| Summary: | Abstract
This paper uses the parametric distance function to analyse the efficiency of the banking sector of Hong Kong by taking into account risk management factors. A sample data for the banks during the period 2005 to 2011 is used. Variables like loan loss provisions (LLP), equity and non-performing loans are included to control for risk. Based on the work of Mester (1996), this paper shows that ignoring risk preferences will not give an accurate estimation of the efficiency level of banks. Moreover, the impact of the recent subprime crisis on the banking sector of Hong Kong is observed and whether proper risk management techniques were adopted during that particular period to mitigate the impact of the crisis. Results show that excluding risk management variables overestimate the efficiency level of banks. It has also been found that the banking sector of Hong Kong has been able to weather the recent global financial crisis and performed above average compared to other economies worldwide. Efficiency scores have been observed to have an upward trend, majorly due to the fact that the regulatory and supervisory framework of the country has been drastically updated after the Asian financial crisis of the late 90s and the banking sector of Hong Kong was therefore better prepared to face any financial instability.
Key Words: Parametric Distance function, subprime financial crisis, risk management, efficiency estimates, HKMA, Loan Loss Provisions
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