Omega 37 (2009) 930 -- 941

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Omega
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Opening the black box of efficiency analysis: An illustration with UAE banks
Necmi K. Avkiran
UQ Business School, The University of Queensland, 11 Salisbury Road, Ipswich QLD4305, Australia

A R T I C L E

I N F O

Article history:
Received 26 January 2008
Accepted 12 August 2008
Available online 21 September 2008
Keywords:
Network DEA
Efficiency
Simulation
Banking

A B S T R A C T

Standard data envelopment analysis (DEA) does not provide adequate detail to identify the
specific sources of inefficiency embedded in interacting divisions of an organization. On the
other hand, network DEA gives access to this underlying diagnostic information that would
otherwise remain undiscovered. As a first study of its kind, the paper illustrates an application of non-oriented network slacks-based measure using simulated profit center data
that, in turn, rely on actual aggregate data on domestic commercial banks in the United
Arab Emirates (UAE). The study also contributes to a perennial research problem, namely,
inability of the outside researcher to access internal data for developing or testing new
methods. In addition to these contributions to the Operations Research literature, focusing
on UAE contributes to banking literature because this rapidly expanding part of the Middle
East seldom appears in frontier efficiency literature.
2008 Elsevier Ltd. All rights reserved.

1. Introduction
In the dynamic, innovative, global environment of today,
organizations are invariably complex and yet, they need to
be flexible enough to deliver their promised outcomes to
an assortment of stakeholders. Furthermore, in the presence of cyclical economic conditions and uncertain federal
budgets, identifying inefficiencies becomes more critical for
long-term survival. The need for identifying inefficiencies
holds equally true for non-profit, as well as for profit-making
organizations.
Another argument in support of identifying inefficiencies
is its contribution to organizational learning. An organization that is not constantly acquiring knowledge, sourced internally from various divisions, or externally, is condemned
to lose its competitive advantage. As Bartlett and Ghoshal
[1, p. 35] eloquently argue, the focus of managers is shifting from strategic planning to organizational learning, that
is, how to develop the organizational capability to sense

This manuscript was processed by Area Editor B. Lev.

Tel.: +61 7 33811216; fax: +61 7 33811227.
E-mail address: n.avkiran@business.uq.edu.au (N.K. Avkiran).

0305-0483/$ - see front matter 2008 Elsevier Ltd. All rights reserved.
doi:10.1016/j.omega.2008.08.001

and respond rapidly and flexibly to change. The current

study argues that responding to change can be more effective if management knows where the operational inefficiencies are located. Thus, efficiency analysis of organizational
divisions can be an integral part of organizational learning
and a source of competitive advantage.
Banking industry, the focus of the empirical application
in this paper, suffers from commoditization. While innovation is the solution to overcome the stifling effect of commoditization on the bottom line, innovation is somewhat
restrained in the banking sector due to the sector's highly
regulated nature. Yet, in the medium term, the change in
banking organizational structures is from a vertical integration toward a more complex network of independent
specialist partners such as clearing houses, mortgage originators, call centers, ATM operators, and so on. Ultimately,
there is a need to identify sources of inefficiency in the most
effective manner to ensure that the potential for improved
performance is not overlooked.
The main purpose of this paper is to illustrate a seldomutilized non-parametric analysis technique called network
data envelopment analysis (NDEA) in the context of banking. Data envelopment analysis (DEA), a well-established

N.K. Avkiran / Omega 37 (2009) 930 -- 941

Head Office

Front Office

931

Back Office
(often shared with
other competitors)

Risk management

Turning the leads and referrals

check clearance

Legal compliance

into sales and serving the ongoing

ATMs, etc.

Corporate planning

financial needs of customers

mortgage

Product innovation

through:

Marketing

Bank branches

Communications and

Internet banking

origination

Phone banking (sometimes

public relations

outsourced to call centres)

Human resources
Information
technology
Auditing
General
administration, etc.

Fig. 1. A general functional organization for commercial banks.

benchmarking technique that measures relative efficiency,

can be a part of the management's toolkit in identifying inefficiencies and potential improvements in an effort to maintain a sustainable competitive advantage (see Section 3.1 for
more details on DEA). Yet, as DEA continues to enjoy increasing popularity, a substantial number of publications fail to
take full advantage of the benchmarking capabilities of this
non-parametric technique. Many published applications of
DEA principally report the overall profile of a sample and
potential improvements at the organizational level.
In short, standard DEA does not provide sufficient detail for management to identify the specific sources of inefficiency embedded in interactions among various divisions
that comprise the organization. Fortunately, NDEA provides
the investigator with a method to pinpoint whether the overall inefficiency observed in a decision-making unit (DMU)
resides in its head office or in one of its other functions (see
Fig. 1). Theoretically, each function and its sub-category can
be treated as a sub-DMU. For example, sub-categories under
the head office can be treated as sub-DMUs whose intermediate outputs become inputs for the front office sub-DMUs.
Similarly, the intermediate outputs from the front office subDMUs become inputs for the back office sub-DMUs. Fa re and
Grosskopf [2] define an intermediate product as an item that
is an output from a sub-DMU that becomes an input for another sub-DMU in the network.
Thus, unlike standard DEA, NDEA can provide insight to
the specific sources of organizational process inefficiency
and enable management to devise targeted remedial action.
In other words, NDEA permits a fuller access to the underlying diagnostic information that would otherwise remain
outside management's reach in what Fa re and Grosskopf
[3] refer to as the black box. Nevertheless, application of
NDEA in the context of the functional framework represented in Fig. 1 is not practical unless the exercise is undertaken by someone who has full access to internal managerial

accounting records. Formulating the numerous interactions

amongst the multiple functions and their corresponding
sub-functions would require an extensive internal audit
of business processes and development of a transfer pricing framework based on the principles of responsibility
accounting (responsibility accounting requires costs and
revenues to be traced to those divisions that are responsible
for them; see [4]). In recognition of this practical problem,
section 2.2 revisits the process of identifying sub-DMUs.
Briefly, the paper identifies profit centers (sub-DMUs)
and their corresponding expenses and revenues for the
purpose of illustrating NDEA. In the empirical illustration,
a DMU is a domestic commercial bank in the United Arab
Emirates (UAE) and sub-DMUs are key profit centers therein.
In so doing, we analyze the profit efficiency of a bank from
a managerial accounting perspective, rather than focusing
on physical or functional divisions. An introduction to the
UAE, which forms the backdrop to the empirical application,
follows.
UAE is a federation established in 1971, comprised of
the following emirates: Abu Dhabi (capital), Dubai, Sharjah, Ajman, Umm Al-Qiwain, Ras Al-Khaima, and Fujeirah.
UAE is a region of rapid economic growth helped by an
extensive banking system, strategically positioned at the
entrance to the Persian Gulf. In 2005, its non-hydrocarbon
sector recorded an 11% growth in real GDP [5]. The same
IMF report refers to the banks' profits doubling in 2005
($5.1 billion), with non-interest income accounting for about
one-third of the industry's income. This sharp rise in bank
profits has been mostly attributed to banks' involvement in
initial public offerings and investments in equity markets.
Non-interest income is one of the two output variables in
the paper's core profit efficiency model (see Section 2.1 for
more details).
Another reason for choosing the UAE banking sector for
the empirical example is the small amount of attention it

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N.K. Avkiran / Omega 37 (2009) 930 -- 941

has received in refereed journals. Notwithstanding any conference presentations, there were only two refereed publications that study UAE banks' relative efficiency at the time
of writing this paper. Ramanathan [6] focuses on the countries of the Gulf Cooperation Council (which includes UAE)
and reports a straightforward single-stage, cross-sectional
application of DEA, and a separate Malmquist productivity index analysis. On the other hand, Rao [7] examines
the cost frontier efficiency of UAE commercial banks (national and foreign) through stochastic frontier analysis. Also
worth mentioning is the paper by Al-Tamimi and Lootah
[8] who investigate operational and profitability efficiency
of the branch network of a single-UAE bank using standard
constant-returns-to-scale DEA.
This innovative study takes the current applications of
DEA to a higher level of sophistication. In summary, there is
a substantial scope for identifying hitherto undetected inefficiencies. Initially, the paper assesses the profit efficiency of
domestic commercial banks in UAE for the fiscal year ending 31 December 2005 using standard DEA in the form of
slacks-based measure (SBM) (see Tone [9], and Morita et al.
[10]). Then the paper demonstrates network slacks-based
measure (NSBM) based on simulated profit center data.
Rest of the paper is structured as follows. Section 2 outlines the conceptual framework. Section 3 is dedicated to
methodology, starting with an overview of DEA, and continuing with details on formulations of NDEA, NSBM and data
simulation. Section 4, results and analysis, is sub-divided
into profit efficiency analysis using SBM and NSBM. Finally,
Section 5 offers concluding remarks.
2. Conceptual framework
2.1. Modeling profit efficiency
In banking, a DMU is often described as either a bank
or a bank branch, although the investigator can conceivably
build a sample by collecting inputoutput data on any identifiable organizational unit (physical or otherwise). While
DEA's ability to capture the interaction among multiple inputs and multiple outputs is its distinctive advantage over
traditional ratio analysis, it suffers from a certain loss of information when data are aggregated at bank level. For example, when non-interest income (fee income) generated in
a bank is used as one of the outputs in DEA, it is impossible to tell which of the profit centers is the main source of
inefficiency. Such an investigation would normally require
going beyond standard DEA and undertaking additional examination of operations as part of an internal audit exercise.
NDEA can assist in this type of in-depth organizational network investigation.
The study follows the common assumption that the
banks' organizational performance can be investigated under the bank behavior model of intermediation (also known
as the asset approach after Sealey and Lindley [11]), where
deposits are converted into loans. This intermediation process can be summarily captured by the proxy inputs of
interest expense (xie ) and non-interest expense (xnie ), and
outputs of interest income (yii ) and non-interest income
(ynii ). This approach effectively measures the banks' profit

Table 1
Gross credit extended by UAE banks (x000,000 AED)a .
Credit categories or profit centers

2005 total

Percent of
grand total

Loans, advances, and overdrafts (LAO)

Mortgaged real estate loans (MREL)
Discounted commercial bills (DCB)
Grand total bank credit

361,564
17,518
15,811
394,893

91.56
4.44
4.00
100.00

AED: United Arab Emirates Dirham.

efficiency because the variables are costs and revenues as

per banks' profit and loss statements. Consistent with the
approach recommended by Dyson et al. [12], this parsimonious inputoutput set is considered appropriate for covering the full range of resources used and outputs created,
while providing adequate discriminatory power. Examples
of other studies where this selection of variables have been
used include: Charnes et al. [13], Yue [14], Miller and Noulas
[15], Bhattacharyya et al. [16], Brockett et al. [17], Leightner
and Lovell [18], Avkiran [1921], and Sturm and Williams
[22]. For a recent example of DEA in measuring profit efficiency outside the banking sector, please see Cherchye and
van Puyenbroeck [23].
2.2. Key profit centers and estimating corresponding data
Based on the latest annual report from the central bank
of UAE [24], Table 1 summarizes the principal credit categories or profit centers. Proportions corresponding to the
profit centers later on become weights in NSBM acting as
proxies for the importance of various lending business generated by the average UAE bank.
Next, the functional structure originally illustrated in Fig.
1 is re-cast in light of the information presented in Table 1.
Fig. 2 (adapted from Fig. 4 in [2]) shows the links among
the three main profit centers by identifying the exogenous
inputs, intermediate products and final outputs in a fivenode production network. Exogenous inputs such as risk
management, human resources, information technology, and
general administration would normally comprise the key
non-interest expenses. Cost of funds, which would be valued
by internal funds transfer pricing (FTP), becomes the key
interest expense for the profit centers loans, advances, and
overdrafts (LAO), mortgaged real estate loans (MREL), and
discounted commercial bills (DCB). Final outputs are comprised of sales of products and services in the current period, captured by the interest income and non-interest income
flows generated by such sales.
Opening the black box to expose the network of subDMUs, can reveal, for example, instances of cross-selling
where business people opening an overdraft facility with the
bank are encouraged to take out a mortgage as well. Such
referrals represent intermediate outputs from the profit center 1 that become intermediate inputs to the profit center 3. Bank's internal activity-based costing systems (ABC)
would recognize such referrals as non-interest revenue for
the profit center 1, and non-interest expense for the profit
center 3 for setting up and maintaining the accounts. In
this study, NSBM measures the network production system,
where the intermediate outputs and the intermediate inputs

N.K. Avkiran / Omega 37 (2009) 930 -- 941

933

Production process P for DMU j showing three profit centres as sub-DMUs

LAO-1

3
x
0

Exogenous
0
Inputs, x

4
y
1

3
y (3x)*
1 1

1
x
0

MREL - 3

4
y
3

Final
Outputs, y

4
y
2

2
0x

DCB - 2

Fig. 2. Opening the black box: network sub-DMUs. Notes: Inputs are denoted by x and outputs are denoted by y, where the subscript number identifies
the origin and the superscript identifies the destination. Asterisks indicates an intermediate output from a sub-DMU that becomes an intermediate input
for another sub-DMU. LAO: loans, advances and overdrafts; MREL: mortgaged real estate loans; DCB: discounted commercial bills.
Table 2
Inputs and outputs for the profit centers (sub-DMUs) .
LAO (1)

MREL (3)

DCB (2)

Inputs (interest and

non-interest expenses)

Outputs (interest and

non-interest income)

Inputs (interest and

non-interest expenses)

Outputs (interest and

non-interest income)

Inputs (interest and

non-interest expenses)

Outputs (interest and

non-interest income)

1
0 xie

4
1 yii

3
0 xie

4
3 yii

2
0 xie

4
2 yii

4
1 ynii

3
0 xnie

4
3 ynii

2
0 xnie

4
2 ynii

3
a
1 ynii

3
b
1 xnie

1
0 xnie

LAO (loans, advances, and overdrafts); MREL (mortgaged real estate loans); DCB (discounted commercial bills).
a
Intermediate output.
b
Intermediate input resulting from intermediate output; interest expense (ie); non-interest expense (nie); interest income (ii); non-interest income (nii).
Subscript numbers indicate the origin for a variable and superscripts indicate the destination.

are treated as discretionary variables representing non-core

profit center activities. According to Fa re et al. [25], Fig. 2,
which represents a static model, is helpful in investigating
the impact of intermediate products. The various inputs and
outputs that flow from Fig. 2 are summarized in Table 2 for
each profit center.
The separation model in Fig. 3 highlights what happens
to the organization's production process if interactions between divisions are ignored. In short, the intermediate input
in Fig. 2 now becomes an exogenous input for MREL and the
intermediate output becomes a final output for LAO. Fig. 3
depicts the three profit centers as independent production
processes.
2.3. Extant NDEA literature
Only five applications of NDEA were found in refereed
academic journals and none are in banking and finance.

These are: Lothgren

and Tambour [26] on pharmacies;

Lewis and Sexton [27] on baseball; Prieto and Zofio [28]

on economies of OECD countries; Sheth et al. [29] on bus
routes; and, Yu and Lin [30] on railways. Primarily methodology publications include Fa re and Grosskopf [2,3,25] and
Hua and Bian [31]. Below we briefly review the five applications and cite the methodological publications throughout
the paper only when relevant. Fa re and Grosskopf's [2]
static NDEA is detailed in Section 3.1.

Lothgren
and Tambour [26] apply the NDEA introduced
in Fa re and Grosskopf [3] to modeling production and consumption activities in pharmacies. They employ Malmquist
indices to capture productivity change. The paper's results
indicate a lower productivity progress with NDEA than the
standard DEA model, and technical change accounts for most
of the observed progress. On the other hand, Lewis and Sexton [27] demonstrate the advantages of NDEA over standard
DEA using the Major League Baseball as their setting. The authors point out how their NDEA modeling differs from that

934

N.K. Avkiran / Omega 37 (2009) 930 -- 941

1
x
0

4
y
1

LAO - 1

3
x*
0
3
x
0

MREL - 3

2
x
0

4
y
3

Final outputs
4

Exogenous inputs
0

4
y*
1

4
y
2

DCB - 2

Fig. 3. Separation model. Notes: Inputs are denoted by x and outputs are denoted by y, where the subscript number identifies the origin and the superscript
identifies the destination. Asterisks indicates the previously intermediate products. LAO: loans, advances and overdrafts; MREL: mortgaged real estate
loans; DCB: discounted commercial bills.

of Fa re and Grosskopf [2] who define the reference set for a

DMU as the set of all convex linear combinations of DMUs;
Lewis and Sexton [27] define the reference set based on the
hypothetical sub-DMUs identified for each sub-DMU. More
importantly, the authors point out that NDEA does not guarantee organizationally efficient DMUs as one would expect
with standard DEA; the same observation can be made about
the results seen in the current paper (see Section 4.2). According to Lewis and Sexton ([27], p. 1396), . . . NDEA model
allows individual DMU managers to focus specific efficiencyenhancing strategies on the individual components of the
production process.
Attempting a somewhat different approach to defining
DMUs and sub-DMUs, Prieto and Zofio [28] consider a group
of economies at country, regional, and local levels to compare relative production systems and determine efficient
benchmarks. The authors observe the standard axioms found
in Fa re and Grosskopf [3] including strong disposability of
outputs and inputs and constant returns to scale. Results
of their empirical application indicate that their model can
help determine the possible rise in final demand, as well as
show how primary inputs and intermediate products can be
reallocated.
Sheth et al. [29] and Yu and Lin [30] both apply NDEA
to measurement of transportation performance. Sheth et al.
[29] combine NDEA as outlined in Fa re and Grosskopf [3]
with goal programming. They measure the performance of
bus routes by combining the perspectives of provider, consumer, and society. Sheth et al. define the service on a bus
route as a DMU. Relationships among operations, public and
society form the linkages connecting sub-DMUs of provider
and passenger perspectives where societal perspective is
treated as an environmental variable. Yu and Lin [30]

investigate the efficiency and effectiveness of an international sample of railways where they focus on production
and consumption sides of operations. Their so-called multiactivity NDEA model simultaneously captures passenger and
freight technical efficiency, as well as service and technical
effectiveness. Yu and Lin link the multiple activities of railways with the central concept of static NDEA (i.e. intermediate products) by assuming that outputs at the production
stage become inputs in the consumption stage.
In closing Section 2, we recognize Fa re and Grosskopf `s
leadership in NDEA literature, which we also follow in the
next section. However, we further note that none of the
existing applications of NDEA has attempted the NSBM, and
that, they all use oriented models, which sets the current
paper apart from extant literature as the first illustration of
a non-oriented, non-radial measure in NDEA. Section 3.2 provides a more detailed justification for the choice of NSBM
model.

3. Methodology
3.1. Overview of DEA and NDEA
DEA (see the seminal papers by Charnes et al. [32], and
Banker et al. [33]) has been applied across a wide range
of industries as well as in not-for-profit organizations. For
brevity, a short introduction to DEA is provided and the
reader is referred to Cooper et al. [34] and Avkiran [35] for
a more in-depth treatment.
DEA is a non-parametric linear programming technique
that computes a comparative ratio of weighted outputs to
weighted inputs for each unit, which is reported as the

N.K. Avkiran / Omega 37 (2009) 930 -- 941

relative efficiency score. The efficiency score is usually

expressed as either a number between 0 and 1, or as a
percentage. A DMU with a score less than one is deemed
inefficient relative to other units. The key limitation of DEA
is that it assumes data to be free of measurement error and
thus, it is more sensitive to the presence of measurement
error than parametric techniques. There is a separate subsection of DEA literature dedicated to measurement error;
for an up-to-date paper, see Avkiran and Rowlands [36]
and the literature review therein. Next, we return to the
static network model depicted in Fig. 2 to formalize the
mathematical relationships.
In this section of the paper, we closely follow the original
notation in Fa re and Grosskopf [2]. Under the NDEA exposed
in [2], inputs and outputs corresponding to various DMUs in
the sample are required to satisfy the following properties:
xkn  0,

ykm  0,

particular profit center participates in the production process. The series of equations below shows that NDEA can be
envisaged as a group of models that share a common characteristic of having linear constraints [2] (where subscript
and superscript numbers, respectively, identify the origin
and destination of variables):
Allocation of exogenous inputs:
1 xn + 2 xn + 3 xn
0
0
0

k=1
K


xkn  0,

K

k=1

zk1  0,
n = 1, . . . , N

(2)

N


k = 1, . . . , K

(3)

k=1

i.e for every DMU, at least one input has a positive value.
K


4 ym 
2

(6a)

m = 1, . . . , M1 final output

(6b)

n = 1, . . . , N exogenous input

(6c)

zk1 31 ykm , m=1, . . ., M1 intermediate output

k = 1, . . . , K

K

k=1

K


xkn  0,

n = 1, . . . , N

(6d)
(6e)

Profit center 2:

k=1

i.e. for every input, there is at least one positive value in the
sample.

zk1 41 ykm ,

zk1 10 xkn  10 xn ,

3 ym 
1

i.e. non-negative inputs and outputs.

K


K


4 ym 
1

k = 1, . . . , K, n = 1, . . . , N
(1)

 xn ,

Profit center 1:

k=1

m = 1, . . . , M

935

k=1

zk2 42 ykm ,

zk2 20 xkn  20 xn ,

zk2  0,

m = 1, . . . , M2 final output

(6f)

n = 1, . . . , N exogenous input

(6g)

k = 1, . . . , K

(6h)

Profit center 3:
ykm  0,

m = 1, . . . , M

(4)

k=1

4 ym 
3

i.e. for every output, there is at least one positive value in

the sample.

K


M


k=1

ykm  0,

k = 1, . . . , K

(5)

k=1

i.e. for every DMU, at least one output has a positive value,
where there are k = 1, . . . ,K DMUs (banks), n = 1, . . . ,N inputs,
and m = 1, . . . ,M outputs. Thus, observations of inputs and
outputs for each DMU can be summarized by the vector (xkn ,
ykm ) = (xk1 , . . . , xkN , yk1 , . . . , ykM ). Explanations for the above
variable properties (15) can be summarized as follows: (a)
input and output values can be zero or positive; (b) there is
at least one activity (DMU) where a particular input is used
or an output is generated; and (c) each activity uses at least
one input and produces at least one output.
In Fig. 2, we open the black box of bank efficiency analysis
to reveal a network of sub-DMUs we called profit centers. A
source of exogenous inputs (node 0) supplies the profit centers (nodes 13) whose final outputs are collected in a sink
(node 4). Not all the available exogenous inputs are necessarily used up by the profit centers. Non-negative intensity
variables zk , k = 1, . . . , K, are used to capture the extent a

K


m = 1, . . . , M3 final output

(6i)

zk3 30 xkn  30 xn ,

n = 1, . . . , N exogenous input

(6j)

zk3 31 xkn  31 xn ,

n = 1, . . . , N1 intermediate input

(6k)

k=1

K

k=1

zk3 43 ykm ,

zk3  0,

k = 1, . . . , K

(6l)

Final outputs:
4 ym + 4 ym + 4 ym
1
2
3

 yn ,

m = 1, . . . , M

(6m)

The above network allows for explicit modeling of intermediate products. A more in-depth exposition of general NDEA
theory can be found in Fa re and Grosskopf [2,3], and Fa re et
al. [25]. The NSBM is explained next where the arguments
in favor of NSBM are also presented.
3.2. NSBM of efficiency
The paper uses DEA-Solver Pro software to execute
weighted NSBM assuming variable-returns-to scale and
non-orientation. The objective function for the DMU and its

936

N.K. Avkiran / Omega 37 (2009) 930 -- 941

respective constraints for divisional weights and intensity

values are shown in Eq. (7) adapted from Tone and Tsutsui
[37].

N
J

j sj
1
no
j

w 1
Nj n=1 xj
j=1
no

(7)
o = min
M
j+
J

1 j smo
j

w 1+
Mj m=1 yj
j=1
mo

subject to
J


wj = 1,

wj  0 (j),

(7a)

j=1
K

j
zk = 1 (j),

k=1

zk  0 (k, j), and

(7b)

t(j,h) zh = t(j,h) zj . ((j, h))

(j,h)

tk

(j,h)

= (t1

(j,h)

, . . . , tK

) RT

(j,h) K

(7c)

where k = a DMU (K = number of DMUs), j = a division (J = number of divisions), n = an input (N = number

of inputs), m = an output (M = number of outputs),
w = divisional weight; Sno = input slack, Smo + = output
slack, z = intensity, (j,h) = intermediate product link between division j and division h, t(j,h) = intermediate product,
and T(j,h) = number of intermediate products.
Briefly, constraint (7a) indicates that weights are nonnegative for all the divisions and add up to 1; that is, we
separately account for the importance of all the divisions.
Constraint (7b) indicates non-negative divisional intensities
that add up to 1, i.e. variable returns to scale. The last constraint, (7c), implies free linking where linking activities are
discretionary while maintaining continuity between inputs
and outputs [37]; that is, an intermediate output from one
division can become an intermediate input for another division.
The objective function for divisional efficiency is shown
in Eq. (8). Optimal input and output slacks to emerge from
Eq. (8) are entered into Eq. (7). Thus, the overall efficiency
of a DMU captured in Eq. (7) is the weighted sum of divisional efficiency scores, but this overall efficiency score is
neither the arithmetic nor the harmonic mean of divisional
efficiencies [37]. Eqs. (7a) and (8) are invariant to the units
of measure used for inputs and outputs.


j
1 Nj sno
1
n=1 j
Nj
xno
j =
(8)

(j = 1, . . . , J)
j+
1 Mj smo
1+
m=1 j
Mj
y
mo

Non-orientation is employed because it can accommodate the simultaneous contraction of inputs and expansion
of outputs. Also, use of SBM instead of the more traditional
CCR or BCC models allows the analysis to capture the nonradial reduction in inputs and non-radial increase in outputs; that is, the radial changes assumed in the CCR and

BCC models are inappropriate unless proportionality can be

supported (CCR and BCC are acronyms for the constant returns to scale DEA introduced in Charnes, Cooper and Rhodes
[32], and the variable-returns-to-scale DEA introduced in
Banker, Charnes, and Cooper [33], respectively). For example, a bank may follow a policy of paying higher salaries
to retain employees who excel in customer service (i.e. incurring relatively more non-interest expense) but makes up
for this by offering slightly lower rates on its deposit accounts, i.e. incurring relatively less interest expense. Similarly,
the same bank may opt to focus its attention on the sale
of those products and services that fetch more fee income
than loans, i.e. earning relatively more non-interest income.
In these examples, radial adjustments cannot account for the
bank's operational preferences. An equally important point
to remember is that such operational preferences are likely
to change over time in a dynamic world of business, thus
making the choice of non-radial efficiency measures more
appropriate for the real world. NSBM also has other desirable properties such as units-invariance and strict monotonicity.
3.3. Data and simulation
Empirical tests use a combination of actual data sourced
from financial statements on the four core profit efficiency
variables identified above for UAE domestic commercial
banks, and simulated data on their key profit centers because such data are not available in the public domain.
BankScope, the source for data on the core profit efficiency model, lists 18 commercial banks. After removing
those banks with missing data, 15 domestic commercial
banks comprise the sample in the fiscal year ending 31
December 2005 (based on the International Financial Reporting Standards), which was the most up-to-date reporting period found in BankScope at the time of writing this
paper.
To estimate profit center data that are not available to
those outside the bank, the study assumes that the actual
observed core bank-level expense and income data (as obtained from BankScope) are allocated among the three profit
centers in randomly varying proportions. Thus, the data corresponding to the variables in Table 2 are simulated within
pre-determined parameters based on what can be observed.
Details are discussed below.
Apportioning income (outputs): Profit centers in a given
bank can be apportioned income levels where the sum
of three proportions does not exceed the sum of the
proportions of lending business mentioned earlier in
describing the activities of an average UAE bank, i.e.
(91.56+4.44+4.00 = 100%). All output (and input) flows
are assumed to be positive. Random simulation of profit
center data occurs within ranges that have a minimum
proportion of 0.5% (an arbitrary choice) and an upper
bound of 99% of observed data. By selecting an upper
boundary of 99%, random generation becomes feasible,
i.e. if one of the proportions is 99%, then the other two
proportions would each be 0.5%. If an upper boundary
of 100% were permitted, this would violate the required

N.K. Avkiran / Omega 37 (2009) 930 -- 941

lower boundary of 0.5% and the main constraint that the

proportions of all three divisions add to 100%.
The relationship between interest income and noninterest income is determined by the actual individual bank proportions, i.e. ratio of interest income to
total income, and ratio of non-interest income to total income, where total income is the sum of interest
income and non-interest income.
The study assumes that a bank's FTP would preserve a
positive profit relationship between intermediate outputs and intermediate inputs. That is, intermediate
outputs (non-interest income) would be greater than
intermediate inputs (non-interest expense). This positive gap is captured by using a given bank's actual net
interest margin. Thus, if a bank's net interest margin
(NIM) is, say, 3%, the value of its intermediate input is
raised by that proportion to estimate the value for its
corresponding intermediate output.
Apportioning expenses (inputs): The study allocates expenses to profit centers by observing the same range of
proportions assumed for income distribution.
The relationship between interest expenses and noninterest expenses is determined by the actual individual bank proportions in the same manner as income
sub-categories. That is, the ratio of interest expense to
total expenses, and the ratio of non-interest expense
to total expenses are computed, where total expense is
the sum of interest expense and non-interest expense.
Within non-interest expenses, intermediate inputs
(i.e. generated by referrals) are distinguished by
arbitrarily capping them at 15% of non-interest
expense.
The above discussion on variables and data generation is
summarized in Appendix A.
In summary, the paper first estimates the proportion
of total outputs corresponding to each profit center by allowing the proportions to vary randomly in the designated
ranges subject to the constraint that they add up to 1.00
(see Eqs. (A6), (A14) and (A20) in Appendix A). Then, the
ratios that emerge from the actual observed data at the
bank level are used to further disaggregate the simulated
profit center data into interest income and non-interest income. A similar procedure is followed in the estimation of
total inputs corresponding to each profit center by allowing the proportions to vary in the designated ranges (see
Eqs. (A3), (A10), and (A17) in the Appendix A), followed by
disaggregating the simulated data to estimate profit center
interest expenses and non-interest expenses. Intermediate
inputs are allowed to vary in a pre-determined range. On
the other hand, intermediate outputs depend on observed
bank-level net interest margins and simulated profit center
intermediate inputs. The examples of intermediate products
in this study, that is, referrals, are treated as discretionary
variables where the profit center managers can control such
activity. The results and analysis section demonstrates the
differences between standard DEA on the core profit efficiency model and the network model that accounts for
subDMUs.

937

4. Results and analysis

4.1. Profit efficiency using standard DEA (SBM)
Recapping, the core variables for each bank are
interest expense (input), non-interest expense (input), interest
income (output), and non-interest income (output). Initial calculations involve the profit efficiency of UAE domestic commercial banks using non-oriented, variable-returns-to-scale
super-SBM and observed data; in Table 3, this estimate is
named the bank black box score. Estimates on the sample
of 15 banks show seven banks as efficient compared to the
others in the sample. Using super-efficiency scores enables
ranking among the efficient banks, where the National Bank
of Umm Al-Qaiwain is leading the others by a considerable
margin (see Chen [38] and Adler and Raveh [39]).
The right-hand section of Table 3 reports similar
estimates but is based on simulated data, where profit centers are treated as independent sub-DMUs rather than interacting sub-DMUs. The idea of independent sub-DMUs was
introduced earlier at the end of Section 2.2 as part of the discussion on the separation model depicted in Fig. 3. A closer
look reveals that the bank black box score is not correlated with the overall profit center score (Pearson's r equals
0.250 with a two-tailed significance level of 0.368). This
implies that the weighted sum of the non-interacting divisional performances does not correspond to the black box
score that represents the organization at aggregate level.
Next, in an attempt to explain the estimated profit efficiency scores with other known financial ratios, the study
compares the group of seven efficient banks against the
group of eight inefficient banks. Table 4 depicts this comparison using descriptive statistics on two key bank performance ratios sourced from BankScope. For brevity, the paper only asks how successful a bank is in, (a) minimizing
its expenses in generating revenues, captured by the costto-income ratio (CIR) and (b) maximizing its NIM, defined as
the ratio of interest income less interest expense to average
earning assets. Both ratios are widely used in banking industry analysis where CIR is accepted as an efficiency ratio and
NIM is a profitability ratio. A comparison of efficient versus
inefficient sub-groups on these ratios indicates that, as expected, on average, the SBM efficient banks have lower CIR
and higher NIM. Similarly gratifying, the National Bank of
Umm Al-Qaiwain's (the most efficient bank) CIR is the second lowest and its NIM is the second highest in the sample
(not shown in Table 4). The convergence of SBM estimates
with traditional ratios adds to the confidence placed in the
ability of DEA to distinguish between efficient and inefficient
banks.
4.2. Profit efficiency using NSBM and simulated profit
center data
Simulation is used to overcome lack of access to internal bank data needed to demonstrate NSBM. Nevertheless,
the innovative approach to simulating data at the divisional
level depends on actual observed data at the sector and individual bank levels. This brings a certain level of realism to

938

N.K. Avkiran / Omega 37 (2009) 930 -- 941

Table 3
Super-efficiency estimates for UAE banks and their profit centers (assuming independent centers) .
Bank
Bank

Bank black
box score

LAO scorea
(0.9156)

DCB score
(0.0444)

MREL score
(0.0400)

Overall profit
center scoreb

National Bank of Umm Al-Qaiwain

Bank of Sharjah
National Bank of Abu Dhabi
Mashreqbank
First Gulf Bank
Commercial Bank of Dubai
Abu Dhabi Commercial Bank
Union National Bank
Emirates Bank International
RAKBANKNational Bank of Ras Al-Khaimah
National Bank of Dubai Public Joint Stock Company
Commercial Bank International
National Bank of Fujairah
Arab Bank for Investment & Foreign Trade
United Arab Bank

1.6293
1.3844
1.3055
1.2209
1.1654
1.1162
1.0790
0.9628
0.8146
0.4599
0.3695
0.3689
0.3423
0.2933
0.2514

0.0104
1.3627
1.2665
0.2999
1.4158
0.1240
1.0793
0.4076
0.0025
0.0058
0.1544
0.0137
0.0012
17.9763
0.0240

3.8927
0.0263
2.7427
0.2028
0.0669
0.6181
0.3060
0.0143
0.5034
0.3061
1.3094
0.2520
0.0833
0.0153
0.0666

0.0383
15.7122
0.1666
1.1108
0.2242
0.1687
0.0700
0.7169
1.3516
0.1353
0.0462
0.0770
1.3518
0.0178
0.0899

0.1839
1.8774
1.2880
0.3280
1.3082
0.1478
1.0046
0.4025
0.0787
0.0243
0.2014
0.0268
0.0589
16.4605
0.0286

LAO (loans, advances, and overdrafts); MREL (mortgaged real estate loans); DCB (discounted commercial bills).
a
Using simulated data, these profit center scores represent the production processes depicted in Fig. 3 and divisional weights are shown in brackets.
b
Overall profit center score is the weighted sum of divisional scores.
Table 4
Financial ratios profiling UAE domestic commercial banks .
Cost-to-income
ratio (CIR)

Net interest
margin (NIM)

Sample
Mean
Maximum
Minimum
Std dev

26.27
51.79
9.77
10.51

3.57
5.28
2.33
1.08

Efficient banks sub-sample

Mean
Maximum
Minimum
Std dev

19.03
28.72
9.77
6.25

3.71
5.10
2.56
1.04

Inefficient banks sub-sample

Mean
Maximum
Minimum
Std dev

32.60
51.79
17.77
9.44

3.44
5.28
2.33
1.17

the simulation exercise, although the current study is unable to draw conclusions on actual individual bank performances based on NSBM results. Table 5 shows the overall
network efficiency estimates, a breakdown of profit center
scores and their corresponding projected inputs and outputs
(please carefully read the footnote to the table before continuing).
Overall NSBM score is the weighted sum of divisional
scores where the divisions are allowed to interact. Since
none of the banks have all three divisions efficient, NSBM efficiency is not achieved (a similar relationship was observed
by Lewis and Sexton [27]). Slacks for divisional level inputs
and outputs indicate some of the hidden inefficiencies that
are not normally visible with standard DEA. For example,
the Union National Bank, whose three profit centers are inefficient, would particularly benefit by focusing its attention
on the DCB profit center. The DCB profit center can increase
its interest income and non-interest income by 728% and
380%, respectively, while reducing non-interest expense by
15%. Exposing this kind of detail at the divisional level is the

main use of non-oriented NSBM that can help in targeting

remedial action.
Further insight into divisional inefficiencies can be gained
by focusing on intermediate products. The column headed
Nii* indicates seven banks (who are in bold font in Table 5)
whose LAO profit centers would be better off reducing intermediate outputs, that is, non-interest income from referrals,
with corresponding similar reductions in the intermediate
inputs of non-interest expense for MREL profit centers. An
exception to this pattern is the National Bank of Fujairah
where the projections suggest an increase of 145% in intermediate products. The ostensibly proportional projections
for intermediate products in this case are explained by the
specially formulated relationship between intermediate inputs and intermediate outputs (see Appendix A, Eqs. (A9)
and (A13)).
An equally important comparison is the rank correlation
between the black box scores in Table 3 and the overall
NSBM scores in Table 5. Kendal's tau-b of 0.390 (0.042) highlights the substantial differences between standard SBM and
NSBM (see Table 6). Table 6 also depicts the robustness of
the simulation method. Starting from the premise that the
original simulation generated random numbers, the simulation is repeated two more times. Insignificant rank correlations between SBM and NSBM scores, as well as insignificant
rank correlations among NSBM scores from different simulations indicate a successful attempt at generating independent samples.
5. Concluding remarks
The key motivation for this paper was that standard DEA
does not provide adequate detail for management to identify
the specific sources of inefficiency embedded in interactions
among divisions of an organization. In an age of global economy characterized by cross-border, fierce competition, business organizations are increasingly forced to look for new
ways of identifying inefficiencies in order to sustain their
competitive advantage in the market. The paper illustrates

N.K. Avkiran / Omega 37 (2009) 930 -- 941

939

Table 5
NSBM analysis of UAE banks (assuming interacting centers) .
Bank

Profit center scoresa

Profit center projections measured

as % changeb

Overall
NSBM score

LAO
(0.9156)

DCB
(0.0444)

MREL
(0.0400)

Inputs

Outputs

Ie

Nie

Nie*

Ii

Nii

Nii*

National Bank of Abu Dhabi

First Gulf Bank
Bank of Sharjah
Abu Dhabi Commercial Bank

0.964
0.915
0.788
0.731

1.000
1.000
1.000
1.000

1.000
0.273
0.106
0.452

0.332
1.000
1.000
0.111

Arab Bank for Investment & Foreign Trade

Union National Bank

0.558
0.516

1.000
0.608

0.040
0.142

1.000
0.678

Mashreqbank

0.289

0.270

0.203

1.000

National Bank of Dubai Public Joint Stock Company

0.102

0.093

1.000

0.058

Commercial Bank of Dubai

0.085

0.036

0.618

0.563

National Bank of Umm Al-Qaiwain

0.059

0.055

1.000

0.054

Commercial Bank International

0.054

0.050

0.252

0.104

RAKBANKNational Bank of Ras Al-Khaimah

0.047

0.041

0.306

0.160

United Arab Bank

0.043

0.040

0.067

0.115

Emirates Bank International

0.008

0.007

0.503

1.000

National Bank of Fujairah

0.006

0.005

0.083

0.718

69
26
0
0
18
0
33
0
53
39
67
69
82
95
4
2
28
87
75
65
82
73
43
54
84
88
75
54
32
75
79
7

51
0
41
36
0
37
37
15
7
76
85
72
66
97
72
40
61
93
82
53
86
90
85
82
77
68
63
81
67
79
67
18

0
n/a
n/a
n/a
0
n/a
n/a
n/a
12
n/a
n/a
n/a
83
n/a
N/a
24
n/a
99
n/a
n/a
96
n/a
n/a
80
n/a
n/a
87
n/a
n/a
n/a
n/a
145

0
98
1212
127
559
993
0
728
7
114
36
0
94
29
0
0
548
22
110
30
0
41
0
0
8
39
0
5093
0
2049
128
0

43
339
84
37
884
2907
14
380
0
2
0
441
614
0
0
81
1262
157
551
94
109
655
35
199
750
434
341
4430
0
7321
311
43

n/a
n/a
n/a
n/a
n/a
n/a
12
n/a
n/a
0
n/a
83
n/a
25
n/a
n/a
99
n/a
96
n/a
n/a
81
n/a
n/a
87
n/a
n/a
0
n/a
145
n/a
n/a

Ie (interest expense); Nie (non-interest expense); Nie* (non-interest expense as intermediate input to MREL); Ii (interest income); Nii (non-interest income);
Nii* (non-interest income as intermediate output from LAO); LAO (loans, advances, and overdrafts); MREL (mortgaged real estate loans); DCB (discounted
commercial bills).
a
These profit center scores represent the production processes depicted in Fig. 2 involving interacting centers (weights are shown in brackets).
b
Profit center projections (rounded to the nearest integer) are reported in the order they appear. For example, for Abu Dhabi Commercial Bank, DCB
projections would be followed by MREL projections. However, since DCB does not have any intermediate products, n/a is inserted for Nie* and Nii*. For
the same bank, the second row of projections indicate n/a for Nii* because MREL is not linked to an intermediate output (however, it is linked to an
intermediate input with a projected change of zero).

how NSBM can address the above need by providing insight

to the specific sources of organizational process inefficiency
in the context of UAE domestic commercial banks. By helping management open the black box of production, NSBM
gives access to the underlying diagnostic information in divisions (profit centers) that would otherwise remain undiscovered.
The groundwork for the NSBM illustration using UAE
banks included developing an innovative approach to
divisional data simulation. This part of the study contributes
to a perennial problem in scientific literature, namely, inability of the outside researcher to access internal data for the
purpose of developing new analytic techniques. Here, simulation of data on profit centers opens the way to demonstrate
a new approach to NDEA in the form of non-oriented NSBM.
The paper's choice of non-orientation and non-radial modeling enhances the relevance of frontier efficiency studies to
the world of business. Non-orientation ensures the analy-

Table 6
Comparison of rank correlations across SBM, NSBM, and multiple simulations .
Kendal's tau-b

NSBM
Simulation 1

Simulation 1
Simulation 2
SBM

0.390(0.042)

Simulation 2

Simulation 3

0.295(0.125)

0.000(1.000)
0.077(0.692)
0.230(0.234)

0.371(0.054)

sis simultaneously captures slacks on the cost and revenue

sides of the profitability equation. Similarly, use of non-radial
modeling acknowledges the generally non-proportional nature of slacks in the real world. In addition to these contributions to the Operations Research literature, focusing on UAE
contributes to banking literature because this dynamic part
of the Middle East is seldom studied in frontier efficiency
literature.

940

N.K. Avkiran / Omega 37 (2009) 930 -- 941

The new approach developed and applied in this paper

has global appeal. It can be used in those countries where an
industry is known to suffer from relatively high levels of inefficiency, as well as in countries where the overall measured
inefficiencies are low but more focused strategies are needed
to identify and eliminate the remaining inefficiencies. Developing reliable performance measures would also assist in
managerial decision-making involving mergers where executives typically search for synergies that are often enjoyed
by acquiring divisions that provide complementary services.

k
3 xk = xk,mrel = xie xk,mrel
ie
0 ie
xk

(A11)

k
3 xk = xk,mrel = xnie xk,mrel
nie
0 nie
xk

(A12)

3 xk = xk,mrel
, 0.15xk,mrel
. . . 0.005xk,mrel
nie
nie
1 nie
nie,ref,lao

(intermediate input range)

(A13)

yk,mrel , 0.99yk . . . 0.005yk (profit center output range)

(A14)

Acknowledgments
I offer my special thanks to Professor Kaoru Tone for supplying the NSBM code that enabled this study. I also greatly
appreciate the encouragement from the editor-in-chief, the
associate-editor and the referees.

(Observed variables are highlighted in bold. The remainder is simulated.)

Core variables for each bank observed from BankScope
are:
Interest expense (input), xj ie
Non-interest expense (input), xj nie
Interest income (output), yj ii
Non-interest income (output), yj nii
where k = 1, . . . , K banks is assumed. Next, the above core
variables are linked with the variables for profit centers detailed in Table 2:
xkie + xknie = xk = xk,lao + xk,mrel + xk,dcb

(A1)

k + yk = yk = yk,lao + yk,mrel + yk,dcb

yii
nii

(A2)

For the LAO profit center:

xk,lao , 0.99xk . . . 0.005xk (profit centre input range)

(A3)

k
1 xk = xk,lao = xie xk,lao
ie
0 ie
xk

(A4)

k
1 xk = xk,lao = xnie xk,lao
nie
0 nie
xk

(A5)

yk,lao , 0.99yk . . . 0.005yk

(A6)

k
4 yk = yk,lao = yii yk,lao
ii
1 ii
yk

(A7)

k
4 yk = yk,lao = ynii yk,lao
nii
1 nii
yk

(A8)

3 yk = yk,lao = (1 + nim)xk,mrel
1 nii
nii,ref
nie,ref,lao

(intermediate output)

(A9)

For the MREL profit center:

xk,mrel , 0.99xk . . . 0.005xk
(profit center input range)

(A15)

k
4 yk = yk,mrel = ynii yk,mrel
nii
3 nii
yk

(A16)

For the DCB profit center:

Appendix A. Simulating data for profit centers

(profit center output range)

k
4 yk = yk,mrel = yii yk,mrel
ii
3 ii
yk

(A10)

xk,dcb , 0.99xk . . . 0.005xk (profit center input range)

(A17)

k
2 xk = xk,dcb = xie xk,dcb
ie
0 ie
xk

(A18)

k
2 xk = xk,dcb = xnie xk,dcb
nie
0 nie
xk

(A19)

yk,dcb , 0.99yk . . . 0.005yk

(profit center output range)

(A20)

k
4 yk = yk,dcb = yii yk,dcb
ii
2 ii
yk

(A21)

k
4 yk = yk,dcb = ynii yk,dcb
nii
2 nii
yk

(A22)

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