Bank Profitability Analysis in China: Stochastic Frontier Approach

Round 1

Reviewer 1 Report (Previous Reviewer 2)

I appreciate the manner in which the authors have addressed the issues and comments raised by myself.  The authors have addressed most of the comments fairly adequately.  The focus of the paper is much clearer.  However, I would like to some clarification on the following before publishing the paper.

 

 

1.       The citations of the literature in the discussions in the revised manuscript are inconsistent.

For example, Vo Phuong Mai Le et al. 2022, Scott, 178 Van Reenen, and Zachariadis 2017, Jinsong Zhao 2022 and Li, Si, and Ge,  2021 , etc.  It is very sloppy throughout the paper.

 

The authors should revise the literature citations using the following throughout the revised manuscript - Li, Si, and Ge (2021).

 

2.       What is the stock market crisis in 2015 refer to?

 

State-owned commercial banks are leaders in profitability efficiency, while cost efficiency is at a higher but better level.

What do you mean by better level?

3.       Finally, the authors are highly encouraged to do some reflection on the choice of words used as they proofread the revised paper. There are still grammatical errors throughout the paper.  The authors should consider getting the paper proof-read by a professional.

Author Response

Response to Reviewer 1 Comments

 

Point 1: The citations of the literature in the discussions in the revised manuscript are inconsistent.For example, Vo Phuong Mai Le et al. 2022, Scott, 178 Van Reenen, and Zachariadis 2017, Jinsong Zhao 2022 and Li, Si, and Ge,  2021 , etc.  It is very sloppy throughout the paper.The authors should revise the literature citations using the following throughout the revised manuscript - Li, Si, and Ge (2021).

 

Response 1: We are very sorry for our negligence of the literature citations. We have made correction according to the Reviewer’s comments. According to the JRFM template:All the references mentioned in the text should be cited in the "Author-Date" format-e.g., (Baranwal and Munteanu [1921] 1955), (Cojocaru et al. 1999) or Driver et al. (2000). We refer to a recent article published by JRFM,we chose the style of Driver et al. (2000) according to the JRFM template.We use the bibliography software Mendeley to reorganize all references.

For example,Mai et al. (2022),Scotta, Reenenb, and Zachariadis (2017),Scotta, Reenenb, and Zachariadis (2017),Zhao et al. (2022), Li, Si, and Ge (2021).

 

Point 2: What is the stock market crisis in 2015 refer to?

 

Response 2: We are very sorry for our incorrect writing. In 2015 China's stock market crash,not crisis.China's stock market crash in 2015:In 2015, the collapse of the Shanghai and Shenzhen stock exchanges evaporated about 5 trillion USD in market value. Investors suffered heavy losses, each losing more than 15,000 USD on average Shi, Chen, and Liu (2022). In 2015, the stock market problems pushed the People’s Bank of China to raise its deposit and lending rates Rathnayake et al. (2022).

References:

1)Shi, Yang, Shu Chen, and Ruiming Liu. 2022. “Fund Renaming and Fund Flows: Evidence from China’s Stock Market Crash in 2015.” Economic Modelling 108. Elsevier B.V.: 1–13. doi:10.1016/j.econmod.2022.105771.

2)Rathnayake, Dilesha, Yang Bai, Pierre Louembé, and Li Qi. 2022. “Interest Rate Liberalization and Commercial Bank Performance: New Evidence From Chinese A-Share Banks.” SAGE Open 12 (2): 1–12. doi:https://doi.org/10.1177/21582440221096648.

 

Point 3: State-owned commercial banks are leaders in profitability efficiency, while cost efficiency is at a higher but better level.What do you mean by better level?

 

Response 3: We totally understand the reviewer's concern. In the conclusion we have rewritten this section:State-owned commercial banks lead in profit efficiency; cost efficiency is also high.  

 

Point 4: Finally, the authors are highly encouraged to do some reflection on the choice of words used as they proofread the revised paper. There are still grammatical errors throughout the paper.  The authors should consider getting the paper proof-read by a professional.

 

Response 4: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. We have used a paid editing service:https://www.mdpi.com/authors/english., the manuscript has been thoroughly revised and so we hope it can meet the journal's standards. Thanks so much for your useful comments.

Author Response File: Author Response.pdf

Reviewer 2 Report (Previous Reviewer 1)

I don't think this is a successful revision, changes are minimal.

• Tables and Figures are still not self-contained, I don't see that the authors changed much. When one looks at a table (e.g. Table 6, or 5, but also others, and Figures), there is no legend that would explain the symbols, so one has to look in the text for explanations. Why hasn't this been improved? Please add a legend with definitions of variables so that one can read and digest the tables and Figures.
• The authors offer lengthy explanations to my comments, but it appears they didn't update the text. When I wanted to look up the newly mentioned references that were stated in the response to the refeee (e.g. Kumbhakar and Lovell 2000, or Sealey and Lindley, 1977), they are not mentioned in the text and in the references section of the paper.

I don't want to look at the paper before these things are fixed.

Author Response

Response to Reviewer 2 Comments

 

Point 1: Tables and Figures are still not self-contained, I don't see that the authors changed much. When one looks at a table (e.g. Table 6, or 5, but also others, and Figures), there is no legend that would explain the symbols, so one has to look in the text for explanations. Why hasn't this been improved? Please add a legend with definitions of variables so that one can read and digest the tables and Figures.

 

Response 1: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. We added notes to Figures 1 to 6, Tables 1 to 3 explained the selection of formula variables, Table 4 explained the classification of the bank types, and Table 5 we added explanations and revised the tables. We deleted Table 6 during the first revision process, and the article only has 5 tables.

 

Point 2: The authors offer lengthy explanations to my comments, but it appears they didn't update the text. When I wanted to look up the newly mentioned references that were stated in the response to the refeee (e.g. Kumbhakar and Lovell 2000, or Sealey and Lindley, 1977), they are not mentioned in the text and in the references section of the paper.

 

Response 2: We have made correction according to the Reviewer’s comments. We tried our best to improve the manuscript. We are very sorry for our negligence of the literature citations. We have made correction according to the Reviewer’s comments. According to the JRFM template:All the references mentioned in the text should be cited in the "Author-Date" format-e.g., (Baranwal and Munteanu [1921] 1955), (Cojocaru et al. 1999) or Driver et al. (2000). We refer to a recent article published by JRFM,we chose the style of Driver et al. (2000) according to the JRFM template.We use the bibliography software Mendeley to reorganize all references.

Sealey and Lindley (1977),this document exists in the article L.422. and references L.863-864.

Kumbhakar and Lovell (2000)this document exists in the article L.488. and references L.819.

Author Response File: Author Response.pdf

Reviewer 3 Report (New Reviewer)

A file with the report is attached.

Comments for author File: Comments.pdf

Author Response

Response to Reviewer 3 Comments

 

Point 1: English. Long sentences should be divided into parts, the language should be corrected over the text. For example, l.5-9 could be rewritten as follows: "The use of stochastic frontier approach for the assessment of the profitability of commercial banks allows us to estimate the bank's ability to generate profits which conform those of the leading banks in the industry.Also, it takes into account the specifics of the used management technologies and the in?uence of the market environment." L.10-12: it should be like "The specifics of the analysis from the bank's perspective imply the focus on the position of the most of banks regarding the level of the best practices and trends in the movement of the overall level of profitability." And so on.

 

Response 1: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. We have used a paid editing service:https://www.mdpi.com/authors/english., the manuscript has been thoroughly revised.

 

Point 2: L.26-27. The references should be corrected. What is DQ?

 

Response 2: We are very sorry for our negligence of the literature citations. We have made correction.We totally understand the reviewer's concern.Tu DQ. Le is the name of the author of the document Le and Ngo (2020). We have changed it to Le and Ngo (2020).

 

Point 3: L.40. The references here should be like (Capraru 2014, Lin 2009) without extra brackets. The style of the references should be corrected over the whole text.

 

Response 3: Thank you so much for your careful check. We have corrected the references over the whole text. We are very sorry for our negligence of the literature citations. We have made correction according to the Reviewer’s comments. According to the JRFM template:All the references mentioned in the text should be cited in the "Author-Date" format-e.g., (Baranwal and Munteanu [1921] 1955), (Cojocaru et al. 1999) or Driver et al. (2000). We refer to a recent article published by JRFM,we chose the style of Driver et al. (2000) according to the JRFM template.We use the bibliography software Mendeley to reorganize all references.

 

Point 4: L.348-350. The matrix u is also random. Does β not depend on neither the firm number i nor the time scale? It should be explained. There should be "where" after (2).

 

Response 4: β not depends on neither the firm number i nor the time scale.β is a vector of unknown parameters to be estimate. Vector dimension = number of resources used + 1.

 

Point 5: L.386-387. What are v_p ,u_p , v_c ,u_c ?

 

Response 5: v_p and v_c - random components in the statistical error of equations 3 and 4, u_p and u_c - non-random components in the statistical error of equations 3 and 4 associated with inefficiency.

 

Point 6: L.491. What is Profit^∗?

 

Response 6: Thank you for pointing out this problem in the manuscript. Profit*,we explained and corrected the article. In the old equation 7 Profit∗. We changed it to total profits(P).In L.501-506, we have explained P in detail. When using the SFA model to analyze profitability, the observations in the panel data should not contain negative values. To ensure this, the profit values in the sample were adjusted based on the results of the study Aielloa and Bonanno (2016). Profit(According to Table 1, Profit =Total profits=Profit before tax) figures were transformed by adding the absolute value of the minimum profit for each bank plus one. （We have added formulas to your pdf file and made corrections in the text.）

 

Point 7: L.547. The parameters of the SFA are estimated given σ_u and σ_v , for example, by the method of Battese and Coelli (1992). But how namely σ_u and σ_v are assessed from the data? The authors should write something about it.

 

Response 7: We did not directly determine σu and σv. To assess the influence of performance factors, we used the gamma parameter from the sfa function of the frontier library. This parameter reflects the relationship of sigma indicators. However, you rightly posed the question because we didn't describe the gamma parameter very accurately in the text. We used the σu and σv M. Le et al. (2020), we used the gamma formula fromAiello and Bonanno (2013), without making sure that the sfa function in the frontier package is formalized based on the Battese and Coelli (1992),Battese and Coelli (1995).

σu and σv represent the random error term v and the non-negative error term u.vit are random errors, independently distributed of the uit.uit are non-negative random variables, associated with technical inefficiency of production, which are assumed to be independently distributed. In most works on similar topics, it is assumed that the random component v has a normal distribution with mean zero, and the component u has a semi-normal distribution, both quantities are independent. （We have added formulas to your pdf file and made corrections in the text.）

 

 

Author Response File: Author Response.pdf

Reviewer 4 Report (New Reviewer)

The authors discuss the stochastic front approach, which significantly improves the profitability of the banking system. The author suggests that this is especially important for countries for which there is a need to evaluate the results of reforms and economic regulations that may affect the interests of commercial banks.   Unfortunately, a part of the article contains duplicated, irrelevant information, as if a bit is rewritten from a textbook. This is not necessary. Please focus on scientific substances.   It is not true, in my opinion, what the author wrote, that "profitability in the banking sector is falling due to the general decline in interest rates." - this is an unsubstantiated idea, for the reason that profitability is falling due to the mutual competition of banks. It is good if it falls. The lower the profitability of banks, the better the economy as a whole. Bank profitability is a burden on the economy and a necessary evil, often resulting from the fact that banks engage unnecessarily and maliciously in excessively risky activities instead of minimizing risk. According to the author, profitability and cost efficiency are statistically significant. It must be assumed that statistical significance is only an additional and inconclusive element that may or may not confirm the truth. The author also calls both production and management factors, along with GDP, significant determinants of profitability. Again, the author runs away from scientific grounds into more journalistic grounds.     We encourage you to expand the number of publications in the article's discussion.

Author Response

Response to Reviewer 4 Comments

 

Point 1: The authors discuss the stochastic front approach, which significantly improves the profitability of the banking system. The author suggests that this is especially important for countries for which there is a need to evaluate the results of reforms and economic regulations that may affect the interests of commercial banks. Unfortunately, a part of the article contains duplicated, irrelevant information, as if a bit is rewritten from a textbook. This is not necessary. Please focus on scientific substances.   

 

Response 1: We appreciate it very much for this good suggestion, and we have done it according to your ideas. L.689-697 (First two paragraphs) of the conclusion section is similar to lines 114-122 of the introduction. Thank you for pointing out this problem in the manuscript and we have deleted this part to improve the quality of the article.

 

Point 2:  It is not true, in my opinion, what the author wrote, that "profitability in the banking sector is falling due to the general decline in interest rates." - this is an unsubstantiated idea, for the reason that profitability is falling due to the mutual competition of banks. It is good if it falls. The lower the profitability of banks, the better the economy as a whole. Bank profitability is a burden on the economy and a necessary evil, often resulting from the fact that banks engage unnecessarily and maliciously in excessively risky activities instead of minimizing risk.

 

Response 2: We deleted: "Profitability in the banking sector is declining due to the general decline in interest rates. Profitability efficiency is also trending downward, while cost efficiency is stable". We added L. 708-709"Liu (2017), Li and Liu (2019),Mott (2022) have shown that interest rate policy affects the profitability of banks."

References:

1) Li, Jingya, and MingHua Liu. 2019. “Interest Rate Liberalization and Pass-through of Monetary Policy Rate to Bank Lending Rates in China.” Frontiers of Business Research in China 13 (8). Frontiers of Business Research in China: 2–19. doi:https://doi.org/10.1186/s11782-019-0056-z.

2) Liu, Kerry. 2017. “China’s Interest Rate Pass-through to Commercial Banks Before and After Interest Rate Liberalisation.” Economic Affairs 37 (2): 279–87. doi:10.1111/ecaf.12233.

3) Mott, Carey. 2022. “China: Reserve Requirements,2015 – 2016.” Journal of Financial Crisis 4 (4): 393–428. https://elischolar.library.yale.edu/journal-of-financial-crises/vol4/iss4/19, 2022.

 

Point 3:  According to the author, profitability and cost efficiency are statistically significant. It must be assumed that statistical significance is only an additional and inconclusive element that may or may not confirm the truth. The author also calls both production and management factors, along with GDP, significant determinants of profitability.

 

Response 3: We totally understand the reviewer's concern.The significance of individual factors characterizes the quality of the created regression model, which allows to explain the estimated parameter. This does not allow us to draw unambiguous conclusions about the real influence of individual factors on the estimated parameter, but characterizes only the statistical relationship. Conclusions about the real influence of individual factors require additional reasoning and analysis. We have deleted this section in conclusions and we corrected this section in L.545-548 and added footnote 12 to the text.

 

Point 4:  Again, the author runs away from scientific grounds into more journalistic grounds. We encourage you to expand the number of publications in the article's discussion.

 

Response 4: We have made correction according to the Reviewer’s comments. We tried our best to improve the manuscript and made some changes in the manuscript.

 

 

Author Response File: Author Response.pdf

Round 2

Reviewer 2 Report (Previous Reviewer 1)

Revisions appreciated

Reviewer 3 Report (New Reviewer)

I have no more questions.

This manuscript is a resubmission of an earlier submission. The following is a list of the peer review reports and author responses from that submission.

Round 1

Reviewer 1 Report

see uploaded referee report

Comments for author File: Comments.pdf

Author Response

Response to Reviewer 1 Comments

 

Point 1: First, the paper starts with weak motivation. The paper should offer a much clearer explanation of the importance of bank profitability for economic stability. In addition, the introduction doesn’t clearly distinguish between productivity (input-output ratios) and profitability (including deposit interest rates, loan interest rates, and other prices affecting revenues and costs).

 

Response 1: We appreciate it very much for this good suggestion, and we have done it according to your ideas. We have recorrected the introduction. (1) The importance of bank profitability for economic stability: In recent years, the profitability of commercial banks in China has significantly decreased as a result of slowing economic growth, increased competition from non-financial organizations, falling rates on financial markets, and tightening capital adequacy requirements. The banking system of China has a relatively high level of state control, while an important task in the regulation of the banking system is to manage the profitability of banks. The use of the stochastic frontier approach to assessing the profitability of commercial banks allows not only to assess the bank's ability to generate profit relative to the leading banks in the industry but also takes into account the specifics of the management technologies used, and the influence of the market environment. (2)Input-output between productivity (input-output ratios) and profitability: A feature of the stochastic frontier approach is the possibility of constructing the production possibilities frontier of companies and determining for each company its distance to this frontier. Thus, it becomes possible to evaluate the effectiveness of all or most firms in the industry. Applying the stochastic frontier approach to assessing the profitability of the Chinese banking sector requires taking into account local features. First of all, this is due to the allocation of groups of banks that focus on certain tasks, and types of clients, and have different access to resources and different opportunities for the placement of assets. These groups are the conductors of the monetary policy of the state in certain areas of the economy. The analysis of the profitability of the banking system should be based on the current level of profitability, which is determined by the current frontal boundary, the deviation of the position of banks from the boundary allows for determining profitability trends. When analyzing profitability, it is important to take into account the state of costs, which will allow us to determine the reason for the change in the state of profitability. We believe that the stochastic frontier approach to assessing the profitability of commercial banks not only assesses the bank's profitability relative to the leading banks in the industry but also takes into account the specific circumstances of the management techniques used and the market environment. Profit efficiency is the ratio of actual observed bank profits to the maximum level of potential efficient bank profits. Cost efficiency is the ratio of the minimum level of potentially efficient banks' costs to the actual observed level of banks' costs. We use the transcendental logarithm (translog) form(Laurits R. Christensen 1973), which is the most commonly used functional form in bank efficiency(Kumbhakar and Lovell 2000). Our profit efficiency frontier model and cost efficiency frontier model. Efficiency scores are calculated by estimating the profit efficiency frontier model and cost efficiency model with three inputs (Loans, Other Earning Assets, Non-interest income) and two outputs (Price of loanable funds, Price of capital).

 

Point 2: Second, the paper doesn’t offer a structural banking model of financial intermediation that would allow us to recognize interest margins as a key determinant of profitability. The stochastic frontier approach based on production functions (see page 3) might be more useful in estimating the determinants of manufacturing profits, but I am rather skeptical that it is a good method to measure bank profitability. In my view, measuring bank profitability should rest on a structural banking model to capture the role of banks in financial intermediation. On page 5, the authors very shortly address the “intermediation approach", and on page 7 bottom they state that "we used the intermediary approach".

 

Response 2: Considering the suggestion, we have added(4.2. Variable definitions, 4.3. Model specification): Our study uses the intermediation approach. The intermediation approach, proposed by (C. W. Sealey and Lindley 1977), viewed the bank as an intermediary that collects customer deposits and grants loans. The bank acts as an intermediary, collecting funds from savers and converting these funds into profit-generating items (loans, etc.). The approach is consistent with the concept of the bank as a financial intermediary and the data required to implement the approach are readily available. (Allen N. Berger and David B. Humphrey 1997) highlight the advantages of stochastic frontier methods over traditional measures of efficiency (e.g., return on assets) because they take into account both relevant bank inputs and outputs and differences in input prices, they believe that the intermediary approach is more appropriate for measuring the efficiency of the bank as a whole. Input-output between productivity (input-output ratios) and profitability: This study analyzes the profit efficiency and cost efficiency of the Chinese banking industry over the period 2012-2020. Efficiency scores are calculated by estimating a model with three inputs (Loans, Other Earning Assets, Non-interest income) and two outputs (Price of loanable funds, Price of capital). Profit efficiency is the ratio of actual observed bank profits to the maximum level of potential efficient bank profits. Cost efficiency is the ratio of the minimum level of potentially efficient banks' costs to the actual observed level of banks' costs. In this paper, profit efficiency is used to measure bank profitability. When analyzing profitability, it is also necessary to take into account the cost situation, which will make it possible to determine the reasons for changes in the profitability situation. Cost efficiency is used to assist in analyzing bank profitability.

References:

1977. W. Sealey, Jr., and James T. Lindley. 1977. “Inputs, Outputs, and a Theory of Production and Cost at Depository Financial Institutions.” Journal of Finance 32(4): 1251–66.

Allen N. Berger, and David B. Humphrey. 1997. “Efficiency of Financial Institutions: International Survey and Directions for Future Research.” European Journal of Operational Research 98(2): 175–212.

 

Point 3: Third, the tables and figures are hard to read. How should the reader digest Table 6? It contains probably the most important results. One must first look up which estimating equation it exactly relates to, and painfully look up what all the parameters exactly mean. After doing that I was still unable to find a discussion of the parameters and locate them in the estimating equations. Similar regards apply to other Tables and Figures. As a general rule, Tables and Figures should allow for self-contained reading!

 

Response 3: We are very sorry for our negligence in the explanation. We have corrected all figures and tables and added data sources. All figures and tables(Section 2.2. Profitability of Chinese banks in the period 2012-2020, Section 4.2. Variable definitions, and Section 5. Results) have been reinterpreted.

 

Point 4: Fourth, by and large, the results appear interesting to me. However, several conclusions appear to be unrelated to actual empirical results. Examples are the last sentence in the introduction; the last paragraph of Section 5; and the sentences in the abstract suggesting that the Chinese banking system is quite stable over time and has successfully adjusted to specific banking reforms and the slowdown in economic growth. How are these conclusions exactly derived from the empirical results of the paper?

 

Response 4: We have reworked the model improvements, and empirical measures, and concluded. The results show that the average level of profit efficiency and cost efficiency of the Chinese banking system is around 80%, showing high profitability and cost efficiency, but the dynamics of profit efficiency and cost efficiency show a decreasing trend over time. The banking system of China has a relatively high level of state control, while an important task in regulating the banking system is to manage the profitability of banks. Using the stochastic frontier approach to assess the profitability of commercial banks allows not only to assess the bank's ability to generate profits relative to the leading banks in the industry but also takes into account the specifics of the management technologies used, and the influence of the market environment. This article analyzes the profitability of the Chinese banking system for the period 2012-2020 using a stochastic frontier approach from the position of the central bank. The specifics of the analysis from the bank's perspective imply a focus on the position of most banks regarding the level of best practices and trends in changing the overall level of profitability. In general, the Chinese banking system demonstrates a high level of profit efficiency and cost efficiency, although the dynamics of these indicators are negative. The reason for the negative dynamics is a decrease in the economic growth rate of the economy, instability of the financial market, and ongoing reforms. State-owned commercial banks are becoming highly profitable, national joint-stock commercial banks are facing increasing competition and reducing the efficiency of profitability, and city and rural commercial banks maintain a high level of profitability due to state support.

 

Point 5: Fifth, language is acceptable but I would still advise careful checking by a language professional.

 

Response 5: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. The manuscript has been thoroughly revised and edited by a native speaker, so we hope it can meet the journal's standards. Thanks so much for your useful comments.

 

Author Response File: Author Response.docx

Reviewer 2 Report

Summary

The idea behind this study was interesting. I tried to read the paper constructively, but I felt it suffers from poor writing. Overall, this study has significant problems, such as unclear discussion, insufficient theoretical analysis, and weak conclusion. In addition, the manuscript did not provide insightful empirical contributions. I struggled understanding this research study. I try to summarize some of my concerns/difficulties below, and I provide more specific comments to other areas of concern below.

 Introduction

The ‘Introduction’ section must be strengthened. The main question is why should someone read this paper? The reason is that a lot of such studies have been conducted so what new things are being investigated?  It should put emphasis sequentially started with the background of the study along with the importance, motivation, and then research gaps and contributions of the study. Merely writing sentences/paragraphs (without relevancy and connectivity between or among sentences/paragraphs) is not the right direction to research.

The authors should clarify their research questions, objectives, background motivation, theoretical and empirical motivation and the lines of contributions to the literature. The authors can do this by sharply articulating their research questions/objectives, identifying the potential theoretical, background and theoretical motivation or gaps, and explaining how their study contributes to the literature. The authors can do this by highlighting the weaknesses of prior studies as well. Currently, the introduction is very dry.

Unless I misread the introduction, the authors should emphasize the main findings and contribution of the paper which have not been detected so far. Are there some insights that prior research has missed?  What insight can emerge from this investigation? What motivates the paper? The paper lacks novelty.

This is very crucial for the research that adds a holistic lens to the meaning and interpretation of the research and reflects how the results can be enhanced by other research and how the results of the study can be practically applied.

Literature Review

As with the introduction, this section needs to be improved significantly.  The review of literature couldn’t create a space for the current study based on which it could claim originality or novelty. The authors should provide an overarching theoretical framework that will explain the underlying predictions and hypotheses of interest. In doing so, please explicitly outline how they help link the dependent and independent variables together by drawing on both seminal (old) and recently (newly) published studies in SFA.

The SFA employs econometric techniques to estimate efficiency scores by allowing an error term with two components: a normally distributed random effects component and an asymmetrically (typically half-normally) distributed technical inefficiency component, estimated via maximum likelihood. This approach has the purported advantage of an ability to measure efficiency in the presence of statistical noise (Coelli, et al., 2005).

Compared with the non-parametric DEA, the SFA method has the ability to capture distortion, such as errors in the data arising from luck, data problems and other issues. This makes misidentification of measurement errors, transitory differences and specification errors in inefficiency less likely (Bauer et al., 1998; Berger et al., 2000, Battese and Coelli, 1995).

The literature review section needs more highlight and focus on China banking industry, then from this the authors could highlight the need to use the SFA methods. This will make readers have more understandings on the motivations and choices of models variables. Difference(s) (and its implications in the banking sector) between X-efficiency and scale/scope efficiency measures need to be explicitly stated in your literature review section.

 

The author(s) should enhance the research hypotheses by: (i) drawing on the theory; (ii) empirical literature; (iii) research setting/contextual insights; and (iv) setting up the hypotheses. Currently, the authors have not developed their hypotheses in this way. The authors will need to do so by drawing on both seminal (old) and recently (newly) published studies in SFA.

 What is the theoretical lens of the research? One issue that hinders the paper contribution is the relative absence of clear theoretical lenses to ground the paper predictions and discussions.  The author(s) presented three theories (institutional theory, legitimacy theory, and agency theory) without forming the theoretical framework to develop the hypotheses. My own view is that choosing one relevant theory as the main theoretical foundation and providing the justification for this choice will enhance the quality of the paper arguments and discussions.

Battese, G. E., and T.J. Coelli, 1995, A model for technical inefficiency effects in a stochastic frontier production function for panel data, Empirical Economics, 20(2), 325-332.Bauer, P. W., A.N. Berger, G.D. Ferrier, and D. B. Humphrey, 1998, Consistency conditions for regulatory analysis of financial institutions: a comparison of frontier efficiency methods, Journal of Economics and Business, 50(2), 85-114.

 Berger, A. N., R. DeYoung, H. Genay and G.F. Udell, 2000, Globalization of financial institutions: Evidence from cross-border banking performance, Brookings-Wharton papers on financial services, 2000(1), 23-120.

 Coelli, T. J., D.S.P. Rao, C.J. O'Donnell and G.E. Battese, 2005, An introduction to efficiency and productivity analysis (2nd ed.), Springer Science  and Business Media, New York, US.

 Data and Method

To add credibility of the data, in terms of the sample period, the authors should motivate the start of the sample period in 2012 and why does the sample period end in 2020?  A better discussion of the total sample of the banks should be provided.  The Orbis database contained 328 representative banks and financial institutions in the PRC. How was the 240 banks selected from the Orbis database?  Why did the sample banks include State Owned Banks which receive support and soft grants from the government? In terms of data, are they quarterly or yearly? Any advantage/limitations of the data?

 It puzzles me why the authors discuss the mathematical derivation of SFA at length without linking to the main theme and focus of the paper.  The derivations are standard textbook materials.  Instead, the authors should discuss previous studies that use SFA to assess bank profitability and bank efficiency.

 Similarly, the stochastic profit frontier function is poorly presented and discussed.  The authors need to link the discussion to commercial banks in China. The authors did not provide a clear justification for using the stochastic frontier method in the paper. This hinders the discussion of the empirical results.

 The choices of inputs, outputs and explanatory variables need to be justified. Also there is no justification why a truncated normal distribution is used in this paper. Please see standard SFA applied work (Rosko, M. D. 2001. "Cost efficiency of us hospitals: A stochastic frontier approach." Health Econ, 10(6), 539-51) where justifications on the distribution of the efficiency scores are very well articulated.

Moreover, it would also be interesting to utilise lagged financial ratios to reduce the level of noise and control other approximation problems inherent in econometric estimation.

Results

The authors should link their findings more strongly to the: (i) theory, (ii) empirics, (iii) context, and (iv) highlight their economic, academic/research and policy implications. Simply mentioning the coefficients and the sign of the coefficients and statistical significance do not provide any insight to the readers. Results should be compared and discussed with similar studies in the literature.  Such approach clarifies what is new in a study and how it contributes to the literature. The discussion of the results needs to be squeezed with more importance towards the theoretical and policy implication parts in the relationship between bank profitability and bank efficiency in China.  The discussion of the tables’ results are important to gauge the standing of study's all main findings in regional and global comparison.

There is no critical analysis of the findings and there is no link between findings. It is completely missing out here. This is very crucial for the research that add a holistic lens to the meaning and interpretation of the research and reflects how the results can be enhanced by other research and how the results of the study can be practically applied.

Another weakness is that the study certainly justify detailed discussion on the practical and/or managerial implications particular in the sphere of how of bank profitability and bank efficiency are related in China. These are lacking in the paper.

For medium and large banks, however, the opportunity to increase return on equity by increasing efficiency is more significant, which makes sense.  Why does it make sense?

In the empirical discussion, the authors conclude that the main things that need to be done to optimize the profitability and profit efficiency of Chinese banking sector are appropriate economic policy liberalization, management and credit quality improvement, and the development of a diversified intermediation business for banks.  However, these are not a reflection of the SFA results.

A major weakness is that the study certainly justifies detailed discussion on the practical and/or managerial implications particular in the sphere of lessons learned Chinese banks in the context of bank profitability and bank efficiency. How can the research be used in practice (economic and commercial impact), in teaching, to influence public policy, in research (contributing to the body of knowledge)? What is the impact upon society (influencing public attitudes, affecting quality of life)? Are these implications consistent with the findings and conclusions of the paper?

Robustness or additional analyses – please demonstrate how your findings are to alternative measures (e.g., different ways of measuring the key dependent and independent variables), estimations (e.g., Generalised Least Square regressions, Fixed or random effects regressions etc) and general endogeneities. The authors should look at the use of input distance functions as a robustness check. The use of input distance function can be used to address the limitations of existing model of SFA. These are lacking in the paper.

Finally, there are many instances where (a) the authors make a relative statement, but do not indicate what the comparison is against and (b) comments are made which don't add anything to the argument.

Minor Comments

The abstract can be improved further. It is critical to write a complete but concise description of the author(s)’s work to entice potential readers into obtaining a copy of the full paper. The author(s) should follow a checklist consisting of: motivation, problem statement, approach, data, results, and conclusions.

I found myself quite confused reading statements that were not well explained or did not provide examples to support what was being stated. For example, on page 1, the authors mentioned “The interest rate difference between the actual profit of the assessed bank and the maximum profit of the frontier bank's operations.”  This statement is incomplete and confusing. 

Similarly on page 2, the authors should explain with evidences why the current focus of Chinese banking regulators is on systemic risks, such as non-performing assets, and strengthening risk-prevention measures, while neglecting the issue of bank profits and efficiency. What corresponding profit efficiency model agrees well with the stochastic frontier approach?

On page 7, the authors mentioned “In terms of static methods, we should conclude that there is a decrease in profitability and give a negative assessment, but this would not correspond to the actual result. This needs to be taken into account in the analysis.”  This statement is confusing.

What does Chinese economy is manageable in the public interest mean?

On page 11, the authors mentioned “There is a spread between 450 rural banks, urban banks and joint-stock banks, possibly related to the stimulus processes 451 undertaken by the government.”  What is the stimulus processes?

There are many more such confusing statements in the paper.

Author Response

Response to Reviewer 2 Comments

 

Point 1: Introduction. The ‘Introduction’ section must be strengthened. The main question is why should someone read this paper? The reason is that a lot of such studies have been conducted so what new things are being investigated?  It should put emphasis sequentially starting with the background of the study along with the importance, motivation, and then research gaps and contributions of the study. Merely writing sentences/paragraphs (without relevancy and connectivity between or among sentences/paragraphs) is not the right direction to research. The authors should clarify their research questions, objectives, background motivation, theoretical and empirical motivation, and the lines of contributions to the literature. The authors can do this by sharply articulating their research questions/objectives, identifying the potential theoretical, background, and theoretical motivation or gaps, and explaining how their study contributes to the literature. The authors can do this by highlighting the weaknesses of prior studies as well. Currently, the introduction is very dry. Unless I misread the introduction, the authors should emphasize the main findings and contribution of the paper which have not been detected so far. Are there some insights that prior research has missed?  What insight can emerge from this investigation? What motivates the paper? The paper lacks novelty.

This is very crucial for the research that adds a holistic lens to the meaning and interpretation of the research and reflects how the results can be enhanced by other research and how the results of the study can be practically applied.

 

Response 1: We appreciate it very much for this good suggestion, and we have recorrected the introduction.One of the important conditions that Central Banks observe when regulating the banking system is to keep commercial banks interested in making profits. The Central Bank needs to make sure that commercial banks can generate the expected profits for their owners and are interested in developing the banking business. To organize profitability control, the Central Bank needs to develop appropriate methods of analysis. In recent years, the profitability of commercial banks in China has significantly decreased as a result of slowing economic growth, increased competition from non-financial organizations, falling rates on financial markets, and tightening capital adequacy requirements. The need to assess profitability from the position of regulatory and supervisory authorities, and identify trends and reasons for changing the behavior of banks requires the development of scientific approaches that allow solving these problems. As the results of a study by Chinese and foreign authors show, the stochastic frontier approach helps to significantly improve the assessment of the profitability of commercial banks from the standpoint of their technological capabilities, the influence of managerial factors, and environmental factors. The stochastic frontier approach can significantly improve the analysis of the profitability of the banking system. For China, this is of particular importance because of the need to evaluate the results of both reforms and the results of economic regulation, which may affect the interests of commercial banks. The analysis of the profitability of the banking system should be based on the current level of profitability, which is determined by the current frontal boundary, the deviation of the position of banks from the boundary allows for determining profitability trends. When analyzing profitability, it is important to take into account the state of costs, which will allow us to determine the reason for the change in the state of profitability.

 

Point 2: Literature Review. The review of literature couldn’t create a space for the current study based on which it could claim originality or novelty. The authors should provide an overarching theoretical framework that will explain the underlying predictions and hypotheses of interest. In doing so, please explicitly outline how they help link the dependent and independent variables together by drawing on both seminal (old) and recently (newly) published studies in SFA.

The SFA employs econometric techniques to estimate efficiency scores by allowing an error term with two components: a normally distributed random effects component and an asymmetrically (typically half-normally) distributed technical inefficiency component, estimated via maximum likelihood. This approach has the purported advantage of an ability to measure efficiency in the presence of statistical noise (Coelli, et al., 2005).

Compared with the non-parametric DEA, the SFA method can capture distortion, such as errors in the data arising from luck, data problems, and other issues. This makes misidentification of measurement errors, transitory differences, and specification errors in inefficiency less likely (Bauer et al., 1998; Berger et al., 2000, Battese and Coelli, 1995).

The literature review section needs more highlighting focusing on China’s banking industry, then from this, the authors could highlight the need to use the SFA methods. This will make readers more understanding of the motivations and choices of model variables. Difference(s) (and their implications in the banking sector) between X-efficiency and scale/scope efficiency measures need to be explicitly stated in your literature review section.

The author(s) should enhance the research hypotheses by (i) drawing on the theory; (ii) empirical literature; (iii) research setting/contextual insights; and (iv) setting up the hypotheses. Currently, the authors have not developed their hypotheses in this way. The authors will need to do so by drawing on both seminal (old) and recently (newly) published studies in SFA.

What is the theoretical lens of the research? One issue that hinders the paper’s contribution is the relative absence of clear theoretical lenses to ground the paper’s predictions and discussions.  The author(s) presented three theories (institutional theory, legitimacy theory, and agency theory) without forming the theoretical framework to develop the hypotheses. My view is that choosing one relevant theory as the main theoretical foundation and providing the justification for this choice will enhance the quality of the paper’s arguments and discussions.

 

Response 2: Thank you very much for the 4 articles which were so helpful that we added them to the reference section and rewrote the literature review section. Considering the suggestion, we have added: Our study uses the intermediation approach. The intermediation approach, proposed by (C. W. Sealey and Lindley 1977), viewed the bank as an intermediary that collects customer deposits and grants loans. The bank acts as an intermediary, collecting funds from savers and converting these funds into profit-generating items (loans, etc.). The approach is consistent with the concept of the bank as a financial intermediary and the data required to implement the approach are readily available. (Allen N. Berger and David B. Humphrey 1997) highlight the advantages of stochastic frontier methods over traditional measures of efficiency (e.g., return on assets) because they take into account both relevant bank inputs and outputs and differences in input prices, they believe that the intermediary approach is more appropriate for measuring the efficiency of the bank as a whole.

References:

1977. W. Sealey, Jr., and James T. Lindley. 1977. “Inputs, Outputs, and a Theory of Production and Cost at Depository Financial Institutions.” Journal of Finance 32(4): 1251–66.

Allen N. Berger, and David B. Humphrey. 1997. “Efficiency of Financial Institutions: International Survey and Directions for Future Research.” European Journal of Operational Research 98(2): 175–212.

In our study, we used the SFA method because its results are quite clear, it is robust to outliers, and it allows us to build a boundary based on the most massive use of technology. Commercial banks in China differ in the level of effective application of banking technology and access to banking product markets and have different sizes. In this case, focusing on the most widespread use of technology would provide a fairer estimate. Note that this assessment would be fair to banks considered as separate entities, without taking into account their importance to the banking sector. This is important when it comes to creating a fair environment for all participants in the banking sector.

In summary, our review of the literature on profit efficiency and cost efficiency in the banking sector reveals some mixed and contradictory results and research gaps. Since 2012, rural commercial banks have played an increasingly important role in the Chinese banking system, but existing studies have under-researched rural commercial banks in China. Commercial banks in China vary in their ability to apply banking technology effectively. The choice of methodology may be related to the specifics of the data. In our study, we added to the existing research analysis of rural commercial banks the classification of Chinese commercial banks in China and used the SFA methodology because its results are illustrative and take into account the inefficiency term.

 

Point 3: Data and Method. To add credibility to the data, in terms of the sample period, the authors should motivate the start of the sample period in 2012 and why the sample period ended in 2020.  A better discussion of the total sample of the banks should be provided.  The Orbis database contained 328 representative banks and financial institutions in the PRC. How were the 240 banks selected from the Orbis database?  Why did the sample banks include State Owned Banks which receive support and soft grants from the government? In terms of data, are they quarterly or yearly? Any advantages/limitations of the data?

It puzzles me why the authors discuss the mathematical derivation of SFA at length without linking to the main theme and focus of the paper.  The derivations are standard textbook materials.  Instead, the authors should discuss previous studies that use SFA to assess bank profitability and bank efficiency.

Similarly, the stochastic profit frontier function is poorly presented and discussed.  The authors need to link the discussion to commercial banks in China. The authors did not provide a clear justification for using the stochastic frontier method in the paper. This hinders the discussion of the empirical results.

The choices of inputs, outputs, and explanatory variables need to be justified. Also, there is no justification for why a truncated normal distribution is used in this paper. Please see standard SFA applied work (Rosko, M. D. 2001. "Cost efficiency of our hospitals: A stochastic frontier approach." Health Econ, 10(6), 539-51) where justifications on the distribution of the efficiency scores are very well articulated.

Moreover, it would also be interesting to utilize lagged financial ratios to reduce the level of noise and control other approximation problems inherent in econometric estimation.

 

Response 3: We gratefully appreciate your valuable suggestions. We have carefully considered the comments.

• Our sample covers 239 Chinese banks over the period from 2012 to 2020, the data is annual., with a total of 1719 observations. We tested our data against theoretical requirements and verified their correctness; incorrect data were removed. The data for China for 2012-2020 are representative, and this interval includes key years of China's economic development: the stock market crisis in 2015, the completion of interest rate liberalization in 2014-2015, and the US-China trade issues in 2018. At the end of 2020, 6 state-owned commercial banks owned almost 95% of the total assets of Chinese commercial banking institutions. Thus, we believe that our sample offers a good representation of the overall Chinese banking market.
• We removed the complex mathematical derivations. We discussed previous studies that use SFA to assess bank profitability and bank efficiency. The SFA method is parametric and uses production functions such as the Cobb-Douglas function to describe the input-output relationship. Using the stochastic frontier approach, the authors (Fotios Pasiouras et al. 2009) studied 615 commercial banks operating in 74 countries over the period 2000-2004, research showed that stronger banking supervision increases the cost and profit efficiency of banks. (Thi Thanh Ngan Le 2014) measured the cost and profit efficiency of 45 Vietnamese commercial banks from 2007-2012 by using the stochastic frontier analysis (SFA) method, and the results showed that state-owned commercial banks (SCOBs) are more efficient in terms of profit efficiency than other domestic commercial banks (JSCBs) and foreign banks, while foreign banks are ahead of state-owned banks in terms of cost efficiency.(Francesco Aiello and Bonanno 2016) using the stochastic frontier analysis (SFA) method showed that: cost efficiency is not related to market risk in Italian banks in 2006-2011, while profit efficiency is related to market risk. The cost efficiency of commercial banks is inversely related to loan diversification. The profits of Italian commercial banks are negatively affected by size. (Yizhe Dong et al. 2016) examined the cost and profit efficiency of four types of commercial banks in China over the period 2002 to 2013. The study shows that cost and profit efficiency increased for state-owned banks, joint-stock banks, foreign banks, and city banks and that banks were more profit efficient than cost-efficient. Foreign banks are the most cost-efficient but the least profit efficient. Using the stochastic frontier approach, (Bitar 2018) analyzed 1992 banks in 39 OECD countries over the period 1999-2013 and found that: higher capital ratios may harm the banking efficiency and profitability of highly liquid banks.
• In the literature on bank efficiency, there are many ways to measure the inputs and outputs of banks: the production approach, the intermediation approach, and the operating approach (Coelli, T. J., Rao, D.S.P., & Battese 2005). Our study uses the intermediation approach. The intermediation approach, proposed by (C. W. Sealey and Lindley 1977), viewed the bank as an intermediary that collects customer deposits and grants loans. The bank acts as an intermediary, collecting funds from savers and converting these funds into profit-generating items (loans, etc.). The approach is consistent with the concept of the bank as a financial intermediary and the data required to implement the approach are readily available. (Allen N. Berger and David B. Humphrey 1997) highlight the advantages of stochastic frontier methods over traditional measures of efficiency (e.g., return on assets) because they take into account both relevant bank inputs and outputs and differences in input prices, they believe that the intermediary approach is more appropriate for measuring the efficiency of the bank as a whole.
• In our study, we used the SFA method because its results are pretty clear, it is robust to outliers, and it allows us to build a boundary based on the most massive use of technology. Commercial banks in China differ in the level of effective application of banking technology and access to banking product markets and have different sizes. In this case, focusing on the most widespread use of technology would provide a fairer estimate. Note that this assessment would be fair to banks considered as separate entities, without taking into account their importance to the banking sector. This is important when it comes to creating a fair environment for all participants in the banking sector. The basic parameters outline the process of turning resources into final products. In general, the profitability and cost functions use loans, investments, and non-interest income as output parameters. Historically, the scientific basis for the construction of production functions was the neoclassical theory of the firm, according to which, in a perfect market, firms had equal access to both resources and sales and competed with each other by reducing individual costs. As was shown later, this was not consistent with practice, in particular, the role of agents was not taken into account. The development of management theory led to an understanding of the role of managerial factors in firm performance. Results of behavioral theory led to the understanding of the importance of harmonious development of the organization, consideration of interests of all interested groups, and influence of external factors. This is especially important for banks because the activity of these organizations is socially important, it is based on the trust of clients, it is regulated, and requires careful consideration of stakeholders' opinions.

 

Point 4: Results: The authors should link their findings more strongly to the: (i) theory, (ii) empirics, (iii) context, and (iv) highlight their economic, academic/research, and policy implications. Simply mentioning the coefficients and the sign of the coefficients and statistical significance does not provide any insight to the readers. Results should be compared and discussed with similar studies in the literature.  Such an approach clarifies what is new in a study and how it contributes to the literature. The discussion of the results needs to be squeezed with more importance towards the theoretical and policy implication parts in the relationship between bank profitability and bank efficiency in China. 

There is no critical analysis of the findings and there is no link between the findings. It is completely missing out here. This is very crucial for the research that adds a holistic lens to the meaning and interpretation of the research and reflects how the results can be enhanced by other research and how the results of the study can be practically applied.

Another weakness is that the study certainly justifies detailed discussion on the practical and/or managerial implications, particularly in the sphere of how bank profitability and bank efficiency are related in China. These are lacking in the paper.

For medium and large banks, however, the opportunity to increase return on equity by increasing efficiency is more significant, which makes sense.  Why does it make sense?

In the empirical discussion, the authors conclude that the main things that need to be done to optimize the profitability and profit efficiency of the Chinese banking sector are appropriate economic policy liberalization, management and credit quality improvement, and the development of a diversified intermediation business for banks.  However, these are not a reflection of the SFA results.

A major weakness is that the study certainly justifies detailed discussion on the practical and/or managerial implications, particularly in the sphere of lessons learned by Chinese banks in the context of bank profitability and bank efficiency. How can the research be used in practice (economic and commercial impact), in teaching, to influence public policy, and in research (contributing to the body of knowledge)? What is the impact upon society (influencing public attitudes, affecting the quality of life)? Are these implications consistent with the findings and conclusions of the paper?

Robustness or additional analyses – please demonstrate how your findings are to alternative measures (e.g., different ways of measuring the key dependent and independent variables), estimations (e.g., Generalised Least Square regressions, Fixed or random effects regressions, etc), and general endogeneities. The authors should look at the use of input distance functions as a robustness check. The use of input distance function can be used to address the limitations of the existing model of SFA. These are lacking in the paper.

Finally, there are many instances where (a) the authors make a relative statement but do not indicate what the comparison is against and (b) comments are made which don't add anything to the argument.

 

Response 4: The stochastic frontier approach significantly improves the analysis of the profitability of the banking system. This is particularly important for China because of the need to assess the results of reforms and the results of economic regulation, which may affect the interests of commercial banks. The analysis of the profitability of the banking system should be based on the prevailing level of profitability, which is determined by the prevailing frontier; the deviation of the banks' positions from the frontier allows us to identify trends in profitability. When analyzing profitability, it is also necessary to take into account the cost situation, which will make it possible to determine the reasons for changes in the profitability situation. The Chinese banking system includes different types of banks with different resource acquisition, asset allocation, and technological capabilities. When characterizing the dynamics of profitability and cost efficiency by type of bank, the following points can be highlighted. State-owned commercial banks are leaders in profitability efficiency, while cost efficiency is at a higher but better level. The position of these banks does not require attention to cost management. After 2015, national joint-stock commercial banks had to compete for the market with systemic, municipal, and shadow banks. This harmed the performance of profitability. It can be concluded that national joint-stock commercial banks were able to manage their business efficiently, but they could not fully control their profitability due to the dramatic changes in the financial markets and the slowdown in economic growth. The profitability and economic efficiency of city banks are similar to those of joint-stock banks. City banks work with small companies and individuals in smaller cities where there is less competition from joint-stock and systemic banks. China's cities have a large concentration of manufacturing, logistics, and financial institutions, all of which are growing. City residents are financially literate and responsive to new banking products. This has forced city banks to improve their customer service techniques, which has affected their efficiency. The profitability and economic efficiency of agricultural banks remain high and stable. We believe that the reason for this stability is related to the fact that the customers of these banks are tied to the domestic market and do not depend on external factors; agricultural banks use rather conservative products, such as loans and deposits, and securities that are less dependent on market factors. The rural development programs are subsidized by the state, which provides a stable income for the agricultural banks. Foreign banks' performance has remained stable and has been increasing since 2015. This can be explained by the fact that their core business is not tied to Chinese lending rates, they do not need to adapt to Chinese reforms, and the demand for services from foreign companies is increasing. The profit efficiency and cost efficiency of foreign commercial banks have increased between 2012 and 2020. Thus, different types of Chinese banks, depending on their characteristics, show different behavior but follow some common trends. The decline in profitability is due to both external economic and political reasons and internal factors related to changes in the structure of the stock market and financial sector reforms.

From the regulator's perspective, the focus should be on the performance of joint-stock banks, as well as on the factors of deterioration in the efficiency of different types of banks. Given the increasing volatility of profitability and cost efficiency, it is necessary to understand the position of outsiders and the reasons for their declining efficiency.

 

Point 5: Minor Comments. The abstract can be improved further. It is critical to write a complete but concise description of the author(s)’s work to entice potential readers into obtaining a copy of the full paper. The author(s) should follow a checklist consisting of motivation, problem statement, approach, data, results, and conclusions.

I found myself quite confused reading statements that were not well explained or did not provide examples to support what was being stated. For example, on page 1, the authors mentioned “The interest rate difference between the actual profit of the assessed bank and the maximum profit of the frontier bank's operations.”  This statement is incomplete and confusing.

Similarly on page 2, the authors should explain with evidence why the current focus of Chinese banking regulators is on systemic risks, such as non-performing assets, and strengthening risk-prevention measures, while neglecting the issue of bank profits and efficiency. What corresponding profit efficiency model agrees well with the stochastic frontier approach?

On page 7, the authors mentioned “In terms of static methods, we should conclude that there is a decrease in profitability and give a negative assessment, but this would not correspond to the actual result. This needs to be taken into account in the analysis.”  This statement is confusing.

What does the Chinese economy is manageable in the public interest mean?

On page 11, the authors mentioned “There is a spread between 450 rural banks, urban banks, and joint-stock banks, possibly related to the stimulus processes 451 undertaken by the government.”  What are the stimulus processes?

There are many more such confusing statements in the paper.

 

Response 5: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. The manuscript has been thoroughly revised and edited by a native speaker, so we hope it can meet the journal's standards.

Thanks so much for your useful comments. The banking system in China is a highly concentrated segment (Vo Phuong Mai Le et al. 2022). Half of the banking system's assets are owned by large commercial banks. The share of foreign banks is negligible. Large commercial banks also hold over 60% of deposits and up to 50% of loans. It is the large commercial banks that are the core of the banking system and they should be the focus of economic analysis. These are the large state-owned joint-stock banks, known as state-owned commercial (SO) banks. Their shares are traded on various stock exchanges in Shanghai, Shenzhen, and Hong Kong. A characteristic of SOCBs is that they focus on financing large infrastructure and important projects for the country. In addition, they have many bank branches and also successfully compete with other types of commercial banks by providing banking services to households and companies.

The government can stimulate certain banking groups to develop infrastructure projects (large state-owned commercial banks play an important role here), to develop wealth in rural areas (rural banks play an important role here), and to develop business in cities (city banks). Thus, the profitability of some banks can be very high, not only due to their efficient functioning but also as a result of government stimulus measures, which promotes their development.

Our sample covers 239 Chinese banks over the period from 2012 to 2020, the data is annual., with a total of 1719 observations. The analysis includes all banks with at least eight years of complete data. We tested our data against theoretical requirements and verified their correctness; incorrect data were removed. The sample comprises 6 state-owned commercial banks, 12 national joint-stock commercial banks, 61 rural commercial banks,130 city commercial banks, and 30 foreign commercial banks.

Thank you so much for your careful check, we have recorrected the abstract.

 

Author Response File: Author Response.docx

Reviewer 3 Report

The authors should consider the following recommendations in order to improve the original manuscript:

- The abstract should be more consistent with the main text of the paper, preferably structured, simple, specific, clear and unbiased. For instance please explain in detail the reason why this analysis has been conducted „over the period 2012-2020” (that is, from January 2012 to December 2020 or readers can decide to imagine based on the lack of explanations ?!?). Currently we are in the middle of January 2023, so the existing gap must be explained.

- The keywords are only 4 and should not overlap with the title of this paper. Please provide more relevant keywords.

- The authors also did not provide sufficient evidence on literature review to support the hypotheses. The Introduction section also includes the Literature review section which is practically non-existent being mentioned only a few bibliographic references quite uncorrelated while is full of equations/ mathematical formulas and figures. For instance, there are authors cited multiple times (see Allen et al.) while relevant and recent research studies are ignored.

- Authors should take into consideration much more recent publications in the sphere of discussed subject matter, especially studies conducted during the last 2 years. Please discuss more about Covid-19 pandemic which also started in China, caused by Severe Acute Respiratory Syndrome Coronavirus 2 (SARS-CoV-2) and its impact on economy, financial and social environment. You can not ignore Covid-19 pandemic but to argue that the results of the research study are relevant and significant.

 I suggest extending the literature section by including more relevant studies such as:

a)       Wanke, P., Azad, M.A.K., Karbassi Yazdi, A., Birau, F.R. &Spulbar, C.M. (2022) Revisiting CAMELS Rating System and the Performance of ASEAN Banks: A Comprehensive MCDM/Z-Numbers Approach, IEEE Access, vol. 10, pp. 54098-54109, 2022, doi: 10.1109/ACCESS.2022.3171339.

- Authors claimed that “a valid sample of 240 banks was selected (The sample used for the calculations includes data from 328 representative banks and financial institutions in the PRC, of which 244 banks are all banks at the end of 2020”. Please explain in detail this paragraph.

Compared to “The sample used for the calculations includes data from 328 representative banks and financial institutions in the PRC (of which 240 are banks) - all banks at the end of 2020” (rows 420-422).

- Deepen the description of the limitations of conducted research and indicate the trends for further empirical research.

- Authors argued that “In contrast to previous studies, we have been able to present the source for commission services as the amount of capital raised, but to identify its role as a factor influencing the demand for commission services.” Which previous studies, please provide evidence? Moreover, do you suggest this is 100% original approach, no other similar research study in the literature?!?  

- To expand the managerial implications in the article.

- The sources must be added under each figure and table.

- Human proofreading, English grammar and spelling correction are also required in order to improve the quality of the manuscript.

- The editing of this paper is a complete mess and does not follow the instructions for authors based on the standards of "Instructions for authors" provided by JRFM.

 

Author Response

Response to Reviewer 3 Comments

 

Point 1: The authors should consider the following recommendations in order to improve the original manuscript:

- The abstract should be more consistent with the main text of the paper, preferably structured, simple, specific, clear and unbiased. For instance, please explain in detail the reason why this analysis has been conducted „over the period 2012-2020” (that is, from January 2012 to December 2020 or readers can decide to imagine based on the lack of explanations ?!?). Currently we are in the middle of January 2023, so the existing gap must be explained.

 

Response 1: Thank you for pointing out this problem in the manuscript. Data for 2023 and 2022 are currently not available in the database of Orbis Bank Focus, Bureau van Dijk, and concerning 2021 data, the data for 2021 is temporarily not available for Russia due to objective factors. The data for China for 2012-2020 are representative, and this interval includes key years of China's economic development: the stock market crisis in 2015, the completion of interest rate liberalization in 2014-2015, and the US-China trade issues in 2018. At the end of 2020, 6 state-owned commercial banks owned almost 95% of the total assets of Chinese commercial banking institutions. Thus, we believe that our sample offers a good representation of the overall Chinese banking market. The data are mainly drawn from ORBIS international bank database. These data are double-checked against other data sources such as the CBRC’s database.

 

Point 2: - The keywords are only 4 and should not overlap with the title of this paper. Please provide more relevant keywords.

 

Response 2: We appreciate it very much for this good suggestion, and we have done it according to your ideas. Keywords: bank profitability; stochastic frontier approach; commercial bank; ROA; ROE; profit efficiency; cost efficiency.

 

Point 3: - The authors also did not provide sufficient evidence on literature review to support the hypotheses. The Introduction section also includes the Literature review section which is practically non-existent being mentioning only a few bibliographic references quite uncorrelated while is full of equations/ mathematical formulas and figures. For instance, there are authors cited multiple times (see Allen et al.) while relevant and recent research studies are ignored.

- Authors should take into consideration much more recent publications in the sphere of discussed subject matter, especially studies conducted during the last 2 years. Please discuss more about Covid-19 pandemic which also started in China, caused by Severe Acute Respiratory Syndrome Coronavirus 2 (SARS-CoV-2) and its impact on economy, financial and social environment. You can not ignore Covid-19 pandemic but to argue that the results of the research study are relevant and significant.

 

Response 3: Thank you for the above suggestion. The impact of the Covid-19 pandemic on the profitability and efficiency of Chinese banks, we leave these issues for further study given the limitations of the available data. Data for 2023 and 2022 are currently not available in the database of Orbis Bank Focus, Bureau van Dijk. After the outbreak of the new crown pneumonia epidemic, the Chinese government took unprecedented measures to contain the adverse effects of the epidemic. Relevant measures have effectively curbed the spread of the epidemic across the country. So, “2012-2020” may be more suitable as the period.

 

Point 4: I suggest extending the literature section by including more relevant studies such as:

10. a) Wanke, P., Azad, M.A.K., Karbassi Yazdi, A., Birau, F.R. &Spulbar, C.M. (2022) Revisiting CAMELS Rating System and the Performance of ASEAN Banks: A Comprehensive MCDM/Z-Numbers Approach, IEEE Access, vol. 10, pp. 54098-54109, 2022, doi: 10.1109/ACCESS.2022.3171339.

 

Response 4: Thank you very much for the article which was so helpful that we added it to the reference section and rewrote the literature review section.

 

Point 5: - Authors claimed that “a valid sample of 240 banks was selected (The sample used for the calculations includes data from 328 representative banks and financial institutions in the PRC, of which 244 banks are all banks at the end of 2020”. Please explain in detail this paragraph.

Compared to “The sample used for the calculations includes data from 328 representative banks and financial institutions in the PRC (of which 240 are banks) - all banks at the end of 2020” (rows 420-422).

 

Response 5: Data: Our sample covers 239 Chinese banks over the period from 2012 to 2020, the data is annual., with a total of 1719 observations. The analysis includes all banks with at least eight years of complete data. We tested our data against theoretical requirements and verified their correctness; incorrect data were removed. The data for China for 2012-2020 are representative, and this interval includes key years of China's economic development: the stock market crisis in 2015, the completion of interest rate liberalization in 2014-2015, and the US-China trade issues in 2018. At the end of 2020, 6 state-owned commercial banks owned almost 95% of the total assets of Chinese commercial banking institutions. Thus, we believe that our sample offers a good representation of the overall Chinese banking market. The data are mainly drawn from ORBIS international bank database. These data are double-checked against other data sources such as the CBRC’s database. All financial variables are measured in dollars (USD), and denoted n thousands.

 

Point 6: - Deepen the description of the limitations of conducted research and indicate the trends for further empirical research.

- Authors argued that “In contrast to previous studies, we have been able to present the source for commission services as the amount of capital raised, but to identify its role as a factor influencing the demand for commission services.” Which previous studies, please provide evidence? Moreover, do you suggest this is 100% original approach, no other similar research study in the literature?!? 

 

Response 6: In the literature on bank efficiency, there are many ways to measure the inputs and outputs of banks: the production approach, the intermediation approach, and the operating approach (Coelli, T. J., Rao, D.S.P., & Battese 2005). Our study uses the intermediation approach. The intermediation approach, proposed by (C. W. Sealey and Lindley 1977), viewed the bank as an intermediary that collects customer deposits and grants loans. The bank acts as an intermediary, collecting funds from savers and converting these funds into profit-generating items (loans, etc.). The approach is consistent with the concept of the bank as a financial intermediary and the data required to implement the approach are readily available. (Allen N. Berger and David B. Humphrey 1997) highlight the advantages of stochastic frontier methods over traditional measures of efficiency (e.g., return on assets) because they take into account both relevant bank inputs and outputs and differences in input prices, they believe that the intermediary approach is more appropriate for measuring the efficiency of the bank as a whole.

Input-output between productivity (input-output ratios) and profitability: This study analyzes the profit efficiency and cost efficiency of the Chinese banking industry over the period 2012-2020. Efficiency scores are calculated by estimating a model with three inputs (Loans, Other Earning Assets, Non-interest income) and two outputs (Price of loanable funds, Price of capital). Profit efficiency is the ratio of actual observed bank profits to the maximum level of potential efficient bank profits. Cost efficiency is the ratio of the minimum level of potentially efficient banks' costs to the actual observed level of banks' costs. In this paper, profit efficiency is used to measure bank profitability. When analyzing profitability, it is also necessary to take into account the cost situation, which will make it possible to determine the reasons for changes in the profitability situation. Cost efficiency is used to assist in analyzing bank profitability.

 

 

Point 7: - Deepen the description of the limitations of conducted research and indicate the trends for further empirical research.

- Authors argued that “In contrast to previous studies, we have been able to present the source for commission services as the amount of capital raised, but to identify its role as a factor influencing the demand for commission services.” Which previous studies, please provide evidence? Moreover, do you suggest this is 100% original approach, no other similar research study in the literature?!? 

 

Response 7: In the literature on bank efficiency, there are many ways to measure the inputs and outputs of banks: the production approach, the intermediation approach, and the operating approach (Coelli, T. J., Rao, D.S.P., & Battese 2005). Our study uses the intermediation approach. The intermediation approach, proposed by (C. W. Sealey and Lindley 1977), viewed the bank as an intermediary that collects customer deposits and grants loans. The bank acts as an intermediary, collecting funds from savers and converting these funds into profit-generating items (loans, etc.). The approach is consistent with the concept of the bank as a financial intermediary and the data required to implement the approach are readily available. (Allen N. Berger and David B. Humphrey 1997) highlight the advantages of stochastic frontier methods over traditional measures of efficiency (e.g., return on assets) because they take into account both relevant bank inputs and outputs and differences in input prices, they believe that the intermediary approach is more appropriate for measuring the efficiency of the bank as a whole.

Input-output between productivity (input-output ratios) and profitability: This study analyzes the profit efficiency and cost efficiency of the Chinese banking industry over the period 2012-2020. Efficiency scores are calculated by estimating a model with three inputs (Loans, Other Earning Assets, Non-interest income) and two outputs (Price of loanable funds, Price of capital). Profit efficiency is the ratio of actual observed bank profits to the maximum level of potential efficient bank profits. Cost efficiency is the ratio of the minimum level of potentially efficient banks' costs to the actual observed level of banks' costs. In this paper, profit efficiency is used to measure bank profitability. When analyzing profitability, it is also necessary to take into account the cost situation, which will make it possible to determine the reasons for changes in the profitability situation. Cost efficiency is used to assist in analyzing bank profitability.

 

Point 8: - - To expand the managerial implications in the article.

 

Response 8: We totally understand the reviewer's concern. Historically, the scientific basis for the construction of production functions was the neoclassical theory of the firm, according to which, in a perfect market, firms had equal access to both resources and sales and competed with each other by reducing individual costs. As was shown later, this was not consistent with practice, in particular, the role of agents was not taken into account. The development of management theory led to an un-derstanding of the role of managerial factors in firm performance. Results of behavioral theory led to understanding of importance of harmonious development of organization, consideration of interests of all interested groups and influence of external factors. This is especially important for banks because the activity of these organizations is socially important, it is based on trust of clients, it is regulated and requires careful consideration of stakeholders' opinion. We believe that the stochastic frontier approach to assessing the profitability of commercial banks not only assesses the bank's profitability relative to the leading banks in the industry but also takes into account the specific circumstances of the management techniques used and the market environment. Control parameters. Risk management is a fundamental element of commercial banks' management. Central banks regulate these risks in the activities of commercial banks through capital adequacy risk, as recommended by BASEL 3. (Peter Wanke et al. 2022)provided a new perspective on the performance of banks in ASEAN member countries, arguing that capital adequacy, asset quality (especially credit quality) are key determinants of banks' financial position and profitability. Bank management may expose the organization to high risk to provide higher profitability to investors. Bank liquidity and bank profitability are interacting(Nicolae Petria 2015). (Ahmad Abu-Alkheil 2018)found that liquidity risk affects placing some assets in non-recoverable form, and reducing liquidity risk leads to lower profitability. Klein (2022) argues that banks' profitability is affected by asset size, which promotes economies of scale on the one hand, and by the fact that larger banks have access to cheaper resources and more reliable funding on the other [Paul-Olivier Klein, Laurent Weill, 2022],(Paul Vera-Gilces 2020). The table shows the control parameters.

 

Point 9: - The sources must be added under each figure and table.

 

Response 9: Thank you so much for your careful check. We have corrected all figures and tables and added data sources. All figures and tables have been reinterpreted.

 

Point 10: - - Human proofreading, English grammar and spelling correction is also required in order to improve the quality of the manuscript.

- The editing of this paper is a complete mess and does not follow the instructions for authors based on the standards of "Instructions for authors" provided by JRFM.

 

Response 10: We are very sorry for the mistakes in this manuscript and the inconvenience they caused in your reading. The manuscript has been thoroughly revised and edited by a native speaker, so we hope it can meet the journal's standards. Thanks so much for your useful comments.

Author Response File: Author Response.docx