Introduction
The global financial sector has witnessed forceful pressure since the international fiscal structure is developing fast owing to the effects of the creation of the Global Trade Association. “Deregulating the financial sectors and financial services, the increasing use of information technology, and the huge speed of dispensing financial information are also among the factors leading to reevaluating and restructuring of financial institutions worldwide” (Hossein & Lamia, 2010, p. 20). In light of these developments, players in the financial sector are increasingly monitoring the efficiency of monetary institutions in dispensing fiscal services. The UAE financial segment is no exception. The economic stability of the Middle East region relies on the UAE monetary institutions. Assessing the efficiency of the UAE fiscal segment can help determine its level of preparedness to deal with its global competitors who may soon be interested to extend their presence in the UAE market. The UAE hosts around forty-seven banks; twenty-two of them are countrywide banks. Five of the countrywide banks operate in line with Islamic principles. The twenty-five remaining banks are multinational. “The Central Bank of the UAE advises the government on monetary and financial issues, issuing currency, maintaining gold and foreign currency reserves, formulating credit policy and providing regulation and supervision” (Hossein & Lamia, 2010, p. 14). The banking sectors in developing nations need serious examination since they lack a standard ‘transitory trend’. Many fiscal analysts have examined the USA, EU, and Japan monetary institutions; however, there is a dearth of analysis on the efficacy of the monetary institutions in transition. This has led to inadequate literature on the efficiency of transition economies. Much information is available that aims at revealing factors that influence the financial performance of banking institutions. In many cases, “bank profitability, is measured by the return on assets (ROA) and/or the return on equity (ROE), is typically expressed as a function of internal and external determinants” (Allen & David, 1997, p. 56). Thus, this literature review seeks to determine the factors that affect the efficiency of the financial institutions in the UAE.
According to Forslund and Hjalmarsson, “efficiency refers to a statement of the performance of processes that transform a set of inputs into a set of outputs which determine bank efficiency” (Forsund & Hjalmarsson, 1974, p. 89). Indeed, efficiency involves the comparison of a financial component against a standard component. Technical efficiency refers to the changing material inputs like services of personnel and equipment into outputs comparative to best practice. This implies that the current technology prevents the misuse of inputs at all in producing the specified amount of output. A best practice firm should have 100 percent technical effectiveness. A company whose efficiency is below 100 percent is partially efficient. Administrative practices and the level or magnitude of functions influence technical effectiveness. Essentially, Data Envelopment Analysis assists in recognizing yardsticks for which monetary institutions can aim their performance (Hu, Su, & Chen, 2008, p. 84). Firms that are not well organized can embrace the operations of the efficient companies that are on the well-organized frontier by applying the best input and output combination. The best practices of well-organized firms if adopted can reorganize the unproductive company’s management and operations to advance its performance. This analysis assists in understanding the nature of a company’s efficiency; hence, it offers important guidelines for studying the determinants of UAE monetary efficiency.
Hossein and Lamia compared the efficiency of the monetary institutions in the UAE with those established in the Gulf Cooperation Council (GCC). The study was carried out from 2000-2005, and it involved the assessment of how efficient Islamic financial institutions are compared to conventional banks. The study employed non-parametric methodologies and productivity index in measuring the effectiveness of the banks. According to the findings of this study, banks operating in the GCC demonstrated comparable levels of effectiveness. Financial institutions operating in Kuwait and Qatar were more efficient than the UAE were. On the other hand, the UAE banks proved to be more effective and productive than the rest of the GCC banks. The bank of Dubai followed by Abu Dhabi bank was the most efficient commercial bank according to this study. During the analysis, UAE banks registered a remarkable level of effectiveness of 4 percent, but the GCC banks showed a decline of effectiveness of similar magnitude. The UAE banks performed well in both technical pure efficacies; however, they were weak in the scale of effectiveness. The legal framework in which these financial institutions operated influenced their level of growth and efficiency. The efficacy of the GCC banks fluctuated because they rely much on the oil proceeds, which are not stable due to the unstable oil prices. “While previous studies have consistently shown the higher efficiency of GCC Islamic banks over their conventional counterparts, this analysis shows inconclusive results concerning the comparative numerical efficiencies of Islamic versus conventional banks at both the UAE and the GCC levels” (Hossein & Lamia, 2010).
Khalid assessed the performance of the Saudi Arabian monetary sector in 2007. He used the Data Envelopment Analysis (DEA) as a key tool for examining the efficacy of the banks in this country. “Data Envelopment Analysis is a linear programming model that measures the efficiency of Decision Making Units (DMUs) in multiple-inputs and multiple-outputs setting” (Khalid, 2010, p. 53). The results indicated that Saudi financial organizations were generally thorough in managing their fiscal resources. “The empirical results revealed that the mean efficiency of the Saudi Arabian banks during the year 2007 was 86.17 percent and 93.9 percent as per Charnes–Cooper–Rhodes (CCR) and Benefit-Cost Ratio (BCR) approach respectively” (Khalid, 2010, p. 57). “Benefit-cost ratios (BCR) indicate the connection between potential profit and expenses, both quantitative and qualitative, of undertaking new projects or replacing old ones” (Khalid, 2010, p. 55). “In the DEA approach, previously formulated by Charnes, Cooper, and Rhodes (CCR), effectiveness is defined as a weighted sum of outputs to a weighted sum of inputs, where the weights structure is calculated using mathematical programming and constant returns to scale (CRS) are assumed” (Khalid, 2010, p. 55). Thus, it is imperative to perform a similar analysis in the UAE to determine how its monetary sector has performed in the recent financial years.
Casu and Girradone conducted a frontier efficacy investigation of some monetary firms operating in Italy. The survey aimed at giving an in-depth evaluation of the experiential estimations of bank efficacy. The survey findings demonstrated that various approaches to assessing efficiency do not automatically yield dependable results. For instance, the impact of amalgamations on profit effectiveness has not given consistent results. In some cases, mergers led to the profitability of the financial institutions, while in some situations it led to significant losses (Casu & Girardone, 2002, pp. 3-20). In general, depository monetary firms such as banks and credit unions analyzed in this study registered approximately 77 percent. The resemblance in average effectiveness for financial institutions across various frontier models did not have any significant difference with the positions of individual companies by their effectiveness levels across models. “This suggests that estimates of mean efficiency for an industry may be a more reliable guide for research purposes than are estimated efficiency rankings of firms and that analysis of the causes or correlates of efficiency should be viewed with caution” (Casu & Girardone, 2002, pp. 2-19). Although this study applied multiple approaches in analyzing the effectiveness of monetary firms, it lacked information on the issues that affect the effectiveness of monetary institutions.
Hussein attempted to find out the primary factors that determine the success of the Islamic banks operating in the UAE as compared to the commercial banks in that region. This study took place from 1996 to 2008, and it applied a regression model that involved the application of both the return on equity (ROE) method of analysis and the return on assets (ROA) approach. The outcome of the analysis revealed that the level of a bank’s cash flow and concentration mainly influenced the effectiveness of the performance of national monetary firms. On the other hand, the operation costs and the number of outlets were the primary factors that affected the success of Islamic banks. In the UAE, the favorable operation costs of Islamic banking have influenced some conventional banks both national and international to shift to Islamic banking to remain competitive and profitable (Hussein, 2008, pp. 16-23).
In 2004, Fatima and Hassan measured the efficacy of the UAE monetary firms and identified the factors influencing their success. Their descriptive examination of the UAE monetary segment indicates that it is vibrant and greatly advanced in organization and size and it uses sophisticated banking technology. The government bolsters the UAE monetary sector and this has enabled it to maintain a high standard of effectiveness. For instance, the government uses the vast resources of the UAE to support the monetary sector when it faces losses. The success of the UAE monetary segment is also due to the absence of serious competition since foreign banks have not fully infiltrated the UAE market. Nonetheless, “the empirical results of efficiency measures indicate that the UAE banks’ overall average of cost efficiency is quite low as compared to those of the developed countries” (Fatima & Hassan, 2004, p. 35). The outcome further revealed that the government’s influence and investment in the monetary sector negatively affect the monetary sector. Lastly, “the results indicate that the UAE banks can use their input resources more efficiently when they have more branches and that newer banks are performing better than older banks on average” (Fatima & Hassan, 2004, pp. 38-39). A similar assessment was done in, China and it gave comparable outcomes. Lee, Cheah, and Koay examined the technical effectiveness of monetary institutions in Malaysia in 2001-2005 (Lee, Cheah, & Koay, 2011, p. 17). Their assessment revealed that newly created private banks in Malaysia were more technically effective than government-owned conventional banks. The outcome was comparable to another analysis by Roman and Anita who found out that government-owned banks demonstrated low effectiveness than the private and foreign banks (Roman & Anita, 2004, p. 234). The study recommended that Malaysia should reorganize its local banking activities in readiness for an international competition because the banking industry is becoming more dynamic. However, the study fails to give suggestions for bridging the structural gaps witnessed in the monetary sector of the UAE.
Enur and Arzu applied the DEA methodology in gauging the level of efficacy of conventional national monetary institutions that operate in countries with transition economies like Chile, Mexico, Thailand, Indonesia, and Malaysia among others. They also aimed at finding out how policies influence the operations of national banks. The survey indicated that banks that command a huge market share are more effective compared to those that target small markets. They also revealed that financial institutions operating in nations with vibrant economies tend to be more efficient since they are able to get more deposits that enable them to have steady liquidity. “The study revealed that while privatization of state-owned enterprises, enterprise competition, and corporate governance-related improvements are important in boosting commercial bank efficiency, the securities market and non-bank financial institutions development hinders the efficiency of banks” (Enur & Arzu, 2006, p. 481). The management practices and policy goals of a given financial institution affect its capacity to excel in its monetary activities. “This survey reveals some of the efficiency determinants that the UAE financial organizations are likely to experience; they include the level of liquidity, credit risk, capital adequacy, operating expenses management, and bank size” (Enur & Arzu, 2006, pp. 483-485). Internal determinants of financial success are greatly affected by the management practices of a financial institution. Management decisions automatically determine the operating outcomes of monetary institutions. Outstanding management practices culminate into the good performance of a given financial institution. Nonetheless, it is not very easy to examine administration quality directly. Indeed, it is presumed that good management practices would be revealed by the operating performance. Consequently, it is not strange to scrutinize the fiscal performance of a bank by assessing the monetary variables established in its financial statements such as the balance sheet and revenue reports. Balance sheet records are common pointers of the revenue generation capacity and the cost of financial institutions. “The determinants that receive the most attention in the banking literature are costs, asset, and liability composition” (Enur & Arzu, 2006, p. 486). The capital ratio is one of the primary instruments for gauging the bank costs and external determinants mainly involve the microeconomic arena within which a given monetary institution operates.
Finally, the recent international monetary crisis had serious ramifications that the UAE monetary institutions had to grapple with. Maher and Jemma did a comparative assessment of how Islamic banks and national financial institutions operated during the crisis (Maher & Jemma, 2010, pp. 12-29). Specifically, they scrutinized how the crisis influenced productivity and asset development in various countries that have these two categories of banks. The study showed that the financial crisis had varying effects on these two financial institutions. Islamic banks were able to mitigate the ramifications of the crisis while the conventional banks were the hardest hit. In particular, the Islamic banks remained stable since they adhered to the Islamic banking guidelines that barred them from venturing into some of the investment schemes that led to serious losses among conventional banks. Therefore, the global monetary crisis acted as a litmus paper for testing the efficiency and resilience of Islamic banks. The crisis revealed the urgent need to solve important constraints in the Islamic Banking services. The crisis has further led to the greater acknowledgment of the significance of liquidity perils, and the necessity for a well-organized bank resolution structure. Therefore, creating a properly performing liquidity administration system is a key priority. Moreover, controllers and quality managers for Islamic Banks should make sure that the decision-making and lawful infrastructure, as well as for bank decree, remain pertinent to the fast altering Islamic monetary landscape and international developments. Improvement initiatives, in this case, should be in line with the worldwide restructuring program. Better convergence and coordination of guidelines and products are required to enhance a well-organized and sustainable development of the banking sector.
The above literature review demonstrates that the efficiency of each bank outlet and the effectiveness of the daily banking process determine the general effectiveness of conventional firms. Thus, a bank that is aiming at attaining a high level of overall efficiency should first ensure that the sub-factors are well coordinated. The effectiveness indicators are in service proceeds per division, spread per local office, deposit per outlet, and advances per outlet (Nageshwar & Shefali, 2008, pp. 74-89). The branches operating in remote areas can produce better outcomes if they are properly structured. The streamlining of the banks should focus on mitigating the overall operation costs to boost the productivity of national banks. The managers of conventional banks can encourage their staff to go for early retirement as a way of minimizing operation costs. Adoption of the current banking and computer technology can significantly improve the competence of the bank personnel. National banks should avoid creating several outlets because they lead to high operating expenses. Consequently, “it is a matter of vital importance for bank managers, bank regulators, and the Central Bank authority of the UAE to get full information about the bank’s economic efficiencies” (Chang & Chiu, 2006, p. 634). This is because ineffective banks are likely to make serious losses, which may make them less competitive in the already saturated banking industry. The effectiveness of the monetary institutions also influences the development of the economy (Ashish & Sunil, 2012, p. 102). In other words, if banks are ineffective, the economy tends to perform poorly. Lastly, it is worth noting that effective banks are the only ones that can cope with the ever-increasing competition in the global financial arena.
Personal Contribution
I have contributed to this research by examining various publications and research works on the primary determinants that are likely to influence the efficacy of various financial institutions based in the UAE. Most of the publications reviewed in this study have focused on the efficiency determinants that affect the financial institutions in both developed and developing countries. This has enabled me to identify several gaps in various articles that describe financial efficacy; hence, I have made informed recommendations that can be applied by UAE monetary institutions to realize better efficiency in their financial operations. Therefore, I contend that mitigation of expenses enhances the performance profile of many monetary firms because it improves the amount of revenue that a given bank can realize. Proficient cost administration is a precondition for the increased productivity of the monetary system. This implies that if banks adopt better management strategies then they stand better chances of realizing good profit margins. Reducing the charges for deposits can improve operational effectiveness. This cost can possibly be mitigated by reorganizing the deposit mix or by increasing the number of cheap deposits in overall deposits.
References
Ashish, K, & Sunil, K. (2012). A Study of Efficiency of Public Sector Banks in India. International Journal of Management Sciences, 1(2), 102.
Casu, B, & Girardone, C. (2002). A cmparative study of the cost efficiency of Italian bank conglomerates. Managerial Finance, 28(9), 3-20.
Chang, T.-C, & Chiu, Y.-H. (2006). Affecting Factors on Risk-Adjustments Efficiency in Taiwan’s Banking Industry. Contemporary Economic Policy, 24(4), 634.
Enur, G, & Arzu, T. (2006). Efficiency Analysis of the Turkish Banking Sector in Precrisis Perido: A DEA Approach. Contemporary Economic Policy, 24(3), 481.
Fatima, A. S, & Hassan, A. (2004). Measuring and Explaining the Efficiencies of the United Arab Emirates Banking System. Journal of Banking & Finance, 6(13), 34- 46.
Forsund, R, & Hjalmarsson, L. (1974). On the measurement of productive efficiency. Swedish Journal of Economics, 6(2), 141-154.
Hossein, K, & Lamia, O. (2010). An Analysis of Productivity Change: are UAE Banks Operating Efficiently When Compared to GCC Banks? Academy of Banking Studies Journal, 9(1), 13-36.
Hussein, A. (2008). Factors Influencing Performnace 3 of the UAE Islamic and Conventional National Banks. Journal of Financial Management and Analysis, 6(8), 14-34.
Hu, J.-L, Su, Y.-Y, & Chen, C.-P. (2008). Efficiency of Nationwide Banks in China. Journal of American Academy of Business, 13(2), 84.
Khalid, A. (2010). Are Saudi Banks Efficient? Evidence Using Data Envelopment Analysis (DEA). International Journal of Economics and Finance, 2(2), 53-57.
Lee, H. Y, Cheah, T. E, & Koay, Y. L. (2011). Efficiency in the Malaysian Banking Industry. ASEAN Economic Bulletin, 18(1), 6-44.
Maher, H., & Jemma, D. (2010). The Effects of the Global Crisis on Islamic and Conventional Banks: A Comparative Study. Journal of Services Research, 3(1), 12-29.
Nageshwar, R, & Shefali, T. (2008). A Study of the Factors Affecting Efficieny of Public Sector Banks. Journal of Services Research, 8(2), 74-89.
Roman, M, & Anita, T. (2004). Efficiency in Banking: Empirical Evidence from the Czech Republic. Economics of Planning, 37(1), 225–244.