majnoni., 2003) This variable capturing the degree of

property rights protection in a country and gathered from the Index of Economic Freedom constructed by the Heritage Foundation They find that better enforcement of legal contracts (property right) is critical to lower the expenses of banks for households and firms Finally, it is more efficient for financial intermediation

However, not all people support for the view securing property rights which are important components for efficiency and growth Schmid (2006) shows that a certain level of insecurity of rights is sometimes crucially important for the growth of economy and development, while too excessive securing property rights may erode innovation and motivation if a business must fully offset for those effects Another argument against on property rights through private titling is that will have conflicts and exist inequality’s level in society generating in this society process, then retarding growth and especially pro-poor growth (Easterly, 2001) Another study points out that property rights may reduce bank performance from Andrianova et al., (2008) who find that property right brings more risks to banking system because of incentives for bank

to feel self confident and safer entering to competitive market intensively leading to reduce the efficiency of bank in domestic

Because property right’s protection is very important for banking sectors, we expect the hypothesis as following:

H5: Higher property rights will be higher bank efficiency in Viet Nam

2.2.6 Business freedom

Business freedom is a measure of how a business to establish or run a business with no interference from the government Regulation and rules with being redundant and burdensome are the most usual barriers to affect business activity Every on its own, we expect business freedom to improve productivity and expand output, especially with private sector resulting in creating more demand for credit Thus, freedom allowing in business will be conductive for the development of banking sector Therefore, we also follow some recent literature such as Chortareas et al.,(2013); Sufian and Habibullah (2010), the business freedom will improve bank

efficiency, implying that higher freedom for entrepreneurs to start businesses, will be better performance for banking sector

H6: Higher business freedom is associated with higher efficiency for Vietnamese banking sector

2.3 Control variables

In addition to economic freedom factors, this study also examines whether some bank-specified factors have relationship with efficiency or not Based on the existing literature, this study also gives few expectations on the relationship between each control variable and bank performance

2.3.1 Bank size

The relationship between size and bank efficiency is vague as many different views among studies In perspective of studies that argue a positive relationship between size and efficiency, a report of IMF (2009) gives an idea that economy scales and less intensive competition for larger bank Large banks have higher performance because of their advantages in perspective of economy scales and power of market on loans or deposits (Delis and Staikouras, 2011) An empirical study of Saghi-Zedek (2016) on European banks finds that larger banks usually have better performance because of effects from diversification and accessing funding with lower costs, but expose to default with higher probability De Jonghe (2010) suggests an association between bank size and economy’s scale and scope In the same infrastructure and management with lower costs; large banks have ability to provide more products and services hence, promoting cost efficiency This is consonant with the finding of Battaglia and Gallo (2017) who confirm the positive and significant effect of bank size

on performance as the advantages of economies of scale Whereas these studies focus

on the advantage of economies of scale and scope or benefit of diversification, Gulamhussen et al (2014) convinces that larger banks can survive better than smaller banks because of competitive power in intensively competitive markets An Omran (2007) examining bank in Egypt also suggests that the state-owned banks are normally

largest banks, which have connection with politicians and government supports behind will perform more efficiency than smaller banks

In contrast, existing few studies give evidences of opposite relationship between bank size and efficiency The study of Kilinc and Neyapti (2012) who point that that large banks will have excessive risks due to self confident themselves with “too big to fail”, which results in exposing them to get chance of bank failure or losses Buck and Schliephake (2013) argues that small size banks are easier in monitoring because of their simple operations and lowering conflict’s levels from interests, thus obviously leading to the more efficiency Furthermore, Abreu and Gulamhussen (2013) give a proof of evidence in the year of financial crisis 2008 that large banks are easy to involve in taking risk activity in order to earn higher returns or exposing themselves with systematic risk because of risky projects taking, turning to serious losses after that Karry and Chichti (2013) assess the effect of bank size on technical efficiency and show the negative relationship between bank size and bank efficiency A study from Mesa et al., (2014) which carries by plotting ratio of efficiency against ten intervals of total assets is shown that there is not constant about the relationship between efficiency and bank size

2.3.2 Equity/Assets (Bank capitalization)

This ratio indicates the capital adequacy in relation with bank risk Obviously, with the higher the equity ratio, the lower bank risks Even though we know that the importance of capitalization is to explain the financial institution’s performance, there

is still ambiguous relationship For example, Athanasoglou et al., (2008) find that a sound capital position is able for banks to have more resilient against unexpected losses and pursue potential chances in an effectively way Saghi-Zedek (2016) finds that banks with higher capitalization achieve less vulnerability because of benefits of diversification Mirzaei et al., (2013) report that well – capitalized banks are less dependent on the cost of external funds, resulting in higher performance It is easy to understand that banks with higher equity’s level might reduce capital’s cost, and then have a positive effect on bank performance (Molyneux, 1993)

However, as lower capital ratio suggests a relatively risky position, one might expect a negative coefficient on this variable (Berger 1995) Meslier et al., (2014) find that unclear relationship between bank capitalization and performance in Philippine banking system Dietrich and Wanzenried (2011) find that Switzerland banks does not transfer in effectively way with higher capital ratio into higher income earnings due to during the crisis the demand of loan not high

2.3.3 ROAE (Profitability)

This indicator is to measure the profitability to assets ratios, and the profitability

is very important to evaluate the bank performance or efficiency This measures the bank using its assets and controlling of its expenses to generate a rate of return As usually, we will think that higher indicator resulting higher efficiency This is realistic and expectable for the result that banks with higher returns can provide better services which can increase efficiency A study of Hasanul et al., (2017) suggests that a return

on average equity ratio has a considerable effect on bank efficiency in Bangladesh

In contrast, a study finds out a proof of negative relationship between efficiency and profitability (Hou et al., 2014) Additionally, El-Moussawi and Obeid (2010) suggest that profitability affecting not consensus way in efficiency (positively and negatively) in the GCC banking sector via the period 2005-2008 Sufian and Habibullah (2009) find that ROA does not have effect on efficiency in Korean commercial banks through the period 1992-2003 Matthew and Ismail (2006) measure the technical efficiency and productivity of banks in Malaysia from 1994 to 2000 They find that the efficient banks are characterized by size, not profitability (ROAE).Another result from Iveta Repkova (2015), the author examines determinants of bank efficiency

in the Czech during the period of 2001-2012, showing that ROA has a negative impact

on efficiency

2.3.4 Loans/ Total assets (Credit risk)

Demirguc-Kunt and Huizinigua (1999) find a relationship that higher bank loan ratio will be better bank performance because of the theory of trade off - credit risk and

returns Loans products are more cost and profit efficient than other bank assets leading

to high performance (Chen, 2009)

In contrast, there are few studies are different views with the trade off theory above: higher risk compensated by higher return A study of Beltratti and Paladino (2015) carrying on 44 countries find that the lower loan’s level stimulates banks to provide more carefully loans and improves the process of management, which in turn have a positive impact on bank efficiency The low loan’s lover will reduce the bank’s funding cost because of reducing bankruptcy costs, and react to asymmetric information in better way, then improve bank efficiency (Flamini et al., 2009)

In conclusion, many existing studies carried for considering and determining the relationship between bank specific factors and bank efficiency However, it is worthy to take those factors combined with economic freedom into consideration bank

efficiency

CHAPTER 3: DATA AND METHODOLOGY

This chapter gives descriptions about the research method, variables and data used in this research

3.1.1 Data Envelopment Analysis (DEA)

Farrell (1957) is seemed as a pioneer for developing the piecewise-linear convex hull approach to create model, though later in 1978 further developed by Charnes, Cooper and Rhodes, who coined the term DEA, applied a mathematical planning model “Constant returns to scale” – CCR is for measuring the technical efficiency frontier And DEA- The non parametric method is linear programming model The DEA involves in constructing a non parametric production frontier relied on the real input-output in a given sample It is worthy that DEA model can be estimated by using either CRS or VRS assumptions

The constant Returns to scale Model (CRS)

This method was firstly introduced by Charnes et al., (1978) In order to discuss the DEA method, let assume that the data consists of S inputs and M outputs for each

bank, and xi and yi vectors for the ith bank will be presented as below:

Tec^i = min Tec^i, λ { Tec > 0 | yi ≤ ∑𝑛𝑖=1yi λ; and Tec^i xi ≥ ∑𝑛𝑖=1xi λ; λ ≥ 0 },

i={1,…, n}banks Where:

- Input Orientation option

- y is a vector of bank outputs

- x is a vector of bank inputs

- λ is a Nx1 vector of constant

- Tec^i is a technical efficiency score for the ith bank Tec^i =1 indicates that the

bank is technical efficient, while Tec^i<1 mean that a bank is inefficient

The programming of linear has to be solved by n times, one by one for every

bank in the whole the sample

The variable Returns to scale Model (VRS)

As the CRS assumption is only appropriate when all banks are operating at an

optimal scale Imperfect competition constraints from government may cause a bank to

be not operating at optimal scale Thus, Banker et al (1984) extend the model by

providing variable returns to scale The use of the CRS specification when all firms are

not operating at the optimal scale results in measures of TE which are confounded by

scale efficiencies (SE) In fact, TE in DEA method has been separated into SE (Scale

efficiency) and PE (Pure efficiency) SE means that a bank works at the most

productive scale in optimum An inappropriate size (too large and too small) may cause

inefficiency SE has DRS (Decrease to scales) and IRS (Increase to scales) DRS

means that a bank which is too large can not reach advantages from that size

PE (Pure Efficiency) is only a ratio of efficiency not considering of scale

The use of the VRS specification permits the calculation of TE devoid of these SE

effects Actually, VRS model is essential from the CRS with an additional constrain

added to the linear programming problem:

 Variable Returns to Scale (VRS): constraint ∑𝑛𝑖=1𝜆 = 1 ( convexity)

In this method, no functional form for data is required, and allowing a

production frontier reflected in the weights of the input and outputs can be calculated

Besides, this is based on banks, after setting the production frontier; the result will

show the rank from the most efficiency scores to the least efficiency ones

Figure 3.1: Variable Returns to scale Model (VRS) and constant Returns to scale Model (CRS)

(Source: Coelli et al., 2005)

However, with the purpose of this study, we employ VRS assumption with oriented to measure the efficiency scores because the CRS assumption is only validity when all banks in the sample have scale at the optimal level (Banker et al 1984) Moreover, advance of technology and changes of regulation may have different effects through banks with different sizes, but VRS assumption allows bank models at the entire levels of technology (Assaf et al., 2011) The reason why this study we aim to use

input-TE as total bank efficiency is to eliminate price changes and simply show bank operation efficiency As AE is difficult to have full price information, and VRS allows

us to count only TE to avoid SE effect instead of counting PE

3.1.2 The bootstrap DEA method

Simar and Wilson (1999) argue that in the statistical sense DEA method generates efficiency scores which significantly depend on each other Then, employing the DEA scores for the second step regression as the nạve studies carried might violate the basic model assumption required by regression models Conventional approaches to

inference are invalid due to complicated and unknown serial correlation among estimated efficiencies Furthermore, the DEA efficiency scores are assumed that is an efficiency index in a relative term, not absolute at all To solve this problem, Simar and Wilson (1998) suggests a method of bootstrap procedures (Data generating process), which are able to be harmonious inference for the second step regression models This bootstrap solution is based on the method of re-sampling, which means that assign original data accordingly to quantities for the interest Recently, in 2007 they further develop their method to consider the effect of environmental variables on the efficiency regression The model is present below:

Tec^

i = Ei β + εiWhere as :

- Tec^

i is TE scores estimated from DEA method of bank N at the time t

- Ei is an environmental variable vector explaining for efficiencies among banks

- β is a parameter’s vector

- εi is statistical noise

The most worthy note in Simar and Wilson (2007) that they solved the correlation issues and efficiency scores dependent on each others which might affect regression in nạve regression models Because that procedure can produce bias corrected estimates of Tec^i, thus valid estimates of the parameters in the second regression model The procedure has a single and double bootstrap (respectively with algorithm#1 and algorithm #2), in order to carry this purpose study, we apply an algorithm #1 with 2000 bootstrap replication as recommendation The process of algorithm #1 can be summarized below:

(1) Calculating TE scores Tec^

i for each bank applying the linear programing DEA with input- oriented

(2) Using the method of maximum likelihood in order to estimate the truncated regression of Tec^

i on Ei so that estimate β^ of β as well as estimating σ^

ε of σε

(3) For every bank i = {1,…n } keep repeating the further steps from 1 to 3 below

with 2000 times to set a bootstrap estimating of Tec^*i,b =1, ,2000

3.1 From the N(0; σ^2ε) distribution and right truncation ( 1- β^Ei ) for drawing εi

3.2 Computing Tec^*i,= β^Ei + εi

3.3 Use Maximum likelihood again to estimate the truncated regression

of Tec^*i, on Ei, yielding estimate (β^*; σ^

ε*) (4) Use bootstrap values (β^*; σ^

ε*) and original values (β^; σ^ε) to construct estimated confidence interval

3.2 Model specification

Truncated regression bootstrap model

Estimation of following model: (based on the model of chortareas et al.,2013)

EFF k,t = α+ β1H t +β2B k,t +β3YEAR t +ε k,t (1)

Where:

“k” is individual bank, and “t” represents for time period

EFF: bank technical efficiency scores, used DEA method to measure (3.1.1), and bounded between 0 and 1

H is a vector of economic freedom indicators which derived from Heritage Foundation

INDEX: Economic freedom index

FINFREE: Financial freedom index

GOVERNINDEX: Government spending index

PROPERTY: Property right index

CORRFREE: Freedom from corruption index

BUSINESS: Business freedom index

Bk is a vector of bank specific characteristics for every single bank

Bk,t= (EQASk , ROAEk , LNTAk , CRk )