Assessing the performance of the Latin American and Caribbean banking industry: Are domestic and foreign banks so different?

Abstract

This paper studies the relative performance of domestic and foreign banks in the Latin American and Caribbean banking industry. Data Envelopment Analysis is used to compute technical efficiency scores for the years 2001 and 2013. Our main contribution is twofold. On the one hand, we assess performance at the level of the management of specific production factors. On the other hand, we distinguish program efficiency from managerial efficiency, which allows us to evaluate whether the differences in technical efficiency between national and foreign banks are due to the use of different technologies (program efficiency) or, conversely, differences in the managerial capacities of managers in both categories of banks (managerial efficiency). The results show that foreign banks are more efficient than domestic ones, and provide evidence that the greater efficiency of foreign banks is mostly due to the superior technology they use.

Full text

Sáez-Fernández et al., Cogent Economics & Finance (2015),
3: 1006976
http://dx.doi.org/10.1080/23322039.2015.1006976
GENERAL & APPLIED ECONOMICS | RESEARCH ARTICLE
Assessing the performance of the Latin American
and Caribbean banking industry: Are domestic and
foreign banks so dierent?
Francisco Javier Sáez-Fernández
1
*, Andrés J. Picazo-Tadeo
2
and Mercedes Beltrán-Esteve
2
Abstract:This paper studies the relative performance of domestic and foreign banks
in the Latin American and Caribbean banking industry. Data Envelopment Analysis is
used to compute technical eciency scores for the years 2001 and 2013. Our main
contribution is twofold. On the one hand, we assess performance at the level of
the management of specific production factors. On the other hand, we distinguish
program eciency from managerial eciency, which allows us to evaluate whether
the dierences in technical eciency between national and foreign banks are due
to the use of dierent technologies (program eciency) or, conversely, dierences
in the managerial capacities of managers in both categories of banks (managerial
eciency). The results show that foreign banks are more ecient than domestic
ones, and provide evidence that the greater eciency of foreign banks is mostly due
to the superior technology they use.
Subjects: Banking; Operational Research/Management Science; Management of
Technology & Innovation
Keywords: Latin American and Caribbean banking industry; eciency; foreign capital
*Corresponding author: Francisco Javier
Sáez-Fernández, Department of Spanish
and International Economics, University
of Granada, Campus de Cartuja, 18011
Granada, Spain
E-mail: saez@ugr.es
Reviewing editor:
Caroline Elliott, Huddersfield University,
UK
Additional information is available at
the end of the article
ABOUT THE AUTHORS
Francisco Javier Sáez-Fernández, PhD in
Economics (University of Granada), is a lecturer
at the University of Granada. He has focused part
of his research on the field of water economics,
where he has published in international journals,
and more recently, in banking and finance,
with particular interest in the study of the Latin
American banking industry.
Andrés J. Picazo-Tadeo, MSc in Economics
(London School of Economics and Political Science)
and PhD in Economics (University of Valencia), is a
professor at the University of Valencia. One of his
main areas of research is the analysis of eciency
and productivity, a field in which he has published
numerous methodological and empirical papers in
international journals.
Mercedes Beltrán-Esteve, PhD in Economics
(University of Alicante), is a lecturer at the
University of Valencia and her research focuses
on the field of eciency and productivity
measurement, an area in which she has recently
published in top-rated journals.
PUBLIC INTEREST STATEMENT
The financial crises experienced by the Latin
American and Caribbean region in the 1980s and
the first half of the 1990s boosted reforms in
the banking system aimed at adapting banks to
international solvency standards, liberalizing their
operational capacity, opening to international
competition, and increasing their eciency and
productivity. Foreign banks were encouraged to
enter these countries and were also meant to play
a leadership role in the process of modernization;
however, the role they actually played still remains
a cause for debate. This paper contributes to this
ongoing debate by analyzing performance in the
regional banking industry. Our results show that
foreign banks are managed more eciently than
their domestic counterparts; furthermore, this
superiority is determined to a great extent by the
use of more ecient technologies. Accordingly, our
results appear to support the opening up of the
Latin American industry, and the positive role of
foreign banks in its modernization.
Received: 25 October 2014
Accepted: 08 January 2015
Published: 09 February 2015
© 2015 The Author(s). This open access article is distributed under a Creative Commons Attribution
(CC-BY) 4.0 license.
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1. Introduction
It is well known that the Latin American and Caribbean (LAC) countries began to overhaul their
banking systems from the mid-1990s onwards, in order to adapt them to international solvency
standards, liberalize their operational capacity, open them to international competition, and
increase their levels of eciency and productivity (De Carvalho, De Paula, & Williams, 2015). The fi-
nancial crises experienced by the region in the 1980s and the first half of the 1990s boosted these
reforms, which counted on the full support of international organizations, such as the International
Monetary Fund and the World Bank, in the context of the increasing globalization that the world
economy was experiencing (World Bank, 2008). Foreign banks were encouraged to set up operations
in these countries and were expected to play an important role in the modernization of LAC banking,
within the framework of the privatization process initiated by many governments in the region
(Chortareas, Garza-Garcia, & Girardone, 2011; Yildirim & Philippatos, 2007).
The process of liberalization and the opening up of the sector to foreign competitors appear to
have had positive results in the light of the financial stability achieved by the region over the last few
years, the growth and extension of financial services to a broader section of society, and the overall
performance of LAC banks over this period (Manuelito & Jiménez, 2010). Nevertheless, the role that
foreign banks have played in this process of modernization in both LAC and in other emerging
regions has been and continues to be a point of contention, especially in the context of the contro-
versy of “competition-eciency” versus “competition-ineciency” (see Schaeck & Čihák, 2008; also
Bang, Pía, & Wu, 2011; Levy & Micco, 2007).
Advocates of the introduction of foreign banks argue that increased competition in local markets
leads to improvements in the operational eciency of domestic entities in a number of dierent
ways, i.e. the implementation of more modern technologies, and the development of new products
and services lead to reduced margins and lower costs for financial services (CEPAL, 2012).
Furthermore, they argue that foreign banks tend to act more cautiously than their domestic coun-
terparts and they also boost economic growth by improving resource allocation eciency as well as
making the sector less vulnerable to internal and external disturbances (Olivero, Li, & Jeon, 2011).
Lastly, they also contend that foreign banks have greater access to capital markets, the loans they
provide tend to be more stable, and they are less dependent on national economic cycles (Chortareas
et al., 2011; Clarke, Cull, Martínez Pería, & Sánchez, 2003; Dages, Goldberg, & Kinney, 2000; Wu, Bang,
& Luca, 2010).
Conversely, other authors maintain that foreign banks develop selective strategies to penetrate
target markets, leaving the least profitable and least solvent customers to the local banks, which
in turn makes these entities less ecient and less competitive (CEPAL, 2003; Green, Murinde, &
Nikolov, 2004; Moguillansky, Studart, & Vergara, 2004). Furthermore, it is said that foreign banks
encourage capital outflows and that the integration of international financial markets increases the
impact of exogenous shocks on credit or domestic interest rates. Lastly, foreign banks tend to apply
greater margins, thus making the whole of the domestic banking market less competitive (de la
Torre, Martínez Pería, & Schmukler, 2010; Galindo, Izquierdo, & Rojas-Suárez, 2010).
This paper contributes to this ongoing debate by analyzing the performance of the banking industry
in LAC countries, and by assessing the relative technical eciency of national and foreign banks in the
region using non-parametric Data Envelopment Analysis (DEA) techniques. The contribution of this
paper to existing literature is twofold. On the one hand, by accounting for slacks in the calculation of
eciency scores, we assess performance at the level of the management of specific production
factors. On the other hand, we distinguish program eciency from managerial eciency, which allows
us to evaluate whether the dierences in technical eciency between national and foreign banks are
due to the use of dierent technologies (program eciency) or, conversely, dierences in the manage-
rial capacities of managers (managerial eciency) in both categories of banks. Our main finding is that
foreign banks perform better than national ones, and the dierence is statistically significant; moreover,
this dierence is based to a great extent on the superior technology that the foreign banks use.

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The paper is structured as follows: following the introduction, Section 2 describes the recent trends
in costs and margins of the banking industry in LAC countries; Section 3 reviews the literature on the
assessment of banking eciency in the LAC region; Section 4 describes the data and the methodol-
ogy; Section 5 presents and discusses the results, while the final Section 6 contains summaries and
conclusions.
2. Background information about the LAC banking sector
Although it is by no means homogeneous, the LAC banking market does have certain common
features that are specific to developing economies. Even though the regional banking market is still
not suciently mature, it has experienced high rates of expansion and has multiplied its activities
over the last decade, diversifying its range of financial services and progressively penetrating new
sectors of Latin American society. Moreover, after almost two decades of opening up to foreign
competitors, regional banks are notably more stable, with significant improvements to their e-
ciency and profitability indicators (Bank for International Settlements, BIS, 2007).
The strong economic performance of the region has led to a growth in financial activity of a similar
intensity to that observed in other emerging regions and much greater than the growth registered
in any developed countries. The growth in banking activity has been accompanied by a very signifi-
cant improvement in the indicators of access to financial services. Therefore, the number of custom-
ers and banking branches has increased substantially with a diversification in the channels used to
oer products and services, although again, these indicators are far removed from the levels seen in
more advanced countries (World Bank, 2012).
The role played by foreign entities in this process may represent one of the most noteworthy features
of the evolution of the Latin American banking market during the last two decades. At the end of the
1980s, the international banking sector began to expand into emerging markets all over the world and
particularly in LAC. Within a short period of time, the biggest banks in the USA, the UK, Spain, Canada,
and the Netherlands had strengthened their presence in the Latin American banking market. The local
authorities in LAC countries, with strong support from dierent international financial organisms,
expected the arrival of foreign banks to contribute to the recapitalization of those local entities that had
been badly damaged by previous crises, to encourage competition in the sector and to facilitate the
incorporation of new technologies and more advanced management procedures, all of which would
help to ensure stability and improve the eciency and productivity of regional banks (Minda, 2007).
At the beginning of the twenty-first century, the process of implantation of foreign banks in LAC
was practically complete. However, after nearly a decade in which foreign banks had obtained over
50% of the market share in most of the countries in the region, from 2001 onwards, there has been
a gradual yet irregular recovery of market share by domestic banks (Figure 1).
The slow but continued fall in the power of foreign banks can primarily be explained by a sharp
increase in the activity of domestic banks, which in the period 2001–2013 managed to increase their
assets more quickly than foreign banks. Foreign banks, in turn, have started to reorganize their
Figure 1. Share of domestic
banks (dashed line) and foreign
banks (continuous line) in the
LAC banking industry.
Source: BankScope and own
elaboration.
0
20
40
60
80
100
Domestic Foreign

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subsidiaries in the region and, since the financial crisis that began in 2007, have partially returned to
their original markets in order to strengthen the liquidity and solvency of the parent companies
(Fender & McGuire, 2010).
Despite the strategies developed by foreign entities, it is primarily the strong performance of
domestic banks that is behind the positive evolution of their market share (CEPAL, 2012). Costs,
margins, and profits are the most important variables where competition has had an impact, and
reflect the main changes to have taken place in banking.
The arrival of foreign banks to LAC was expected to bring about significant reductions in interme-
diation costs and margins (Jeon, Olivero, & Wu, 2011).1 It was estimated that increased competition
accrued from the process of opening up to foreign companies and the supposedly superior techno-
logical and management skills of these companies would guarantee this [Levy and Micco (2007) and
Bang et al. (2011) analyze competition and concentration in the LAC banking sector]. Regarding
margins, with the exception of specific cases such as Mexico, the interest dierential of lending
and deposit rates has remained relatively high throughout the period, at levels which are far
removed from the narrower margins observed in advanced economies such as the USA or the
Eurozone (Table 1).2 Consequently, it seems that, in this respect, increased competition has not sig-
nificantly aected regional banking practices (Gelos, 2009). It is also striking that foreign entities
have displayed higher interest dierentials than those of domestic entities’, except for the years in
the middle of the decade (Figure 2(a)).
On the other hand, operating costs have been significantly reduced in terms of the total assets for
the period, which could be explained, among other reasons, by the increase in competition and
technological, organizational and managerial modernization that took place after the arrival of for-
eign banks (Carvallo & Kasman, 2005). The reduction in costs has been particularly intense in the
case of domestic banks, which have outperformed foreign ones and have displayed a great ability to
adapt to the new institutional framework and a more competitive scenario (Figure 2(b)). Nevertheless,
the levels of relative costs among Latin American banks are still notably higher than those observed
in the USA and especially those in the Eurozone (see Table 1).
Regarding profitability performance, the growth of the banking business in the region and the
increases in eciency and productivity should boost profit levels, although the increase in competi-
tion could also negatively influence these levels due to the narrowing of margins (Claessens,
Demirgüç-Kunt, & Huizinga, 2001). Nevertheless, as has been noted, banking margins remained
Table 1. Performance indicators of the LAC banking industry, 2001–2011
Net interest margin (%) Overhead cost
(% total assets)
Return on assets
(ROA, %)
2001 2011 2001 2011 2001 2011
Argentina 6.3 7.1 10.1 7.2 −0.1 2.8
Brazil 5.4 5.0 5.5 3.4 1.0 1.2
Chile 0.1 3.6 2.9 4.6 1.5 7.8
Colombia 3.6 6.1 9.1 8.0 0.7 2.2
Mexico 5.6 3.0 4.5 2.5 0.8 0.6
Peru 4.2 6.2 4.7 4.2 0.4 2.6
Uruguay 3.2 4.9 6.3 4.4 −2.1 1.2
LAC 3.9 5.9 4.8 4.3 0.9 1.8
United States 3.0 3.6 3.2 2.9 1.1 0.8
Eurozone 2.1 1.4 1.5 1.3 0.5 0.1
Note: Figures of capital for Argentina in 2001 refer to year 2003.
Source: World Bank.

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relatively high during the 2000s, and therefore one would expect the opening up of the sector to
foreign competitors to have led to an increase in profit levels derived from the growth of business as
well as improvements in eciency. Indeed, over the period analyzed, the rate of return on assets in
the LAC banking market increased substantially, while it fell considerably in the USA and even more
so in the Eurozone (see Table 1). The profiles of the rate of return of domestic and foreign banks are
very similar, although the financial crisis that started in 2007 has had a greater impact on the profits
of foreign entities (Figure 2(c)).
In summary, the dierent indicators analyzed above show that the LAC banking industry has
evolved favorably between 2001 and 2013; furthermore, domestic and national banks have performed
in a very similar way. This would seem to suggest that the presence of foreign banks has boosted
Figure 2. Performance
indicators of the LAC banking
industry: domestic banks
(dashed line) versus foreign
banks (continuous line).
Source: BankScope and own
elaboration.

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competition and modernization in the regional banking system, which was the original aim behind the
decision to liberalize and open up the sector.
Given the similarity of the developments observed, it might be worthwhile asking if there are
currently any significant dierences in the comparative levels of eciency and, therefore, if it is
reasonable to expect even greater changes in the LAC banking scenario over the coming years. The
next sections aim to provide partial answers to these questions.
3. Eciency in the LAC banking industry: a brief review of literature
Over the last few decades, a great deal of literature has addressed eciency analysis in the banking
industry. A variety of dierent methodological approaches have been used that include both
parametric and non-parametric techniques (Berger & Mester, 1997; Carbó, Humphrey, & López del
Paso, 2007; Duygun, Sena, & Shaban, 2013). Dierent concepts of eciency have also been ana-
lyzed, including technical, cost and profit eciency (Wheelock & Wilson, 2013), as well as the impact
on eciency of dierent environmental variables, i.e. public or private ownership of capital, the
origin (domestic or foreign) of investors, or the nature of the regulations that govern banking activity
(Chortareas, Girardone, & Ventouri, 2012, 2013; Servin, Lensink, & van den Berg, 2012). Lastly, there
has been analyses at a global scale (Barth, Lin, Mac, Seade, & Song, 2013; Kösedağ, Denizel, &
Özdemir, 2011), as well as in terms of developed countries (Brissimis, Delis, & Tsionas, 2010; Feng
& Serletis, 2010; Tabak, Boueri, & Fazio, 2013), and emerging countries or regions (Ariss, 2010;
Assaf, Matousek, & Tsionas, 2013; Ray & Das, 2010), and economies in transition (Bonin, Hasan, &
Wachtel, 2005; Koutsomanoli-Filippaki, Margaritis, & Staikouras, 2009).
Regarding studies specifically focused on the banking industry in LAC countries, several papers
over the last decade have assessed the relative performance of domestic and foreign banks. The
results obtained using dierent methodological approaches are mixed, although many papers indi-
cate that the performance of domestic and foreign banks is currently very similar (CEPAL, 2012).
Using regression analysis, Micco, Panizza, and Yañez (2007) found that foreign banks in developing
countries have higher profit margins and lower costs than domestic banks. Furthermore, Figueira,
Nellis, and Parker (2009) estimated several stochastic and non-stochastic frontiers and found only
slight dierences in performance between domestic and foreign banks in LAC countries.
In the case of Brazilian banks, Tecles and Tabak (2010) estimated both stochastic and non-
parametric frontiers and found that large foreign banks are somewhat more ecient than
domestic banks. Moreover, using non-parametric DEA techniques, Staub, da Silva e Souza, and
Tabak (2010) showed that Brazilian state-owned banks are more ecient than foreign banks and
private domestic banks, with or without minority foreign participation. Nevertheless, these results
should be no surprise, given the functions of the wholesale banking sector and the important role
that public banking plays in this emerging economy. Garza-García (2012) conducted a two-stage
performance analysis for Mexican banks and concluded that GDP growth, loan intensity, and
foreign ownership are the main factors that influence banking eciency. Finally, Sanchez, Hassan,
and Bartkus (2013) measured allocative, technical, and scale eciency in seven Latin American
banking industries, and suggested that the source of ineciency is regulatory (allocative), rather
than managerial (technical), and that financial liberalization has led to productivity increases
throughout Latin America as a consequence of technological progress, rather than enhanced
technical eciency.
In summary, literature in this field of research suggests that the origin of capital, either domestic
or foreign, might be one of the factors that influence banking eciency. In the following sections, we
go one step further by assessing the technical eciency of foreign and domestic LAC banks in terms
of how they manage specific production factors. We also investigate the relative eciency of the
production technologies used by foreign and domestic banks.

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4. Eciency assessment: data and methodological issues
4.1. Data and sample
In order to evaluate the eciency of the banking industry in LAC countries, we use data from the
BankScope database, a widely used source of accounting and financial statistics in recent years
(Soares, 2011). Our data-set includes banks from Argentina, Bolivia, Brazil, Chile, Colombia, Costa
Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru,
Paraguay, Trinidad and Tobago, Uruguay, and Venezuela. To avoid any distortions that productive
specialization (commercial or investment banks) or the legal status of institutions (banks, saving
banks, and cooperative banks) might have on our analysis, the sample only includes commercial
banks. We assess the relative eciency of domestic and foreign banks in the years 2001 and 2013.
After eliminating observations with missing information on relevant variables for the purpose of our
research, our sample includes 164 banks for 2001, 91 of which are domestic and 73 foreign; and 145
banks for 2013, 87 of which are domestic and 58 foreign. It should be noted that Mexican banks are
not present in the sample, given the lack of available information on sta costs.
The characterization of the production technology in the banking industry is based on the financial
intermediation approach (Sealey & Lindley, 1977), according to which banks use basic production
factors (physical capital and labor) and gain resources through dierent means, such as deposits or
capital (inputs), to invest in dierent financial products, including credits, loans, or securities (out-
puts). This approach has been widely used in previous literature (see Berger, Hasan, & Zhou, 2009;
Chiu, Jan, Shen, & Wang, 2008; Koutsomanoli-Filippaki, Margaritis, & Staikouras, 2009, among
others). More specifically, the inputs considered in our analysis are sta costs as a proxy of labor,
non-profitable assets as a proxy of physical capital, and customer deposits and own resources as
financial inputs. On the other hand, outputs are gross loans, interbank credits, and investment in
securities (Ray & Das, 2010). Table 2 shows some descriptive statistics.
4.2. Methodological issues
For the methodology, let us assume that the k=1, … , N, banks in our sample, either 164 in 2001 or
145 in 2013, use a vector of inputs xik (i=1, … , 4), i.e. non-profitable assets, customer deposits, own
resources, and sta costs, to produce a vector of outputs yrk (r=1, … , 3), i.e. gross loans, interbank
credits, and investment in securities, through a technology that is given by:
(1)
T
=
[
(x,y)
||
xcan produce y
]
Table 2. Sample description: averages in current millions US$
Year 2001 Year 2013
All banks
(164)
Domestic
banks (91)
Foreign
banks (73)
All banks
(145)
Domestic
banks (87)
Foreign
banks (58)
Outputs
Gross loans 1,116 1,387 779 7,261 8,758 5,016
Interbank
loans
284 318 240 3,102 4,378 1,187
Securities 651 918 318 2,203 2,735 1,404
Inputs
Non-profit-
able assets
348 494 167 2,053 2,463 1,438
Customer
deposits
1,178 1,478 804 6,143 7,239 4,500
Own
resources
459 576 312 2,785 3,519 1,685
Sta costs 72 98 40 229 280 153

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This reference technology provides a complete description of all feasible relationships between
inputs and outputs, and it is assumed that it satisfies the standard axioms proposed by Shephard
(1970). These properties include the possibility of inaction, no free lunch, free disposability of inputs,
and strong disposability of outputs; furthermore, outputs and inputs are assumed to be
non-negative.
Based on this characterization of the production technology, the technical eciency of banks in
our sample is assessed using DEA techniques. DEA is a well-known approach to measuring eciency
based on mathematical programming that was pioneered by Charnes, Cooper, and Rhodes (1978),
and it has been used in hundreds of empirical papers (see Cook & Seiford, 2009 for a review). In
essence, this technique allows the comparison of the position of each bank in our sample, i.e. its
input and output vectors, with the best observed practices in the sample in terms of a performance
indicator (the details are in Cooper, Seiford, & Tone, 2007).3 Formally, assessing the technical
eciency of bank 0 requires solving the following program:
where xi0 and yr0 stand for the observed values of input i and output r for bank 0, and λk represents
the weighting of each bank k in the sample in the composition of the ecient frontier. Moreover, all
inputs are assumed to be variable, which means that we carry out an analysis of long-run perfor-
mance; constant returns to scale are also imposed (see Banker, Charnes, & Cooper, 1984).
The solution to program (2) assesses the maximum feasible proportional reduction in all inputs
that bank 0 could achieve without decreasing its outputs, thus providing a measure of conventional
Farrell-type input-oriented technical eciency, i.e. it assesses technical eciency in a Farrell–Debreu
sense (Farrell, 1957). This score ranges from zero to one, with one indicating best performance. For
instance, a figure of 0.85 would mean that bank 0 could produce the same vector of outputs using
only 85% of inputs; in other words, all inputs could be proportionally reduced by 15%.
However, once the maximum proportional reduction of all inputs has been attained, additional
reductions may still be feasible for some particular inputs while maintaining the vector of outputs;
the so-called input slacks measure these input-specific potential reductions. The existence of slacks
means that the extent of ineciency cannot be fully assessed by simply computing radial measures,
as non-radial reductions also need to be considered in order to provide a complete picture of e-
ciency (Torgersen, Førsund, & Kittelsen, 1996). Formally, these additional shrinkages are measured
for bank 0 from the solution to the following program (Ali & Seiford, 1993):
with Si0 and Sr0 standing for the slacks in inputs and outputs, respectively, i.e. input excesses and
output shortfalls;
𝜑∗
0
is the solution for proportional eciency obtained for bank 0 from program (2).
(2)
Minimize
𝜑0,𝜆k
Technical efficiency
=𝜑0
subject to:
𝜑0xi0≥
N
∑
k=1
𝜆kxik i=1, …,4 (i)
yr0≤
N
∑
k=1
𝜆kyrk r=1, …,3 (ii)
𝜆
k
≥0k=1, …,N(iii
)
(3)
Minimize
𝜑0,𝜆kS0=

4

i=1
Si0+
3

i=1
Sr0

subject to:
𝜑∗
0xi0−Si0=
N

k=1
𝜆kxik i=1, …,4 (i)
yr0+Sr0=
N

k=1
𝜆kyrk r=1, …,3 (ii)
Si0,Sr0≥0i=1, …, 4 and r=1, …,3 (iii
)
𝜆
k
≥
0k
=
1,
…
,N
(
iv)

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Potential proportional reductions in inputs computed from mathematical program (2) and input-
specific slacks arising from program (3) can be used to assess Pareto–Koopmans input-specific tech-
nical eciency (Koopmans, 1951). Accordingly, the Pareto–Koopmans ecient use of input i on
behalf of bank 0 is computed by subtracting its aggregate potential reduction, i.e. proportional plus
input-specific reduction, from its observed use:
Finally, slack-adjusted scores for the input-specific technical eciency of bank 0 in the management
of input i are computed as the quotient between the Pareto–Koopmans ecient level of that input
and its observed level:
The input-specific eciency scores are, by construction, always equal to or lower than the radial
scores and have a similar economic interpretation. Furthermore, as input slacks enter expression (5)
as a percentage of observed inputs, input-specific measures of technical eciency are unit invariant.
While the inclusion of information on input-specific reductions when assessing technical eciency
reveals the full potential of banks in our sample to reduce inputs while maintaining outputs, the
importance of slacks in explaining ineciency can be evaluated by calculating the weight of poten-
tial input-specific reductions on aggregate potential input reductions. Formally, for input i:
with
xradial
ik
=𝜑
∗
k
x
ik
.
Once both proportional and input-specific technical eciency of all banks in our sample have been
evaluated, the statistical significance of dierences between domestic and foreign banks can be
assessed using a number of non-parametric tests of hypotheses. A standard test is the Kolmogorov–
Smirnov distribution test (see Conover, 1999); in addition, we also use the Simar–Zelenyuk-adapted-
Li test (Li, 1996; Simar & Zelenyuk, 2006), which is more appropriate to our case study because it is
specifically designed for statistical inference with eciency scores computed with DEA.
Nevertheless, some possible dierences in technical eciency between domestic and foreign
banks in LAC countries might be due either to the fact that they are using dierent production tech-
nologies or to what we might call a concentration of good/bad managers in a given category of
banks. In order to distinguish between these two sources of ineciency in the case of our radial
technical eciency scores, in the second stage of our research, we use the program approach first
proposed by Charnes, Cooper, and Rhodes (1981) and later further developed by authors, such as
Silva Portela and Thanassoulis (2001) and O’Donnell, Rao, and Battese (2008). Essentially, this
approach suggests that production units belonging to dierent programs or groups within the same
economic activity might have access to dierent production technologies. Furthermore, in our case
study, it would allow us to assess managerial or intra-program eciency by comparing banks in our
sample to best observed practices in the group they belong to, either domestic or foreign banks, and
also to assess inter-program eciency, or simply program eciency, which identifies dierences in
performance between both groups that stem from technological dierences.
In practice, assessing program eciency in the LAC banking industry requires the following four
steps to be taken. Firstly, all banks in the sample need to be grouped according to their type, either
domestic or foreign, and then program (2) must be run separately for each group Kh (h=1, 2) in order
to assess managerial eciency, namely φmanagerial; i.e. banks are compared to best observed practices
(4)
xPareto−Koopmans efficient
i0
=x
i0
−
[(
1−𝜑∗
0)
x
i0
+S
i0]
=𝜑∗
0
x
i0
−S
i0
(5)
Input-specific technical efficiency
=x
Pareto−Koopmans efficient
i0
x
i0
=𝜑∗
0−Si0
x
i0
(6)
Importance of slacks
i=

N
i=1

xradial
ik −xPareto−Koopman efficient
ik


N
i=1

xik −xPareto−Koopman efficient
ik

=N
k=1Sik

N
k=1

1−𝜑∗
k

xik +Sik


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in the group they belong to. Secondly, observed data on inputs are projected onto the technological
frontier of their own group in order to clean up managerial ineciencies. This can be formally done
for bank k in group Kh and input i by means of the expression:
The third step requires solving program (2) again using the joint sample of banks and the projected
data obtained in the previous step instead of the original observed data. This provides an estimation
of program eciency, represented by φprogram, which, for each group, is equivalent to the distance
between the technological frontier of this group and the joint technological frontier. Finally,
the significance of dierences in program eciency between domestic and foreign banks needs to
be tested using appropriate statistical procedures, such as those mentioned above.
In summary, the aforementioned procedure allows us to decompose scores for radial technical
eciency into the result of the product of scores for managerial eciency and program eciency.
Formally:
5. Results and discussion
Using the characterization of the technology in the banking industry described in Section 4.1, we
have assessed the performance of the LAC banks in the years 2001 and 2013 separately. To do so,
we firstly computed radial or proportional scores of technical eciency from mathematical program
(2) using the joint sample of banks as the reference to construct the technological frontier. The
results are shown in Table 3.
Computed scores of eciency in 2013 suggest that, on average, in the long run, the banks in the
sample could reduce their use of inputs by almost 27%, while maintaining their levels of outputs, i.e.
the average radial eciency is 0.731. This potential proportional reduction of inputs reaches 28% for
domestic banks and 25% for foreign banks, i.e. technical eciency scores are 0.719 and 0.750,
respectively; furthermore, results from the Kolmogorov–Smirnov and Simar–Zelenyuk-adapted-Li
tests show that this dierence is statistically significant at standard confidence levels. Accordingly,
a first conclusion from our results is that, from a technical point of view, foreign banks in the LAC
banking industry are more eciently managed than their domestic counterparts. These results con-
tradict those of Figueira et al.’s (2009), which found that in LAC countries, the local banks are slightly
more ecient; however, they are similar to those of Garza-García (2012) and Berger et al.’s (2009),
which found that foreign banks were more ecient than domestic ones in Mexico and China,
respectively.
However, a relevant issue is whether or not higher eciency of foreign banks in LAC countries
holds true when it comes to the management of specific production factors. In order to answer this
question, we have computed input-specific technical eciency scores according to expression (5)
using figures on input excesses from program (3). The results appear in Table 3. The averages for all
banks are 0.511, 0.727, 0.723, and 0.645 for non-profit assets, customer deposits, own resources,
and sta costs, respectively. Moreover, the weight of slacks in explaining potential input-specific
reductions, which is assessed from expression (6), ranges from scarcely 1% for customer deposits to
nearly 47% for non-profitable assets, highlighting the relevance of taking them into consideration
when assessing the technical eciency of the LAC banking industry.
Regarding the economic interpretation of the averages of input-specific eciency, the greatest
ineciencies arise in the management of non-profitable assets and sta costs, i.e. basic production
factors, while the best-managed production factors are customer deposits and own resources, i.e.
financial inputs. Furthermore, the higher performance of foreign banks holds true for the specific
(7)
xprojected K
h
ik
=𝜑
∗managerial K
h
k
x
ik
k∈K
h
and h=
1, 2
(8)
Technical efficiency
(𝜑k)=managerial efficiency

𝜑managerial
k

×program efficiency

𝜑program
k

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management of all inputs included in the analysis, with the exception of sta costs, where the
dierence with domestic banks is not statistically significant according to the results from the
Kolmogorov–Smirnov and the Simar–Zelenyuk-adapted-Li tests.4
In addition to the above-mentioned results for 2013, we also assessed eciency of the LAC bank-
ing industry in 2001. The results appear in Table 3. Before commenting on them, let us point out that
the eciency scores, whether radial or input-specific, computed in 2001 and 2013 are not directly
comparable to each other. The reason for this is that eciency is a relative concept that is assessed
with respect to a technological frontier constructed from observations of best practices in a given
data-set of observations (see Cooper et al., 2007), and the 2001 and 2013 data-sets are dierent.5
That said, eciency scores computed with data for 2001 also point to the greater eciency of for-
eign LAC banks compared to their domestic counterparts; for instance, while the average radial e-
ciency is 0.699 for foreign banks, i.e. they could maintain their output levels with a 30% reduction in
inputs, for domestic banks this figure stands at 0.620, with the dierence being statistically significant.
Our results also reveal that in 2001, foreign banks were more ecient than domestic ones in the
specific management of all production factors considered in our analysis, with the dierences being
statistically significant in all cases. Lastly, it is worth noting that in 2001, both domestic and foreign LAC
banks were operating further away from their contemporaneous technological frontiers than in 2013.
As previously noted, the dierences in performance between domestic and foreign banks within
the LAC banking industry may be due to dierences in the capabilities of their respective managers
and/or to dierences in the technology they use. In order to shed some light on this issue, we have
considered that domestic and foreign banks belong to dierent groups or programs and have
decomposed radial eciency into the product of managerial eciency and program eciency,
Table 3. Radial and input-specific technical eciency: domestic versus foreign banks
All banks Domestic
banks
Foreign banks Kolmogorov–Smirnov
testa
KS-statistic (p-value)c
Simar–Zelenyuk–Li
testb
Li-statistic (p-value)d
Mean SD Mean SD Mean SD
Year 2013
Radial technical eciency 0.731 0.213 0.719 0.195 0.750 0.237 0.224 (0.041)
**
4.978 (0.000)***
Input-specific technical eciency
Non-profitable assets 0.511 0.320 0.481 0.354 0.556 0.294 0.201 (0.086)* 0.639 (0.261)
Customer deposits 0.727 0.212 0.715 0.235 0.746 0.196 0.200 (0.087)* 1.519 (0.064)*
Own resources 0.723 0.221 0.710 0.254 0.742 0.197 0.224 (0.040)** 2.626 (0.004)***
Sta costs 0.645 0.263 0.615 0.272 0.689 0.255 0.195 (0.103) 0.891 (0.186)
Year 2001
Radial technical eciency 0.655 0.226 0.620 0.199 0.699 0.249 0.235 (0.023)** 4.087 (0.000)***
Input-specific technical eciency
Non-profitable assets 0.544 0.291 0.488 0.261 0.614 0.313 0.237 (0.020)** 2.821 (0.002)***
Customer deposits 0.634 0.228 0.602 0.207 0.675 0.247 0.218 (0.042)** 1.988 (0.023)**
Own resources 0.652 0.228 0.614 0.202 0.699 0.249 0.259 (0.009)*** 4.352 (0.000)***
Sta costs 0.524 0.299 0.458 0.269 0.607 0.316 0.284 (0.002)*** 4.214 (0.000)***
aThe null hypothesis is that the two samples have the same distribution.
bThe null hypothesis is that the two samples have the same probability distribution function.
cCorrected p-value.
dOriginal estimates of technical eciency are smoothed using the algorithm II in Simar and Zelenyuk (2006, p. 508).
*Significant at 10%.
**Significant at 5%.
***Significant at 1%.

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which, in our case study, might also be referred to as ownership eciency, since it identifies dier-
ences in performance between domestic and foreign banks. The results for years 2001 and 2013
appear in Table 4.
On the one hand, the average managerial eciency score of domestic banks in 2013 is 0.818,
which means that when compared to the best observed practices in their group, they could propor-
tionally save around 18% of their consumption of inputs. Average managerial eciency for foreign
banks is 0.773, suggesting a potential reduction of inputs of almost 23%. However, the managerial
eciency scores of domestic and foreign banks are not directly comparable because they have been
obtained in relation to dierent technological frontiers and, as mentioned above, eciency is a rela-
tive concept.
On the other hand, program eciency averages 0.916 for domestic banks and 0.969 for foreign
ones, indicating that, on average, the group of foreign banks performs closer to the joint technological
frontier than the group of domestic banks. Moreover, the dierence between both distributions is
statistically significant according to both the Kolmogorov–Smirnov and the Simar–Zelenyuk-adapted-Li
tests. In addition, Figure 3 represents the Kernel density estimation functions of the radial technical
Table 4. Decomposition of radial eciency into managerial and program eciency: domestic versus foreign banks
Domestic banks Foreign banks Kolmogorov–Smirnov testaSimar–Zelenyuk–Li testb
Mean SD Mean SD KS-statistic (p-value)cLi-statistic (p-value)d
Year 2013
Radial eciency 0.719 0.195 0.750 0.237 0.224 (0.041)** 4.978 (0.000)***
Managerial eciency 0.818 0.194 0.773 0.221 – –
Program eciency 0.916 0.417 0.969 0.110 0.667 (0.000)*** 11.997 (0.000)***
Year 2001
Radial eciency 0.620 0.199 0.698 0.249 0.235 (0.023)** 4.087 (0.000)***
Managerial eciency 0.800 0.188 0.725 0.247 – –
Program eciency 0.774 0.158 0.962 0.065 0.649 (0.000)*** 20.127 (0.000)***
aThe null hypothesis is that the two samples have the same distribution.
bThe null hypothesis is that the two samples have the same probability distribution function.
cCorrected p-value.
dOriginal estimates of technical eciency are smoothed using the algorithm II in Simar and Zelenyuk (2006, p. 508).
*Significant at 10%.
**Significant at 5%.
***Significant at 1%.
Figure 3. Kernel density
estimation functions of radial
eciency scores: domestic
(dashed line) versus foreign
(continuous line) banks.

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eciency scores for the groups of domestic and foreign LAC banks, providing a graphical illustration of
the dierence between both distributions. These results suggest that the technology used by foreign
banks in LAC countries is more technically ecient than that used by domestic banks. In 2001, the
group of domestic banks was also operating further away from the contemporaneous joint frontier
when compared to the group of foreign banks; however, in 2013, their distance from that year’s joint
frontier decreased noticeably.
In terms of the relative eciency of domestic and foreign banks in LAC countries, the results
appear to partially support the policy measures taken in the 1980s by the national governments in
the region aimed at opening up the banking industry to international competition. Accordingly, our
empirical evidence supports the hypothesis that foreign banks, equipped with more advanced tech-
nologies, greater experience, and management capacity, in addition to having better access to
financial international markets, are more eciently managed than their domestic counterparts, and
could potentially have contributed to the modernization of the LAC banking sector.
6. Summary and conclusions
The LAC banking industry opened up to international competition in the mid-1980s. Judging by the
financial stability and the expansion that the banking sector in the region achieved in the years after
first opening up the market to foreign competitors, it seems that the arrival of foreign banks had a
positive eect. Nevertheless, there is no consensus in the literature as to the role played by foreign
banks in this process. In the context of this debate, this article studies the performance of domestic
and foreign banks in LAC countries, analyzing their levels of relative eciency. One of the most
relevant contributions made is the assessment of eciency related to the management of specific
production factors; moreover, analysis is carried out in order to determine whether or not the dier-
ences in eciency between domestic and foreign banks are due to the dierence in abilities
between their managers and/or the restrictions imposed by the use of dierent technologies.
Firstly, the performance of the banking industry in the region during the period 2001–2013 showed
a significant improvement in cost and profit indicators. In this sense, it seems that domestic banks
adapted quickly to the new competitive environment and even recovered a good proportion of the
market share that they lost in the years immediately following the arrival of foreign banks. The
performance indicators analyzed also show a certain convergence between domestic and foreign
banks, particularly in terms of costs; nonetheless, these indicators are still more favorable for foreign
banks.
Secondly, the eciency analysis results show that foreign banks are more ecient in their techni-
cal management than their domestic counterparts, and the dierence is statistically significant.
Furthermore, a noteworthy result of the research is that the superiority of foreign banks in terms of
technical eciency is determined to a great extent by their technology, which is more ecient than
that used by domestic banks. Finally, in 2013, domestic banks were closer to their contemporaneous
joint technological frontier than they had been in 2001.
On balance, the results obtained from this research appear to support the position adopted by LAC
governments when they decided to open up their banking markets to international competition. In
this sense, the empirical evidence provided supports the hypothesis that foreign banks, with more
advanced technology, greater experience and management ability, and better access to interna-
tional financial markets, might well have played an important role in the process of modernization
of the LAC banking industry.
Finally, we would like to highlight some limitations of our research, as well as several topics that,
in our opinion, merit further investigation. Firstly, commercial banks produce good outputs but also
bad outputs, such as impaired loans, and for these to be reduced requires increased expenditure on
evaluating customers’ credit risk; however, this issue is not accounted for in our eciency analysis.

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Concerning areas for further research, it might be interesting to explore dierences in performance
between foreign commercial banks and foreign investment banks. In addition, using dynamic mod-
eling to assess the contribution of changes in eciency to productivity growth of LAC banks, or using
multidirectional eciency analysis techniques to examine in more depth the nature of ineciencies
relative to input-specific improvement potentials are also interesting methodological challenges
that could be dealt with in future research.
Acknowledgments
We would like to acknowledge the constructive comments
of two anonymous referees. Francisco J. Sáez-Fernández
would like to acknowledge the support of the David
Rockefeller Center for Latin American Studies and Real
Colegio Complutense (Harvard University).
Funding
We would also like to gratefully acknowledge the
financial support of the Spanish Ministry of Economy and
Competitiveness [grant number ECO2012-32189], [grant
number ECO2011-30260-C03-01].
Author details
Francisco Javier Sáez-Fernández
1
E-mail: saez@ugr.es
Andrés J. Picazo-Tadeo
2
E-mail: andres.j.picazo@uv.es
Mercedes Beltrán-Esteve
2
E-mail: mercedes.beltran@uv.es
1
Department of Spanish and International Economics,
University of Granada, Campus de Cartuja, 18011 Granada,
Spain.
2
Department of Applied Economics II, University of Valencia,
Campus de Tarongers, 46022 Valencia, Spain.
Citation information
Cite this article as: Assessing the performance of the Latin
American and Caribbean banking industry: Are domestic and
foreign banks so dierent? Francisco Javier Sáez-Fernández,
Andrés J. Picazo-Tadeo, & Mercedes Beltrán-Esteve,
Cogent Economics & Finance(2015), 3: 1006976.
Notes
1. Compared to domestic banks, the large size of foreign
banks allows them better access to international finan-
cial markets, e.g. reducing liability costs and investing in
superior technology. Foreign banks can also develop the
same marketing policy for dierent national markets
and centralize bureaucratic tasks in international cen-
ters, thus reducing unit costs.
2. Although our analysis covers the period 2001–2013,
the latest available information in the Global Financial
Development Database of the World Bank used in Table
1 corresponds to 2011.
3. In addition to DEA techniques, Stochastic Frontier
Analysis (see Aigner, Lovell, & Schmidt, 1977; Meeusen &
van Den Broeck, 1977) is a parametric technique widely
employed to assess eciency. However, we have de-
cided in favor of DEA because it allows the calculation of
input-specific eciency scores that account for slacks,
which are an important source of ineciency in our case
study. Moreover, DEA techniques facilitate the modeling
of production processes with multiple outputs, as is the
case of the banking industry.
4. In the case of non-profitable assets, results from these
two tests are, however, contradictory.
5. The entry of new banks in the LAC banking industry from
2001 and the exit of others means that there are dier-
ences between the 2001 and 2013 samples. Addition-
ally, observations on banks in both data-sets also belong
to dierent moments of time.
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