The impact of financial integration on banking system efficiency in ASEAN countries

Financial integration is a situation in which financial markets of countries around the world are closely linked together through the process of banking deregulation, capital account liberalization and financial openness. In theory, the liberalized financial system would stimulate higher competition, increase the flows of funds into the domestic banking system and improve the efficiency of the financial intermediation process. The objective of the study is to determine the impact of financial integration on the banking system efficiency for five major economies in ASEAN countries. This study employs the unbalanced panel data for five selected ASEAN countries, which are Malaysia, Indonesia, Philippines, Singapore and Thailand between the periods of 2004 to 2014. The dependent variables for this study is banking system efficiency which is represented by the bank net interest margin to total earning assets ratio, the main independent variable is the financial integration and the control variables are inflation, economic growth rate, income group and real interest rate. The study discovers the positive relationship between financial integration and banking system efficiency for five ASEAN countries. In addition, the study also finds the positive link between inflation and banking system efficiency while the higher and middle income countries have a better efficiency performance as compared to the lower and middle income group. In contrary, the economic growth rate is found to have a negative relationship with the banking system efficiency. In addition, the result argues that the real interest rate is not one of the factors that determine the banking sector efficiency. For the robustness model, the bank overhead costs to total assets ratio (operational cost) is employed as the dependent
variables to measure the banking system efficiency. Despite of using the bank overhead costs to total assets ratio as the dependent variable, the findings support the earlier conclusion that the financial integration, inflation and income group enhance the banking sector efficiency. Therefore, these findings would assist the policy makers in assessing the effectiveness of the current regulations on the financial integration.