Annals of Operations Research

https://doi.org/10.1007/s10479-020-03879-z

S.I.: BUSINESS ANALYTICS AND OPERATIONS RESEARCH

Stochastic efficiencies of network production systems

with correlated stochastic data: the case of Taiwanese
commercial banks

Chiang Kao1 · Shiang-Tai Liu2

Accepted: 13 November 2020

© Springer Science+Business Media, LLC, part of Springer Nature 2021

Abstract
Although the business environment is stochastic, deterministic data envelopment analysis
(DEA) models are typically used to measure the efficiency of commercial banks for the
purpose of simplicity. Bank operations are characterized by a network structure due to the
dual role of deposits, which, on the one hand, are the output of the process of borrowing
funds from depositors and, on the other hand, are the input of the process of making loans.
Since the outputs of the production process of the bank are correlated with its inputs, the
model for measuring efficiency in this case is a stochastic program with correlated data.
To take the correlation between the inputs and outputs into consideration, in this paper, a
standard normal transformation is applied for the correlated data, and a network stochastic
model is developed to obtain the distribution of the stochastic efficiency. The model is used
to measure the efficiency of twenty-two commercial banks in Taiwan. The results are more
reliable, discriminative, and informative than those obtained from the existing models. They
also show that the performance of a bank is mainly affected by its loan performance. Different
from the stereotype suggesting that private companies usually operate more efficiently than
state-owned companies, public banks perform better than private banks in Taiwan.

Keywords Data envelopment analysis · Network system · Stochastic data · Banks

1 Introduction

Business is full of complexity and uncertainty. Using the same effort as made in the previous
year does not ensure that a company will have the same sales in the present year. The
banking industry is no exception. There are many uncontrollable factors that will affect bank

B Shiang-Tai Liu
stliu@vnu.edu.tw
Chiang Kao
ckao@mail.ncku.edu.tw
1 Department of Industrial and Information Management, National Cheng Kung University, Tainan,
Taiwan
2 Graduate School of Business and Management, Vanung University, Zhongli District, Taoyuan, Taiwan

123
 Annals of Operations Research

operations. In addition, the collected data is often snapshot observations, and if it is collected
a little earlier or later, the values may be different. The inputs and outputs of a bank over a
period of time are thus stochastic variables. Another situation is that the performance of a
bank in the next year must be predicted (Kao and Liu 2004), where operations have not yet
begun. In this case, the quantity of the inputs that will be used and the quantity of the outputs
that will be produced are not known and must be predicted, and they are thus also stochastic
variables.
In addition to stochasticity, another issue of concern in efficiency measurement is the
effects of the detailed operations that make up the overall operations of a bank. The overall
operation of a bank is composed of several specific operations interrelated with each other.
The way that these specific operations are related also affects bank performance. Most of
the studies on the performance appraisal of banks look at the overall operation, ignoring
individual operations. This will overstate the efficiency of the bank (Kao and Liu 2009) and,
in some cases, will produce misleading results (Kao 2017). The objective of this paper is to
measure the performance of Taiwanese commercial banks, taking the internal operations of
banks and the stochastic nature of such operations into consideration.

1.1 Bank performance measurement

To measure the performance of banks, the data envelopment analysis (DEA) approach, devel-
oped in Charnes et al. (1978) and Banker et al. (1984), is widely applied [see, for example,
Berger and Humphrey (1997), Fethi and Pasiousas (2010), and Paradi and Zhu (2013), Wang
(2015), Puri et al. (2017), Simper et al. (2017), Ouenniche and Carrales (2018), Tziogkidis
et al. (2018), Zervopoulos et al. (2019), Dutta et al. (2020) and Galariotis et al. (2020)].
This approach measures the relative efficiency of a set of production units, or more generally
decision making units (DMUs), which applies multiple inputs to produce multiple outputs in
the most favorable way and is thus widely accepted by the DMUs to be assessed. According
to a survey conducted by Liu et al. (2013), banking is the largest area of DEA applications.
Several approaches have been proposed to deal with the randomness of the observations
in efficiency measurement, among which the stochastic frontier analysis (SFA) proposed in
Aigner et al. (1977) and Meeusen and van den Broeck (1977), is probably the most typical
approach. The idea is based on a regression analysis, where the dependent variable, an output,
is assumed to be affected by random effects, such as measurement errors, simple noise, and
specification errors. Many studies have applied this approach to measure the efficiency of
banks (Lampe and Hilgers 2015). This approach is a parametric approach in that a functional
form must be specified for the production or cost function. Mistakenly specified functional
forms lead to erroneous efficiency measures, and the regression-type analysis used in this
approach only allows for one dependent variable to be stochastic. The independent variables,
which mostly are input factors, are assumed to have deterministic values. This approach was
extended by Kuosmanen and Kortelainen (2012) to a stochastic semi-parametric approach,
where the functional form need not be specified. It was used by Eskelinen and Kuosmanen
(2013) to measure the efficiency of twenty-two branches of the Helsinki OP Bank. The
independent variables, however, were still assumed to be deterministic.
Another common approach for dealing with stochastic data is chance-constrained pro-
gramming (Cooper et al. 2002; Land et al. 1993; Olesen and Petersen 1995). Due to the
stochastic characteristic of the data, the constraints in the DEA multiplier model, which
require the aggregate output to be less than or equal to the aggregate input, only need to
be satisfied with specified probabilities. The obtained efficiencies are expected values, and

123
Annals of Operations Research

different specified probabilities produce different efficiencies. Chen (2002) used a sample
of thirty-nine Taiwanese banks to compare the chance-constrained approach and the SFA
approach. The results were significantly different. Olesen and Petersen (2016) conducted
a comprehensive review of the stochastic DEA, focusing on the semi-parametric SFA and
chance-constrained DEA.
In its early stages of development, DEA was criticized for its lack of statistical properties
(Greene 1993; Schmidt 1985). Banker (1993) laid the statistical foundation for DEA by
showing that the DEA estimators are also maximum likelihood estimators under certain
conditions. Gijbels et al. (1999) and Kneip et al. (1998) derived the asymptotic distribution
of the DEA estimators. Simar and Wilson (1998, 2000) developed a model to approximate
sample distributions using bootstrapping procedures to allow for inferences on the estimated
efficiency scores. These studies showed that the DEA approach has basic statistical properties.
The simplest way to deal with stochastic data is to use the expected data, in the form of
the average of several years, to measure efficiency via conventional DEA models. However,
this method will overstate efficiencies, as illustrated by an example in Kao and Liu (2009).
In addition, similar to the chance-constrained DEA, the results are single-valued efficiencies,
without distribution information. An advanced method is to use the interval, instead of the
average, of the observations collected in a period of time to measure efficiency (Kao and Liu
2004). The results show the interval in which the efficiencies fall. The distribution, however, is
still unknown. Kao and Liu (2009) proposed a stochastic programming approach to obtain an
efficiency distribution. This approach treats the input and output observations of all DMUs as
random variables. By randomly generating a set of variates from their respective distributions,
an instance of efficiency score can be calculated. Repeating this procedure a sufficient number
of times yields the distribution of the efficiency. The input and output variables of each DMU
are assumed to be independent in Kao and Liu (2009). This is obviously unrealistic because
DEA requires isotonicity, which implies that the outputs are correlated with the inputs.
Ignoring this correlation will produce misleading results. To amend this deficiency, Kao and
Liu (2019) allowed the input and output variables to be correlated and transformed them into
a standard normal random variable. The resulting stochastic program was then solved via a
simulation technique.

1.2 Efficiency decomposition

The study of Kao and Liu (2019) emphasized the overall operation of the commercial banks,
ignoring the detailed operations. In reality, a system is usually composed of several inter-
dependent divisions that perform different operations. The division of such operations must
be considered to make it possible to obtain reliable results (Kao 2017). The study of the
influence of the division of operations on the performance of a banking system was initiated
by Seiford and Zhu (1999), in that the functions of the US commercial banks were separated
into profitability and marketability. The two functions were connected in series. A similar
idea was applied to measure the efficiency of US mutual fund families, where the overall
efficiency was an aggregation of the efficiencies of the operation management function and
the portfolio management function (Premachandra et al. 2012). Other network structures
have also been applied to investigate the efficiency of banks. According to Lozano (2016),
there are at least twelve network structures that have appeared in the banking literature.
In a network system, it is expected that there is a relationship between the system and divi-
sion efficiencies. In studying the efficiency of nonlife insurance companies, Kao and Hwang
(2008) found that the efficiency of a two-division system can be decomposed into the product

123
 Annals of Operations Research

Fig. 1 Structure of general

network systems

of that of each of the two divisions. Kao (2009) proposed an idea of system transformation
that can decompose the system efficiency into the division efficiencies with specific mathe-
matical relationships. The merit of efficiency decomposition is that a relationship between
the system and division efficiencies is obtained, based on which the division that affects
the performance of the entire system the most can be identified. Making improvements to
this division will improve the performance of the system most effectively. This idea of effi-
ciency decomposition, however, works only for deterministic cases. When the observations
are stochastic variables with multivariate normal distributions, they can be transformed into
a variable with a standard normal distribution (Kao and Liu 2019). The appearance of the
stochastic variables destroys the mathematical structure for efficiency decomposition pro-
posed in Kao (2009), and another method for efficiency decomposition must be devised. The
objective of this paper is to develop a model to measure the efficiency of the commercial
banks that have several divisions performing specific operations. This model is able to handle
stochastic data and decompose the overall efficiency of the system into division efficiencies
with a specific mathematical relationship.
In the following sections, we firstly develop a model that is able to measure the efficien-
cies of a network system and the component divisions when the observations are correlated
stochastic variables. A relationship between the system and division efficiencies is also
derived. Secondly, we describe commercial bank operations in Taiwan, with the inputs and
outputs specified. Thirdly, we use the model to measure the efficiency of twenty-two com-
mercial banks in Taiwan based on the data for the period 2010–2017. Some findings are
explored and discussed. Finally, some conclusions are drawn based on the discussions in the
preceding sections.

2 Efficiency measurement with correlated stochastic data

Consider a general network system composed of q divisions where each division p applies
inputs X i , i ∈ I p supplied from the outside and intermediate products Z f , f ∈ M p produced
by other divisions to produce outputs Yr , r ∈ O p to send out of the system and intermediate
products Z g , g ∈ N p for other divisions to use, as expressed in Fig. 1. Sets I p , M p , O p ,
and N p contain the indices of the exogenous inputs X i , endogenous inputs Z f , exogenous
outputs Yr , and endogenous outputs Z g , respectively, for Division  p. In total, there are m
q
inputs, s outputs, and h intermediate products in the system, that is, p1 I p  {1, . . . , m},
q q q
p1 O p  {1, . . . , s}, and p1 M p  p1 N p  {1, . . . , h}. Note that the intermediate
q
products produced in the system, p1 N p , are the same as those consumed in the system,
q
p1 M p .

123
Annals of Operations Research

The conventional radial model for measuring the relative efficiency of DMU k in a set of
n DMUs under variable returns to scale is (Kao 2017):
q 
u 0 + p1 r∈O p u r Yrk
E kS  max q 
p1 i∈I p vi X ik
q  
q 
s.t. u0 + u r Yr j − vi X i j ≤ 0, j  1, . . . , n
p1 r ∈O p
 p1 i∈I p

( p)  
u0 + u r Yr j + wg Z g j
 r ∈O p g∈N p
 (1)
 
− vi X i j + w f Z f j ≤ 0, p  1, . . . , q; j  1, . . . , n
i∈I p f ∈M p
q
( p)
u0  u0
p1
u r , vi , w f , wg ≥ 0 r  1, . . . , s; i  1, . . . , m; f  g  1, . . . , h
( p)
u 0 , u 0 , p  1, . . . , q unrestricted in sign.

If the production technology is assumed to have constant returns to scale, then one
( p)
simply delete the intercepts u 0 and u 0 , p  1, …, q. The objective function is a linear
fractional, which can be linearized by setting the denominator to one,as a constraint,
 and
q
leaving the numerator as the objective function. That is, “max. u 0 + p1 r ∈O p u r Yr k ,
q 
with p1 i∈I p vi X ik  1” (Charnes and Cooper 1962).
The first set of constraints in Model (1) corresponds to the system and the second set of
constraints corresponds to the q divisions. Since the system constraint is the sum of the q
division constraints for each DMU j, it is redundant and can be deleted. At optimality, the
( p)
system efficiency E kS and the q division efficiencies E k , p  1, …, q are calculated as:
q 
u ∗0 + p1 r ∈O p u r∗ Yr k
E kS  q  ∗
p1 i∈I p vi X ik
( p)∗  
( p)
u 0 + r ∈O p u r∗ Yr k + g∈N p wg∗ Z gk
Ek   ∗
 ∗ , p  1, . . . , q, (2)
i∈I p vi X ik + f ∈M p w f Z f k

where the asterisk “*” denotes an optimal solution.

( p)
Let skS and sk be the slack variables associated with the system and pth division constraints
for DMU k in Model (1), respectively. That is:


q  
q 
u0 + u r Yr k − vi X ik + skS
p 1 r ∈O p p 1 i ∈I p

0
⎛ ⎞ ⎛ ⎞
   
⎝u ( p) + u r Yr k + wg Z gk ⎠ − ⎝ vi X ik + w f Z f k ⎠ + sk
( p)
0
r ∈O p g∈N p i∈I p f ∈M p

 0, p  1, . . . , q.

123
 Annals of Operations Research

q ( p)
Since the system constraint is the sum of the q division constraints, we have p1 sk 
( p)
skS .
According to the expression of and E kS
in Expression (2), we have Ek
⎛ ⎞

q
( p) ⎝
  q 
1 − Ek ∗
vi X ik + ∗ ⎠
w f Z f k  1 − Ek S
vi∗ X ik  1 − E kS ,
p1 i∈I p f ∈M p p1 i∈I p
(3)
q 
where the last equality is due to the constraint of p1 i∈I p vi X ik  1 obtained from the
linear transformation of the objective function of Model (1). In this expression, the system
( p)
inefficiency score (1 − E kS ) is a linear combination of the q division inefficiencies (1 − E k ),
p  1, …, q.
Equation (3) can also be expressed as:
⎛ ⎞
q  q   
q
w ∗f Z f k + Ek ⎝ vi∗ X ik + w ∗f Z f k ⎠  αk +
( p) ( p) ( p)
E kS  − βk E k ,
p1 f ∈M p p1 i∈I p f ∈M p p1
(4)
q   
w ∗f Z f k and βk vi∗ X ik + w ∗f Z f k . That is,
( p)
where αk  − p1 f ∈M p  i∈I p f ∈M p
( p)
the system efficiency E kS is a linear combination of the division efficiencies E k , p  1, …,
 ( p)
q adjusted by a negative constant αk . In addition, since f ∈M p w f Z f k ≥ 0 and E k ≤ 1,
Eq. (4) implies:


q  
q  
q 
w ∗f Z f k + vi∗ X ik + w ∗f Z f k
( p) ( p)
E kS  − Ek Ek
p1 f ∈M p p1 i∈I p p1 f ∈M p


q 
vi∗ X ik ,
( p)
≤ Ek
p1 i∈I p

which states that the system efficiency is less than or equal to a weighted average of the q
division efficiencies.
When inputs X i , outputs Yr , and intermediate products Z f are stochastic variables, Model
(1) becomes a stochastic program. If all stochastic variables are assumed to be independent,
then a straightforward simulation can be conducted by generating a set of random variates
from the distributions of the stochastic variables and applying the conventional DEA models
to calculate efficiency, as was done in Kao and Liu (2009). However, since the inputs and
outputs of a production process are normally correlated, assuming them to be independent
will lead to misleading results (Kao and Liu 2019), and a stochastic model that is able to
handle correlated data must thus be developed.
Suppose X i , Yr , Z f , and Z g for each DMU j have a multivariate normal distribution. Let
⎛ ⎞ ⎛ ⎞
   
R  ⎝u + wg Z g j ⎠ − ⎝ w f Z f j⎠
( p) ( p)
j 0 u r Yr j + vi X i j +
r ∈O p g∈N p i∈I p f ∈M p

≤ 0, p  1, . . . , q.

Then, based on the central limit theorem, the random variables

123
Annals of Operations Research


( p) ( p)
Rj − E Rj
( p)
ζj    , p  1, . . . , q
( p)
Var R j

have a standard normal distribution. Denote μiXj  E[X i j ], μrYj  E[Yr j ], μ Zf j  E[Z f j ],
and μgZj  E[Z g j ]. We have
⎛ ⎞ ⎛ ⎞
    
 ⎝u 0 + wg μgZj ⎠ − ⎝ w f μ Zf j ⎠
( p) ( p)
E Rj u r μrYj + vi μiXj +
r ∈O p g∈N p i∈I p f ∈M p
    
( p)
Var R j  u r u b Cov[Yr j , Ybj ] + u r wg Cov[Yr j , Z g j ]
r ∈O p b∈O p r ∈O p g∈N p
   
− u r vi Cov[Yr j , X i j ] − u r w f Cov[Yr j , Z f j ]
r ∈O p i∈I p r ∈O p f ∈M p
   
+ wg wc Cov[Z g j , Z cj ] − wg vi Cov[Z g j , X i j ]
g∈N p c∈N p g∈N p i∈I p
  
− wg w f Cov[Z g j , Z f j ] + vi va Cov[X i j , X a j ]
g∈N p f ∈M p i∈I p a∈I p
   
vi w f Cov[X i j , Z f j ] + w f wd Cov[Z f j , Z d j ]
i∈I p f ∈M p f ∈M p d∈M p

Note that the covariance of two variables that are the same is the variance of this variable,
for example, Cov[X i , X i ]  Var[X i ].
( p)
Subtracting both sides of each of the division constraints in Model (1) by E[R j ] and

( p)
dividing by Var[R j ] produces the following constraint:

( p)    
− u 0 + r ∈O p u r μrYj + g∈N p wg μgZj − i∈I p
vi μi
X +
j f ∈M p
w f μ Z
f j
( p)
ζj ≤   ,
( p)
Var R j

which is equivalent to
 ⎛ ⎞ ⎛ ⎞
    
Var R j + ⎝u 0 + wg μg j ⎠ − ⎝ w f μ f j ⎠ ≤ 0.
( p) ( p) ( p)
ζj u r μr j +
Y Z
vi μi j +
X Z

r ∈O p g∈N p i∈I p f ∈M p
(5)
Adding the constraints corresponding to the q divisions together, one gets:
 ⎛ ⎞
 q  
q  
q 
+ ⎝u 0 + u r μrYj ⎠ −
( p) ( p)
ζ Var R
j j vi μiXj ≤ 0. (6)
p1 p1 r ∈O p p1 i∈I p

The two sets of constraints associated with the multivariate normal random variables X i ,
Yr , and Z f in Model (1) are transformed into the constraints associated with the standard
( p)
normal random variable ζ j , p  1, …, q as expressed in constraint sets (5) and (6).
Constraint (6) can also be expressed as:
123
 Annals of Operations Research

 
q ( p) ( p) q 
p1 ζ j Var R j + u 0 + p1 r ∈O p u r μrYj
q  ≤ 1,
i∈I p vi μi j
X
p1

where the left-hand side is the system efficiency. Combining these, we have transformed
the stochastic program with correlated variables into the following one with independent
standard normal random variables that can be used to calculate the efficiency of DMU k:
 
q ( p) ( p) q 
p1 ζk Var u r μrk
Rk + u0 + Y
p1 r∈O p
ekS  max q 
i∈I p vi μik
X
 p1 
  
( p) ( p) ( p)
s.t. ζj Var R j + u 0 + u r μrYj + wg μgZj
r ∈O p
  g∈N p
  (7)
− vi μi j +
X w f μ f j ≤ 0, p  1, . . . , q,
Z j  1, . . . , n
i∈I p f ∈M p
q
( p)
u0  u0
p1
u r , vi , w f , wg ≥ 0, r  1, . . . , s; i  1, . . . , m; f  g  1, . . . , h
( p)
u 0 , u 0 , p  1, . . . , q unrestricted in sign.
Here the redundant system constraints have been deleted for simplicity.
By applying the variable substitution technique proposed in Charnes and Cooper (1962),
Model (7) can be transformed into the following mathematical program:
  
q  
q 
( p) ( p)
ek  max
S ζk Var Rk + u 0 + u r μr k
Y
p1 p1 r ∈O p
q 
s.t. vi μik
X 1
p1 i∈I p
  
  
( p) ( p) ( p)
ζj Var Rj + u0 + u r μrYj + wg μgZj
r ∈O p
  g∈N p (8)
 
− vi μiXj + w f μ Zf j ≤ 0, p  1, . . . , q, j  1, . . . , n
i∈I p f ∈M p
q
( p)
u0  u0
p1
u r , vi , w f , wg ≥ 0, r  1, . . . , s; i  1, . . . , m; f  g  1, . . . , h
( p)
u 0 , u 0 , p  1, . . . , q unrestricted in sign.

( p)
This model is a nonlinear program due to the nonlinear terms Var[R j ].
If the expected values and covariance values are not known, they can be estimated from
( p)
samples. Each time a set of standard normal random variates is generated for ζ j , p  1,
…, q, Model (8) is solved to obtain an instance of the system efficiency ekS for DMU k. At
optimality, the q division efficiencies are obtained at the same time, as:
 
( p)∗  
Var Rk + u 0 + r ∈O p u r∗ μrYk + g∈N p wg∗ μgk
( p) ( p)
ζk Z
( p)
ek   ∗ X
 ∗ Z
, p  1, . . . , q. (9)
i∈I p vi μik + f ∈M p w f μ f k

123
Annals of Operations Research

( p)
When comparing the stochastic efficiencies ek in Expression (9) with the deterministic
( p)
efficiencies E k in Expression (2), it can be observed that the only difference is that a random

( p) ( p)
term ζk Var[Rk ] appears in Expression (9) that disturbs the deterministic efficiencies.
( p) ( p) ( p)
The expectation of ek is equal to E k because the random variable ζk has a standard normal
distribution with mean zero. Repeating this simulation process for a sufficient number of times
( p)
produces distributions for the stochastic efficiencies. Since ζk is a standard normal random
( p)
variable, it is possible to generate a very negative value to make ek negative although the
( p)
chance is very low. From the definition of ζk , one will find that at least one Yr k or Z gk is
( p)
negative when ζk is negative, which is unreasonable. In this case, this replication is deleted,
and another replication is conducted to replace it.
The system efficiency in the stochastic case can also be decomposed into the division effi-
ciencies, similar to the deterministic case. According to Expression (4), the system efficiency
of the lth replication in the simulation analysis can be expressed as:

q
( p) ( p)
S
ekl  αkl + βkl ekl .
p1

( p)
Suppose Model (8) is conducted for t replications. The expected values for ekS , ek ,
( p) t ( p) t ( p) t ( p)
αk , and βk are ekS  l1 ekl /t, ek
S  l1 ekl /t, αk  l1 αkl /t, and βk 
t ( p) ( p)  t ( p) ( p)
l1 ekl βkl / l1 ekl , respectively. Note that βk (p  1, …, q) are weighted averages,
instead of simple arithmetic averages. In this case, the relationship where the system efficiency
is a linear combination of the division efficiencies adjusted by a constant still holds:

q
( p) ( p)
ekS  αk + βk ek . (10)
p1

In the next section, we construct a network structure to show the operations of commercial
banks in Taiwan, based on which a stochastic model is developed to measure efficiencies.

3 Taiwanese commercial banks

The general function of commercial banks is to lend money to business firms for operations
and to individuals for personal loans. In order to acquire money for lending, commercial
banks collect funds from the public in the form of deposits. As stated in the Banking Act of
the Republic of China (Taiwan), the principal function of commercial banks (in Taiwan) is
to accept deposits and extend loans (Financial Supervisory Commission 2019).
In the literature, different inputs and outputs have been used to measure bank performance
(Paradi and Zhu 2013). It should be noted that some factors, for example, deposits, were used
as inputs in some studies and as outputs in others. This confusion, in the opinion of Sealey
and Lindley (1977), is a direct result of the failure to analyze both the technical and economic
aspects of production of commercial banks. The technical production process is a process of
transformation that converts specific goods and services into other goods and services. This
transformation process involves the borrowing of funds from depositors and lending these
funds to borrowers. The production in the economic sense is the attempt to create a product
that is more highly valued than the original inputs. From this analysis, Sealey and Lindley
(1977) concluded that the commercial bank production process is a multistage production

123
 Annals of Operations Research

process involving intermediate outputs, where loanable funds, borrowed from depositors
and serviced by the bank with the use of capital, labor, and material inputs, are used in the
production of earning assets. This type of production is similar to that of a manufacturing
firm, where one production division produces an output that is used as an input for another
division.
The idea of Sealey and Lindley (1977) was developed into two popular approaches to
identifying inputs and outputs: production and intermediation approaches (Humphrey 1985).
The former views the bank as a production system such that the staff, equipment, and floor
space are used as the inputs to attract different types of deposits and loans as the outputs, while
the latter views banks as financial intermediaries, and the inputs and outputs are measured
in monetary terms. Based on these two approaches and the idea of Sealey and Lindley
(1977), Holod and Lewis (2011) proposed a two-stage network to describe the operation
of commercial banks. In the first stage, fixed assets and employees are utilized to produce
deposits under the production approach, where deposits are viewed as a service provided by
a bank to its customers. In the second stage, deposits are used to generate loans under the
intermediation approach, where banks are viewed as intermediaries that take deposits and
make loans. Letting deposits play the dual role of output of the deposit collection process
and input of the deposit utilization process solves the controversy of whether deposits should
be treated as input or output discussed in the literature.
In making loans, the Banking Act of Taiwan (Article 72) requires the total amount of
medium-term loans extended by a commercial bank to not exceed the balance of its time
deposits received. Accordingly, the deposits are differentiated as time deposits and demand
deposits, and the loans are separated into short-term loans (S-loans) and medium- and long-
term loans (ML-loans) in this study. S-loans refer to loans that mature within 1 year, and
ML-loans refer to those that mature after a longer period than 1 year. Excluding the profit
earned from making loans, service fees and commission income are the largest source of
revenue for banks in Taiwan. They are therefore adopted as an output of the first stage. In
making loans, selling and administration expenses, including advertisement, promotion, and
professional services, are incurred and are thus considered as an input of the second stage.
To summarize, the operation of a commercial bank in Taiwan has a two-division network
structure, as shown in Fig. 2, where Division 1 utilizes the inputs of assets (X 1 ) and labor
(X 2 ) to generate the output of service fees and commission income (Y1 ) and the intermediate
products of time deposits (Z 1 ) and demand deposits (Z 2 ) for Division 2 to use, and Division
2 uses the input of selling and administration expenses (X 3 ) and two intermediate products
produced by Division 1, time deposits (Z 1 ) and demand deposits (Z 2 ), to produce the outputs
of S-loans (Y2 ) and ML-loans (Y3 ).
After the Asian Financial Crisis in 1997, Taiwan’s government implemented two financial
restructurings, with the aim of stabilizing the financial market in Taiwan. The first restructur-
ing was launched in 2001, where many regulations were relaxed to give financial institutions
more flexibility in their operations. The second restructuring was initiated in 2004, where
mergers and acquisitions were encouraged in order to increase competitiveness among larger
banks. In 2010, twenty-two banks listed on the Taiwan Stock Exchange Corporation (TSEC)
remained. Table 1 shows the averages and standard deviations, in parentheses, of each factor
for the twenty-two banks over an eight-year period from 2010 to 2017. All numbers are in
million Taiwan dollars (1 USD ∼  30 Taiwan dollars). The banks marked with an asterisk “*”
are public, and there are only seven of this type. The average asset of each public bank is 9521
million Taiwan dollars, while it is 6120 million Taiwan dollars for each private bank. The
former is approximately 56% larger than the latter. The relatively small standard deviations
indicate that the observations during the 8 years are stable.

123
 Table 1 The means and standard deviations, in parentheses, of the inputs (X i ), intermediate products (Z f ), and outputs (Yr ) for the twenty-two Taiwanese commercial banks
from 2010 to 2017
Bank X1 X2 X3 Z1 Z2 Y1 Y2 Y3

1 Chang Hwa* 22,834 9617 3965 1,067,124 363,316 4466 330,262 893,805
(1415) (821) (586) (101,121) (61,098) (545) (34,905) (104,289)
2 King’s Town 2588 887 645 129,641 25,154 1247 30,104 84,466
(158) (57) (149) (14,022) (44,702) (485) (4712) (13,457)
Annals of Operations Research

3 Taichung 5817 2585 1566 331,850 107,916 1789 107,387 249,517

(2999) (613) (555) (65,957) (30,606) (508) (22,541) (47,119)
4 Taiwan Business* 14,052 7148 3373 839,653 301,288 2825 348,401 644,281
(237) (235) (626) (62,847) (55,350) (778) (76,080) (27,881)
5 Kaohsiung* 2636 1388 621 171,730 25,377 476 65,186 106,602
(375) (90) (96) (18,209) (4121) (56) (7127) (11,866)
6 KGI 6067 2626 1776 207,261 24,436 1328 43,987 122,269
(143) (739) (230) (106,663) (12,912) (219) (15,193) (79,134)
7 Union 7893 2896 2835 316,166 59,314 1835 79,111 164,932
(206) (345) (542) (45,320) (12,573) (531) (28,472) (20,996)
8 Far Eastern 2865 3493 2294 344,854 49,462 2718 64,551 243,945
(50) (396) (201) (34,078) (16,952) (511) (9414) (39,691)
9 Ta Chong 4038 3744 2139 282,512 50,992 2857 64,804 206,689
(1268) (226) (225) (24,356) (5164) (325) (10,023) (9455)
10 En Tie 1113 1872 1156 205,351 25,381 2041 39,449 151,359
(465) (188) (95) (18,314) (4641) (304) (2815) (7506)
11 Hua Nan* 28,535 10,750 5247 1,263,011 540,657 5824 427,455 1,005,642
(1202) (849) (923) (122,343) (72,169) (884) (33,486) (107,770)
12 Fu Bon 15,656 9634 6616 1,168,205 315,333 9811 331,382 812,963
(4839) (2104) (983) (212,014) (96,503) (1830) (81,981) (110,277)
13 Cathay 24,404 10,107 10,453 1,356,538 355,684 10,841 316,402 822,959
(1074) (2046) (3049) (170,981) (97,940) (3825) (91,825) (126,023)

123
 Table 1 continued
Bank X1 X2 X3 Z1 Z2 Y1 Y2 Y3

123
14 East Sun 20,545 7232 7453 913,899 332,273 9293 210,599 682,672
(5267) (2302) (2636) (188,316) (109,614) (4301) (62,408) (162,582)
15 Yuanta 3715 3328 2024 419,679 81,167 2028 93,262 324,872
(1924) (652) (399) (101,311) (24,378) (730) (19,137) (56,244)
16 Mega* 14,532 12,121 5704 1,341,474 599,822 7500 432,096 1,186,299
(482) (1025) (979) (209,625) (108,170) (857) (38,196) (158,602)
17 Taishin 18,660 9190 6247 746,706 184,093 8457 173,226 577,013
(2323) (1289) (719) (123,377) (48,566) (1546) (38,738) (112,685)
18 Shin Kong 6202 3756 2698 488,278 105,505 2723 98,016 346,850
(581) (551) (547) (78,750) (25,902) (511) (12,893) (58,058)
19 Sino Pac 9678 7715 4707 833,340 237,256 5192 211,372 599,778
(812) (576) (509) (65,418) (34,579) (711) (42,626) (30,179)
20 China Trust 40,481 22,733 28,006 1,592,133 483,691 17,139 421,574 1,142,803
(6619) (5135) (5060) (504,347) (172,676) (4389) (132,538) (354,871)
21 First* 26,302 11,460 5010 1,275,206 506,757 6327 441,671 1,010,427
(1543) (1110) (703) (86,472) (85,618) (1340) (26,629) (92,563)
22 Taiwan 36,937 14,162 5766 1,841,852 462,688 5251 387,921 1,532,330
Cooperative* (2367) (851) (814) (87,447) (73,625) (903) (38,194) (50,799)
Annals of Operations Research
Annals of Operations Research

Selling & Administration

expenses (X3)

Assets (X1) 1 Time deposits (Z1)

2 S-loans (Y2)
Deposit Deposit
Labor (X2) Collection Demand deposits (Z2) Utilization ML-loans (Y3)

Service fees &

commission income (Y1)
Fig. 2 Network structure of the operations of Taiwanese commercial banks

Table 2 Correlation coefficients Factors X 2 X3 Z1 Z2 Y1 Y2 Y3

among the eight factors
X1 0.9101 0.7327 0.9079 0.8261 0.7480 0.8335 0.8842
X2 0.8558 0.9213 0.8594 0.8619 0.8655 0.8976
X3 0.6586 0.5731 0.8998 0.5758 0.5824
Z1 0.9332 0.7589 0.9300 0.9820
Z2 0.7002 0.9596 0.9413
Y1 0.6831 0.6839
Y2 0.9246

Table 2 shows the correlation coefficients among the eight factors, including three inputs
(X i ), two intermediate products (Z f ), and three outputs (Yr ), of the twenty-two banks during
the eight years. It can be noted that most coefficients have a value greater than 0.7, indicating
a high correlation between these factors. The stochastic model developed in the preceding
section that is able to handle correlated data is thus needed.
Based on Model (8) and the network structure of Fig. 2, the stochastic model for measuring
the efficiency of Taiwanese commercial banks is:
    
(1) (1) (2) (2) 
ek  max ζk
S Var Rk + ζk Var Rk + u 0 + u 1 μ1k Y + u μY + u μY
2 2k 3 3k

s.t. v1 μ1k + v2 μ2k + v3 μ3k  1

X X X

(1) (1) (1)

ζj Var R j + u 0 + u 1 μ1Y j + w1 μ1Zj + w2 μ2Z j

− v1 μ1Xj + v2 μ2Xj ≤ 0, j  1, . . . , 22
  (11)
(2) (2) (2)
ζj Var R j + u 0 + u 2 μ2Y j + u 3 μ3Y j

− v3 μ3Xj + w1 μ1Zj + w2 μ2Z j ≤ 0, j  1, . . . , 22

(1) (2)
u0  u0 + u0
u 1 , u 2 , u 3 , v1 , v2 , v3 , w1 , w2 ≥0
(1) (2)
u 0 , u 0 , u 0 unrestricted in sign,
where

(1)
Var R j  u 21 Var[Y1 j ] + u 1 w1 Cov[Y1 j , Z 1 j ] + u 1 w2 Cov[Y1 j , Z 2 j ]

123
 Annals of Operations Research

− u 1 v1 Cov[Y1 j , X 1 j ] − u 1 v2 Cov[Y1 j , X 2 j ]
+ w12 Var[Z 1 j ] + w1 w2 Cov[Z 1 j , Z 2 j ] − w1 v1 Cov[Z 1 j , X 1 j ]
− w1 v2 Cov[Z 1 j , X 2 j ] + w22 Var[Z 2 j ]
− w2 v1 Cov[Z 2 j , X 1 j ] − w2 v2 Cov[Z 2 j , X 2 j ]
+ v12 Var[X 1 j ] + v1 v2 Cov[X 1 j , X 2 j ] + v22 Var[X 2 j ]

(2)
Var R j  u 22 Var[Y2 j ] + u 2 u 3 Cov[Y2 j , Y3 j ]
− u 2 v3 Cov[Y2 j , X 3 j ] − u 2 w1 Cov[Y2 j , Z 1 j ] − u 2 w2 Cov[Y2 j , Z 2 j ]
+ u 23 Var[Y3 j ] − u 3 v3 Cov[Y3 j , X 3 j ] − u 3 w1 Cov[Y3 j , Z 1 j ]
− u 3 w2 Cov[Y3 j , Z 2 j ] + v32 Var[X 3 j ]
+ v3 w1 Cov[X 3 j , Z 1 j ] + v3 w2 Cov[X 3 j , Z 2 j ]
+ w12 Var[Z 1 j ] + w1 w2 Cov[Z 1 j , Z 2 j ] + w22 Var[Z 2 j ]

The system efficiency is the value of the objective function, and the two division efficien-
cies are calculated as:
 
Var Rk + u 0 + u ∗1 μ1k Y + w∗ μ Z + w∗ μ Z
(1) (1) (1)∗
ζk 1 1k 2 2k
(1)
ek  ∗ ∗
v1 μ1k + v2 μ2k
X X
 
Var Rk + u 0 + u ∗2 μ2k Y + u ∗ μY
(2) (2) (2)∗
ζk 3 3k
(2)
ek  ∗ ∗ ∗
. (12)
v3 μ3k + w1 μ1k + w2 μ2k
X Z Z

The relationship between the system and two division efficiencies, according to Expression
(10), is:
(1) (1) (2) (2)
ekS  αk + βk ek + βk ek , (13)
(1) (2)
where αk  −(w1 μ1k Z + w μ Z ), β
2 2k k  v1 μ1k + v2 μ2k , and βk  v3 μ3k + w1 μ1k + w2 μ2k .
X X X Z Z

In the next section, the stochastic efficiencies of twenty-two commercial banks in Taiwan
are measured using models (11) and (12).

4 Efficiencies of Taiwanese commercial banks

Conventionally, efficiencies in DEA are measured under deterministic conditions, in that

observations of a number of years are averaged to represent deterministic data. For the case
of Taiwanese commercial banks, this means that the average values in Table 1 are applied
to Model (1) to calculate efficiencies. Table 3 shows the efficiencies and linear combination
coefficients for the twenty-two banks. There are five, ten, and eight banks that are efficient for
the system, Division 1, and Division 2, respectively. The ranks of the efficient banks cannot
be distinguished. The numbers in brackets in column three are the ranks of the corresponding
banks, where the rank of 3 for the five efficient banks is the average of the first five ranks.
The last row shows the averages of the corresponding columns. Here, again, the respective
averages of β(1) and β(2) are weighted averages of the twenty-two banks instead of the simple
arithmetic average.

123
Annals of Operations Research

Table 3 Results for the deterministic model

(1) (2) (1) (2)
Bank E kS [Rank] Ek Ek αk βk βk

1 Chang Hwa* 0.9831 [13] 0.8120 0.9833 − 0.0008 0.0009 0.9999

2 King’s Town 1.0000 [3] 1.0000 1.0000 − 0.5553 1.0000 0.5553
3 Taichung 0.9604 [15] 0.9989 0.9615 − 1.0028 1.0000 1.0028
4 Taiwan Business* 0.9999 [8] 0.8495 1.0000 − 0.0004 0.0005 0.9999
5 Kaohsiung* 0.9999 [6] 0.7663 1.0000 − 0.0000 0.0001 0.9999
6 KGI 0.4778 [22] 0.5527 0.7875 − 0.4917 0.8739 0.6178
7 Union 0.5739 [21] 0.7703 0.7509 − 0.7883 1.0000 0.7883
8 Far Eastern 0.8818 [17] 0.9339 0.9233 − 0.6802 1.0000 0.6802
9 Ta Chong 0.7009 [20] 0.7010 0.9531 − 0.0026 1.0000 0.0026
10 En Tie 1.0000 [3] 1.0000 1.0000 − 0.6506 0.7958 0.8548
11 Hua Nan* 0.9609 [14] 1.0000 0.9629 − 1.0534 0.9999 1.0535
12 Fu Bon 0.9999 [7] 1.0000 0.9971 − 0.0207 0.9999 0.0208
13 Cathay 0.9970 [12] 1.0000 0.7877 − 0.0142 0.9999 0.0143
14 East Sun 0.9981 [11] 1.0000 0.8124 − 0.0099 0.9999 0.0099
15 Yuanta 0.9996 [10] 1.0000 0.9996 − 0.9185 1.0000 0.9185
16 Mega* 1.0000 [3] 1.0000 1.0000 − 0.0015 0.0006 1.0010
17 Taishin 0.8202 [18] 0.8205 0.9519 − 0.0077 0.9999 0.0077
18 Shin Kong 0.8941 [16] 0.9999 0.8945 − 1.0026 1.0000 1.0027
19 Sino Pac 0.8146 [19] 0.9091 0.8831 − 0.8085 1.0000 0.8086
20 China Trust 1.0000 [3] 1.0000 1.0000 − 0.5939 0.9997 0.5942
21 First* 0.9999 [9] 0.8859 1.0000 − 0.0006 0.0007 0.9999
22 Taiwan Cooperative* 1.0000 [3] 1.0000 1.0000 − 0.9010 0.8082 1.0928
Average 0.9119 0.9091 0.9386 − 0.4321 0.7611 0.6947

Expression (4) indicates that system efficiency can be expressed as a linear combination of
(1) (1) (2) (2) (1) (2)
the two division efficiencies: E kS  αk + βk E k + βk E k . The coefficients αk , βk , and βk
shown in the last three columns confirm this relationship. Using Bank No. 1 to verify this, we
(1) (1) (2) (2)
have α1 +β1 E 1 +β1 E 1  −0.0008+0.0009×0.8120+0.9999×0.9833, which is exactly
equal to the system efficiency of 0.9831. The average values of the twenty-two banks shown
in the last row of Table 3 also satisfy this relationship, where we have the average system
efficiency, 0.9119, equal to the linear combination of the two average division efficiencies,
− 0.4321 + 0.7611 × 0.9091 + 0.6947 × 0.9386. Since the deterministic model ignores the
stochastic nature of the problem, the deterministic result will make the top management
over-confident with the presumably uncertain results.
The simplest way to handle stochastic data is to assume the eight factors to be independent
and apply a simulation analysis to measure efficiency (Kao and Liu 2009). Specifically, a set
of normal random variates for the eight factors of the twenty-two banks with the means and
standard deviations shown in Table 1 is generated. With the set of random variates, Model
(1) is applied to calculate one instance of efficiencies. Repeating this process a number of
times produces the distributions of efficiencies for each bank. Table 4 shows the respective
averages of different kinds of efficiencies and coefficients from 12,000 replications.

123
 Annals of Operations Research

Table 4 Results for the independent stochastic model

(1) (2) (1) (2)
Bank E kS [Rank] Ek Ek αk βk βk

1 Chang 0.9796 [9] 0.7305 0.9812 − 0.0087 0.0117 0.9986

Hwa* (0.0285) (0.0663) (0.0266)
2 King’s 1.0000– [1] 1.0000 0.9994 − 0.5150 0.5782 0.9374
Town (0.0000) (0.0000) (0.0133)
3 Taichung 0.9180 [14] 0.9699 0.9410 − 0.7801 0.8083 0.9714
(0.0648) (0.0379) (0.0489)
4 Taiwan 0.9983 [8] 0.8622 0.9993 − 0.1143 0.1309 1.0004
Business* (0.0092) (0.1182) (0.0062)
5 Kaohsiung* 0.9990 [7] 0.7865 1.0000 − 0.0099 0.0218 0.9918
(0.0068) (0.0913) (0.0000)
6 KGI 0.5246 [22] 0.5752 0.7996 − 0.3310 0.8530 0.4563
(0.0661) (0.0946) (0.1174)
7 Union 0.5690 [21] 0.7467 0.7114 − 0.6104 0.9427 0.6685
(0.0636) (0.0533) (0.0571)
8 Far Eastern 0.8429 [16] 0.9041 0.8522 − 0.4225 0.9297 0.4985
(0.1199) (0.0943) (0.0561)
9 Ta Chong 0.6984 [20] 0.7071 0.8583 − 0.1817 0.9504 0.2424
(0.0708) (0.0709) (0.0774)
10 En Tie 1.0000– [5] 1.0000 0.9927 − 0.4389 0.8219 0.6216
(0.0012) (0.0008) (0.0416)
11 Hua Nan* 0.9764 [10] 0.9417 0.9793 − 0.4325 0.4229 1.0320
(0.0266) (0.0893) (0.0238)
12 Fu Bon 0.9685 [11] 0.9942 0.9003 − 0.2390 0.8970 0.3507
(0.0319) (0.0218) (0.0599)
13 Cathay 0.8622 [15] 0.9655 0.7071 − 0.3349 0.9395 0.4103
(0.0996) (0.0627) (0.0977)
14 East Sun 0.9665 [12] 0.9964 0.7121 − 0.1423 0.9807 0.1848
(0.0518) (0.0154) (0.0961)
15 Yuanta 0.9543 [13] 0.9961 0.9549 − 0.8364 0.8434 0.9955
(0.0461) (0.0143) (0.0458)
16 Mega* 1.0000– [3] 0.9990 1.0000 − 0.6641 0.5539 1.1108
(0.0006) (0.0166) (0.0000)
17 Taishin 0.7378 [19] 0.7526 0.8304 − 0.1144 0.9792 0.1387
(0.0569) (0.0613) (0.0702)
18 Shin Kong 0.8377 [17] 0.9711 0.8495 − 0.7975 0.8862 0.9117
(0.0311) (0.0346) (0.0304)
19 Sino Pac 0.8023 [18] 0.9080 0.8391 − 0.6206 0.8980 0.7241
(0.0416) (0.0489) (0.0340)
20 China 1.0000– [4] 1.0000 0.9945 − 0.0706 0.7790 0.2932
Trust (0.0007) (0.0007) (0.0592)
21 First* 0.9992 [6] 0.8478 0.9995 − 0.1641 0.0794 1.0965
(0.0041) (0.0988) (0.0041)
22 Taiwan 1.0000– [2] 0.9994 1.0000 − 0.5050 0.4086 1.0967
Coopera- (0.0000) (0.0159) (0.0000)
tive*
Average 0.8925 0.8934 0.9046 − 0.3788 0.6749 0.7388

123
Annals of Operations Research

There are still three banks that are efficient in Division 1 and another three banks that are
efficient in Division 2. Although the five efficient banks, from the system’s point of view, are
now inefficient such that the ranks can be distinguished, their efficiencies are very close to
one (superscripted with “–”). The average system efficiency from the 12,000 replications for
each bank can also be expressed as a linear combination of the average division efficiencies
based on Expression (10). Using Bank No. 1 to explain this, we have 0.9796  − 0.0087 +
0.0117 × 0.7305 + 0.9986 × 0.9812. This relationship also holds for the average values of the
twenty-two banks shown in the last row of Table 4: 0.8925  − 0.3788 + 0.6749 × 0.8934 +
0.7388 × 0.9046.
The stochastic model that assumes all variables to be independent is apparently inadequate
for Taiwanese commercial banks because every pair of variables is highly correlated, as
revealed by the correlation coefficients shown in Table 2. To take this into account, stochastic
model (11) that is able to handle correlated data is applied to measure efficiency. Table 5
shows the averages of 12,000 replications of a simulation. Similar to the previous two models,
the system efficiency can also be expressed as a linear combination of the two division
efficiencies. For example, Bank No. 1 has a system efficiency of 0.9641, which is exactly
equal to − 0.0119 + 0.0164 × 0.6839 + 0.9966 × 0.9681. The average efficiencies shown
in the last row of Table 5 also satisfy the relationship where the system efficiency is a
linear combination of the two division efficiencies: 0.8671  − 0.3635 + 0.6695 × 0.8554 +
0.7604 × 0.8652.
Since the correlated stochastic model proposed in this study takes the stochastic nature
and the correlation between observations into consideration, the results are more reliable.
Compared to the results obtained from the deterministic model and the independent stochastic
model, several phenomena can be observed.
First, the correlated stochastic model has the strongest discrimination power since the
rankings of the twenty-two banks can be distinguished. Second, the correlated stochastic
model, in general, produces the smallest average efficiencies. Of the sixty-six efficiencies of
(1) (2)
the twenty-two banks (E kS , E k , and E k ), there are only five efficiencies with values greater
than those of the corresponding efficiencies calculated from the deterministic model and four
efficiencies that have values greater than those calculated from the independent stochastic
model. The efficiencies are overstated by the other two models. Third, the efficiencies calcu-
lated from the correlated stochastic model have the largest standard deviation, noting that the
deterministic model produces deterministic efficiencies with a zero variance. The other two
models will make the top management over-confident with the results. Fourth, the rankings
for the twenty-two banks determined by the three models are quite similar although there are
still differences. Specifically, the average absolute difference between the ranks determined
by the proposed and the deterministic models is 1.73 ranks, with the largest difference of
five ranks occurring for Bank No. 1. Compared with the independent stochastic model, the
average absolute difference is 1.00 rank, with the largest difference of four ranks occurring
for Bank No. 16. Fifth, all three models have a smaller average efficiency for Division 1
than for Division 2 (0.9091 vs. 0.9386 for the deterministic model, 0.8934 vs. 0.9046 for the
independent stochastic model, and 0.8554 vs. 0.8652 for the correlated stochastic model),
indicating that the deposit utilization process has greater effect on the performance of a bank
than the deposit collection process.
The most important feature of the proposed model is that it is able to produce efficiency
distributions. The distribution, on the one hand, helps identify the rankings of the efficient
banks evaluated from the deterministic model. Specifically, the five efficient banks evaluated
by the deterministic model are ranked, in sequence, as King’s Town (No. 2), Taiwan Cooper-

123
 Annals of Operations Research

Table 5 Results for the correlated stochastic model

(1) (2) (1) (2)
Bank E kS [Rank] Ek Ek αk βk βk

1 Chang 0.9641 [8] 0.6839 0.9681 − 0.0119 0.0164 0.9966

Hwa* (0.0590) (0.1322) (0.0474)
2 King’s 0.9989 [1] 0.9990 0.9956 − 0.2569 0.8314 0.4270
Town (0.0291) (0.0271) (0.0434)
3 Taichung 0.8688 [14] 0.9308 0.8353 − 0.3432 0.6026 0.7795
(0.1004) (0.0844) (0.1043)
4 Taiwan 0.9837 [6] 0.8497 0.9872 − 0.1856 0.2375 0.9800
Business* (0.0481) (0.1273) (0.0400)
5 Kaohsiung* 0.9913 [5] 0.8277 0.9975 − 0.0359 0.1383 0.9150
(0.0398) (0.1350) (0.0352)
6 KGI 0.5335 [21] 0.5215 0.6891 − 0.1158 0.8607 0.2909
(0.1350) (0.1381) (0.1850)
7 Union 0.5101 [22] 0.6072 0.6485 − 0.2886 0.8580 0.4282
(0.0839) (0.0756) (0.0922)
8 Far Eastern 0.8165 [16] 0.8364 0.8600 − 0.2511 0.9225 0.3441
(0.1344) (0.1294) (0.0996)
9 Ta Chong 0.7074 [20] 0.7096 0.7843 − 0.0952 0.9251 0.1864
(0.1577) (0.1625) (0.1098)
10 En Tie 0.9976 [4] 0.9976 0.9845 − 0.1913 0.8177 0.3790
(0.0294) (0.0282) (0.0712)
11 Hua Nan* 0.9126 [12] 0.9056 0.9153 − 0.4335 0.4505 1.0249
(0.0783) (0.1549) (0.0752)
12 Fubon 0.9456 [11] 0.9764 0.8410 − 0.2264 0.9237 0.3211
(0.0650) (0.0582) (0.1109)
13 Cathay 0.8522 [15] 0.9093 0.6630 − 0.2051 0.9348 0.3126
(0.1159) (0.0967) (0.1262)
14 East Sun 0.9513 [10] 0.9842 0.6493 − 0.1112 0.9658 0.1725
(0.0788) (0.0503) (0.1383)
15 Yuanta 0.8777 [13] 0.8920 0.9193 − 0.4869 0.7898 0.7180
(0.0926) (0.1056) (0.0921)
16 Mega* 0.9832 [7] 0.9945 0.9847 − 1.2252 0.6269 1.6096
(0.0458) (0.0469) (0.0397)
17 Taishin 0.7323 [19] 0.7510 0.7747 − 0.0808 0.9686 0.1106
(0.1035) (0.1050) (0.0831)
18 Shin Kong 0.7391 [18] 0.8374 0.7986 − 0.4740 0.8096 0.6701
(0.0726) (0.0757) (0.0844)
19 Sino Pac 0.7512 [17] 0.8489 0.7813 − 0.4264 0.8728 0.5590
(0.0882) (0.0967) (0.0685)
20 China 0.9979 [3] 0.9974 0.9937 − 0.6481 0.6221 1.0320
Trust (0.0378) (0.0429) (0.0530)
21 First* 0.9637 [9] 0.7917 0.9647 − 0.1512 0.1456 1.0361
(0.0681) (0.1942) (0.0641)
22 Taiwan 0.9980 [2] 0.9664 0.9995 − 1.7522 0.3580 2.4054
Coopera- (0.0349) (0.1139) (0.0156)
tive*
Average 0.8671 0.8554 0.8652 − 0.3635 0.6695 0.7604

123
Annals of Operations Research

ative (No. 22), China Trust (No. 20), En Tie (No. 10), and Mega (No. 16). Interestingly, the
last efficient bank, Mega (No. 16), is ranked seventh, instead of in a place between one and
five. The fifth ranked bank is Kaohsiung (No. 5), which is ranked sixth by the deterministic
model. On the other hand, the stochastic efficiency indicates that one bank is not definitely
worse than another, as determined by the deterministic result. For example, the deterministic
model shows that the efficient bank En Tie (No. 10) definitely outperforms the inefficient
bank Kaohsiung (No. 5). However, the proposed model indicates that Kaohsiung performs
better than, or at least the same as, En Tie 2652 times out of the 12,000 replications. In
other words, Kaohsiung still has 22.1% chance of outperforming En Tie. Figure 3 depicts
the distributions of the system efficiency of the twenty-two banks. Most of the distributions
are skewed to the left. There are also some distributions that have a symmetrical shape that
resemble a normal distribution, and a couple of distributions that are skewed to the right. The
stochastic results advise the top management to be conservative in making judgments.
Of the twenty-two banks, seven banks, marked with an asterisk “*” in Table 5, are
state-owned. These banks have higher ranks than the remaining private banks. The aver-
age system, Division 1, and Division 2 efficiencies of these banks are 0.9707, 0.8599, and
0.9739, respectively, as opposed to 0.8187, 0.8532, and 0.8145, respectively, of the private
banks. A Mann–Whitney test is applied to examine the difference between the efficiencies of
these two types of banks, obtaining p values of 0.026, 0.731, and 0.005 for the system, Divi-
sion 1, and Division 2, respectively. The p values indicate that the system efficiencies and the
Division 2 efficiencies of the two types of ownership are significantly different, respectively,
at the 5% significance level. In other words, public banks outperform private banks, and this
is mainly due to the better performance in Division 2, the deposit utilization process.
Before the 1990s, banking was a strictly regulated industry in Taiwan and was monopolized
mostly by state-owned financial institutions. Even now, most companies and customers are
used to engaging in depositing and loaning with public banks since they are more reliable in
the changing environment. In terms of deposit balance, the seven public banks hold 47.4% of
the total deposits among the twenty-two banks. As for loans, the seven public banks absorb
49.9% of the total loans. This is different from the general stereotype suggesting that private
companies typically perform better than state-owned companies.
Three private banks, Union (No. 7), KGI (No. 6), and Ta Chong (No. 9), have the worst
performance. Affected by the slowed demand for loans and narrowing interest margins in
recent years, private banks have turned to consumer businesses for profits, including wealth
management and unsecured consumer loans, through credit cards and cash cards. This busi-
ness can have a profit rate as high as 15%. However, it is more risky where problematic
lending with a loose credit policy can lead to increased bad credit card and cash card loans.
KGI (No. 6), originally named Cosmos, was hurt seriously from the so-called credit card
default crisis and finally agreed to be a subsidiary of China Development Financial Holding
Company in 2014. Union (No. 7) and Ta Chong (No. 9) were not hurt so seriously. However,
Taiwan’s banking industry is saturated. Under such circumstances, it is not easy for small
banks like these two to survive. Ta Chong officially merged with Yuanta (No. 15) at the end
of 2017. Union (No. 17) belongs to a large group, the Union Group, which owns several
companies from different industries. Whether this bank is making a sufficient profit or not
does not have much impact on this group. We believe the top management of this group
will not make any decisions regarding whether to continue operating the bank or not in the
foreseeable future.

123
 Annals of Operations Research

1.0 Bank 1 Bank 2 Bank 3 Bank 4 Bank 5

0.15

0.1

0.05

1.0 Bank 6 Bank 7 Bank 8 Bank 9

0.15

0.1

0.05

1.0 Bank 10 Bank 11 Bank 12 Bank 13

0.15

0.1

0.05

1.0 Bank 14 Bank 15 Bank 16 Bank 17

0.15

0.1

0.05

1.0 Bank 18 Bank 19 Bank 20 Bank 21 Bank 22

0.15

0.1

0.05

0.2 0.4 0.6 0.8 1.0 0.2 0.4 0.6 0.8 1.0 0.6 0.8 1.0 0.6 0.8 1.0 0.6 0.8 1.0

Fig. 3 Distribution of the system efficiency of the twenty-two banks obtained from the correlated stochastic
model

5 Conclusion

This paper discusses the issues of stochastic environment and the role of deposits in measuring
the efficiency of commercial banks. Regarding the role of deposits, it is controversial whether
it should be treated as an output or an input. According to the studies of Sealey and Lindley
(1977) and Holod and Lewis (2011), deposits are actually an intermediate product in a
network structure of bank operations, which are the output of one process conducted by one
division and the input of another process conducted by another division. Here, we propose
a two-division network structure to describe the operations of commercial banks following

123
Annals of Operations Research

the Banking Act of Taiwan. The deposits are the output of the deposit collection division and
the input of the deposit utilization division.
Under a stochastic environment, the observations are random variables, and the measured
efficiencies of a DMU are also random variables. To obtain the distribution of efficiencies, we
develop a stochastic programming model that allows the random observations to be correlated
to conform to the principle of production economics. This model is transformed into one
with independent standard normal random variables based on the central limit theorem. A
simulation technique is then applied to obtain the distribution of efficiencies. This idea is
applied to measure the efficiency of twenty-two commercial banks in Taiwan using the data
for the period 2010 to 2017. The same data is also applied to a stochastic model that assumes
the observations to be independent, and the average data is applied to the conventional
deterministic model. There are two major findings, which are also the contributions of this
paper.
First, the two-division network structure of bank operations helps explain that the perfor-
mance of the commercial banks in Taiwan is mainly affected by their loan performance rather
than the ability to receive deposits. Second, the correlated stochastic model proposed in this
paper is able to obtain distributions of the stochastic efficiencies, which is more informative
than the deterministic results. It is more discriminative in distinguishing the efficient banks
evaluated by the deterministic model. It also provides information about the probability of
one bank outperforming another. A bank with a smaller average efficiency may still have
some chance of outperforming another. This is different from the deterministic result, which
firmly judges one bank to be better than another.
In addition to these two major findings, there are some minor ones. One is that assuming
the correlated observations to be independent overstates efficiencies and produces misleading
results, and assuming the stochastic data to be deterministic overstates efficiencies to an even
greater extent and produces more misleading results. Another is that the independent stochas-
tic model produces stochastic efficiencies with smaller standard deviations than the correlated
stochastic model does, and the deterministic model produces deterministic efficiencies with
zero standard deviations. This indicates that the top management will be over-confident with
the unreliable results obtained from the independent stochastic and deterministic models. It
is also found that public banks in Taiwan perform better than private banks because public
banks are, in general, larger in scale, which makes them more reliable. This is different from
many cases where private enterprises normally perform better than public enterprises.
The correlated stochastic model proposed in this paper is a nonlinear program that requires
a powerful nonlinear programming solver to find the optimal solution. In this paper, LINGO
was used. It took approximately one hour to conduct one hundred replications in the simula-
tion, which was also time-consuming. It would thus be desirable for the proposed model to
be transformed into a linear program for easy computation, which requires further study.

Acknowledgements This research was partially supported by the Ministry of Science and Technology of
the Republic of China (Taiwan) under Grants MOST108-2410-H-006-102-MY3 and MOST108-2410-H-238-
002-MY2.

Appendix

List of symbols

ekS Stochastic system efficiency for DMU k

123
 Annals of Operations Research

ēkS Expected value for ekS with t replications

( p)
ek Stochastic pth division efficiency for DMU k
( p) ( p)
ēk Expected value for ek with t replications
E kS System efficiency for DMU k
( p)
Ek pth division efficiency for DMU k
( p)
Rj Multivariate normal distribution of the pth division for DMU j
(S)
sk Slack variable of the system for DMU k
( p)
sk Slack variable of the pth division for DMU k
u0 Total value of returns-to-scale for q divisions
( p)
u0 Value of returns-to-scale for the pth division
ur Weight of exogenous output r
vi Weight of exogenous input i
wf Weight of endogenous input f
wg Weight of endogenous output g
Xi j Exogenous input i consumed by DMU j
Yr j Exogenous output r produced by DMU j
Z fj Endogenous input f consumed by DMU j
Zgj Endogenous output g consumed by DMU j
αk Constant for the adjustment of the system efficiency E kS for DMU k
ᾱk Expected value for αk with t replications
( p)
βk Constant for the adjustment of the pth division efficiency for DMU k
( p) ( p)
β̄k Expected value for βk with t replications
( p)
ζj Standard normal random variable of the pth division for DMU j
μiXj Expected value of exogenous input X i j
μrYj Expected value of exogenous output Yr j
μ Zf j Expected value of endogenous input Z f j
μgZj Expected value of endogenous output Z g j

References
Aigner, D. J., Lovell, C. A. K., & Schmidt, P. (1977). Foundation and estimation of stochastic frontier models.
Journal of Econometrics, 6, 21–37.
Banker, R. D. (1993). Maximum likelihood, consistency and data envelopment analysis: A statistical founda-
tion. Management Science, 39, 1265–1273.
Banker, R. D., Charnes, A., & Cooper, W. W. (1984). Some models for estimating technical and scale effi-
ciencies in data envelopment analysis. Management Science, 30, 1078–1092.
Berger, A. N., & Humphrey, D. B. (1997). Efficiency of financial institutions: International survey and direc-
tions for future research. European Journal of Operational Research, 98, 175–212.
Charnes, A., & Cooper, W. W. (1962). Programming with linear fractional functionals. Naval Research Logis-
tics, 9, 181–186.
Charnes, A., Cooper, W. W., & Rhodes, E. (1978). Measuring the efficiency of decision making units. European
Journal of Operational Research, 2, 429–444.
Chen, T. Y. (2002). A comparison of chance-constrained DEA and stochastic frontier analysis: Bank efficiency
in Taiwan. Journal of the Operational Research Society, 53, 492–500.
Cooper, W. W., Deng, H., Huang, Z. M., & Li, S. X. (2002). Chance constrained programming approaches to
technical efficiencies and inefficiencies in stochastic data envelopment analysis. Journal of the Opera-
tional Research Society, 53, 1347–1356.

123
Annals of Operations Research

Dutta, P., Jain, A., & Gupta, A. (2020). Performance analysis of non-banking finance companies using two-
stage data envelopment analysis. Annals of Operations Research. https://doi.org/10.1007/s10479-020-0
3705-6.
Eskelinen, J., & Kuosmanen, T. (2013). Intertemporal efficiency analysis of sales teams of a bank: Stochastic
semi-nonparametric approach. Journal of Banking & Finance, 37, 5163–5175.
Fethi, M. D., & Pasiouras, F. (2010). Assessing bank efficiency and performance with operational research and
artificial intelligence techniques: A survey. European Journal of Operational Research, 204, 189–198.
Financial Supervisory Commission. (2019). The Banking Act of the Republic of China. https://law.moj.gov.
tw/ENG/LawClass/LawALL.aspx?pcode=G0380001.
Galariotis, E., Kosmidou, K., Kousenidis, D., Lazaridou, E., & Papapanagiotou, T. (2020). Measuring the
effects of M&As on Eurozone bank efficiency: An innovative approach on concentration and credibility
impacts. Annals of Operations Research. https://doi.org/10.1007/s10479-020-03586-9.
Gijbels, I., Mammen, E., Park, B., & Simar, L. (1999). On estimation of monotone and concave frontier
functions. Journal of the American Statistical Association, 94, 220–228.
Greene, W. (1993). The econometric approach to efficiency measurement. In H. Fried, C. A. K. Lovell, & S.
Schmidt (Eds.), The measurement of productive efficiency: Theory and applications (pp. 92–250). NY:
Oxford University Press.
Holod, D., & Lewis, H. F. (2011). Resolving the deposit dilemma: A new DEA bank efficiency model. Journal
of Banking & Finance, 35, 2801–2810.
Humphrey, D. B. (1985). Costs and scale economies in bank intermediation. In R. C. Aspinwall & R. Eisenbeis
(Eds.), Handbook of banking strategy (pp. 745–783). New York: Wiley.
Kao, C. (2009). Efficiency decomposition in network data envelopment analysis: A relational model. European
Journal of Operational Research, 192, 949–962.
Kao, C. (2017). Network data envelopment analysis: Foundations and extensions. Bern: Springer International
Publishing.
Kao, C., & Hwang, S. N. (2008). Efficiency decomposition in two-stage data envelopment analysis: An
application to non-life insurance companies in Taiwan. European Journal of Operational Research, 185,
418–429.
Kao, C., & Liu, S. T. (2004). Predicting bank performance with financial forecasts: A case of Taiwan com-
mercial banks. Journal of Banking & Finance, 28, 2353–2368.
Kao, C., & Liu, S. T. (2009). Stochastic data envelopment analysis in measuring the efficiency of Taiwan
commercial banks. European Journal of Operational Research, 196, 312–322.
Kao, C., & Liu, S. T. (2019). Stochastic efficiency measures for production units with correlated data. European
Journal of Operational Research, 273, 278–287.
Kneip, A., Park, B., & Simar, L. (1998). A note on the convergence of nonparametric DEA estimators for
production efficiency scores. Econometric Theory, 14, 783–793.
Kuosmanen, T., & Kortelainen, M. (2012). Stochastic non-smooth envelopment of data: Semi-parametric
frontier estimation subject to shape constraints. Journal of Productivity Analysis, 38, 11–28.
Lampe, H. W., & Hilgers, D. (2015). Trajectories of efficiency measurement: A bibliometric analysis of DEA
and SFA. European Journal of Operational Research, 240, 1–21.
Land, K., Lovell, C. A. K., & Thore, S. (1993). Chance-constrained data envelopment analysis. Managerial
and Decision Economics, 14, 541–554.
Liu, J. S., Lu, L. Y. Y., Lu, W. M., & Lin, B. J. Y. (2013). A survey of DEA applications. Omega, 41, 893–902.
Lozano, S. (2016). Slacks-based inefficiency approach for general networks with bad outputs: An application
to the banking sector. Omega, 60, 73–84.
Meeusen, W., & van den Broeck, J. (1977). Efficiency estimation from Cobb–Douglas production function
with composed error. International Economic Review, 8, 435–444.
Olesen, O. B., & Petersen, N. C. (1995). Chance constrained efficiency evaluation. Management Science, 41,
442–457.
Olesen, O. B., & Petersen, N. C. (2016). Stochastic data envelopment analysis—A review. European Journal
of Operational Research, 251, 2–21.
Ouenniche, J., & Carrales, S. (2018). Assessing efficiency profiles of UK commercial banks: A DEA analysis
with regression-based feedback. Annals of Operations Research, 266, 551–587.
Paradi, J. C., & Zhu, J. (2013). A survey on bank branch efficiency and performance research with data
envelopment analysis. Omega, 41, 61–79.
Premachandra, I. M., Zhu, J., Watson, J., & Galagedera, D. U. A. (2012). Best-performing US mutual fund
families from 1993 to 2008: Evidence from a novel two-stage DEA model for efficiency decomposition.
Journal of Banking & Finance, 36, 3302–3317.

123
 Annals of Operations Research

Puri, J., Yadav, S. P., & Garg, H. (2017). A new multi-component DEA approach using common set of weights
methodology and imprecise data: An application to public sector banks in India with undesirable and
shared resources. Annals of Operations Research, 259, 351–388.
Schmidt, P. (1985). Frontier production functions. Econometric Reviews, 4, 289–328.
Sealey, C. W., & Lindley, J. T. (1977). Inputs, outputs, and a theory of production and cost at depository
financial institutions. The Journal of Finance, 32, 1251–1266.
Seiford, L. M., & Zhu, J. (1999). Profitability and marketability of the top 55 US commercial banks. Manage-
ment Science, 45, 1270–1288.
Simar, L., & Wilson, P. W. (1998). Sensitivity of efficiency scores: How to bootstrap in nonparametric frontier
models. Management Science, 44, 49–61.
Simar, L., & Wilson, P. W. (2000). A general methodology for bootstrapping in nonparametric frontier models.
Journal of Applied Statistics, 27, 779–802.
Simper, R., Hall, M. J., Liu, W., Zelenyuk, V., & Zhou, Z. (2017). How relevant is the choice of risk management
control variable to non-parametric bank profit efficiency analysis? The case of South Korean banks. Annals
of Operations Research, 250, 105–127.
Tziogkidis, P., Matthews, K., & Philippas, D. (2018). The effects of sector reforms on the productivity of
Greek banks: A step-by-step analysis of the pre-Euro era. Annals of Operations Research, 266, 531–549.
Wang, T. (2015). Competition and increasing returns to scale: A model of bank size. Economic Journal, 125,
989–1014.
Zervopoulos, P. D., Sklavos, S., Kanas, A., & Cheng, G. (2019). A multi-parametric method for bias correction
of DEA efficiency estimators. Journal of the Operational Research Society, 70, 655–674.

Publisher’s Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and
institutional affiliations.

123