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The interrelationships among default risk, capital ratio and efficiency: Evidence from Indian banks

Thanh Pham Thien Nguyen (Department of Accounting, Finance and Economics, Griffith University, Brisbane, Australia and Banking Faculty, University of Economics Ho Chi Minh City, Vietnam)
Son Hong Nghiem (Institute of Health and Biomedical Innovation (IHBI), Queensland University of Technology, Kelvin Grove, Australia)

Managerial Finance

ISSN: 0307-4358

Article publication date: 11 May 2015

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Abstract

Purpose

The purpose of this paper is to examine the interrelationships among default risk, capital and efficiency of the Indian banking system over 1990-2011. This study also took into account the impact of ownership on these interrelationships

Design/methodology/approach

This paper employed Data Envelopment Analysis (DEA) Windows Analysis to estimate efficiency levels and trends of individual banks. This paper then used a model of seemingly unrelated regression equations (SURE) to examine the interrelationships among default risk, capital and efficiency.

Findings

This study found a two-way negative association between efficiency and default risk, and between capital ratio and default risk. However, this study found a two-way positive relationship between capital ratio and only profit efficiency. Public banks behaved differently from private banks regarding the association between capital and efficiency. Moreover, public banks had greater probability of default risk, lower capital ratio but higher efficiency level than private banks. Further, default risk, capital ratio and efficiency of the Indian banking system increased over time, but the two formers were driven by public banks while the latter was driven by private banks.

Practical implications

The findings of this study appear to favour capital ratio as an efficient tool to improve efficiency and reduce default risk of the Indian banking system.

Originality/value

This paper is the first investigating the interrelationships between bank risk, capital and efficiency of the Indian banking system, where bank risk is measured by Z-score value and efficiency is captured by cost, revenue and profit efficiencies, and then considering the impact of agency issues on these interrelationships.

Keywords

Acknowledgements

JEL Classification — G21, G32, C61, C33

The authors are grateful for the comments and feedback received from Professor Knox Lovell. The authors thank the two anonymous referees for insightful and helpful comments particularly with regard to estimation issues, risk choice and paper presentation.

Citation

Nguyen, T.P.T. and Nghiem, S.H. (2015), "The interrelationships among default risk, capital ratio and efficiency: Evidence from Indian banks", Managerial Finance, Vol. 41 No. 5, pp. 507-525. https://doi.org/10.1108/MF-12-2013-0354

Publisher

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Emerald Group Publishing Limited

Copyright © 2015, Emerald Group Publishing Limited

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