Capital allocation and risk appetite under Solvency II framework

The aim of this paper is to introduce a method for computing the allocated Solvency II Capital Requirement (SCR) of each Risk which the company is exposed to, taking in account for the diversification effect among different risks. The method suggested is based on the Euler principle. We show that it has very suitable properties like coherence in the sense of Denault (2001) and RORAC compatibility, and practical implications for the companies that use the standard formula. Further, we show how this approach can be used to evaluate the underwriting and reinsurance policies and to define a measure of the Company's risk appetite, based on the capital at risk return.

Introduction
The Solvency II directive requires that insurance undertakings have to calculate the Solvency Capital Requirement taking into account for the correlation among the risk driver. This implies the existence of a diversification effect.
The evaluation of the Solvency II Capital Requirement net of diversification effect is a needful procedure to know the real capital absorption of the lines of business and to evaluate the relative financial performance.
Academic research addresses the capital allocation for many years. Indeed they were formulated various approaches to the problem by moving from game theory or establishing the principles of coherence through axiomatic definitions for evaluating allocation methods in relation to the specific risk measures. This last line of research has provided significant applications respect to various risk measures assuming different distributions for the underlying risk variable and identifying the Euler's allocation principle as the highest performing. The most important papers we refer are: • Tasche (1999) [17] define the RORAC compatibility as the most important economic property of an allocation principle and state that, for risk measures with continuous derivatives, the unique continuous per-unit allocation principle RORAC compatible is that of Euler • Denault (2001) [8] establishes the principles of coherence for an allocation principle and derive the Euler allocation principle moving from game theory • A. Buch, G. Dorfleitner (2008) [5] state that the Euler allocation principle associated with a coherent risk measure produce a coherent allocation of risk capital The aim of this paper is to study the Solvency II capital requirement allocation for European insurance companies that calculates the SCR by means of the Standard Formula providing an allocation principle and an approach to evaluate the financial performance of the risk capital invested.
Our way it is to consider the SCR as risk measure noticing that, under the set of hypothesis underlying the standard formula, is coherent in the sense of Artzner (1999) [4]. Then, by means of the Euler's allocation principle, we derive the closed formulas to calculate the allocated SCR among the risk considered in the multilevel aggregation scheme of Solvency II standard formula. Due to the cited results we know that the allocation provided is coherent in the sense of Denault (2001) [5]). In the section 2 we describe the Standard Formula approach to SCR calculation and show a set of coherent hypothesis and definitions. In the section 3 we define the diversification effect as variable and we provide the formulas for the SCR allocation among each single macro and micro risk included in the multilevel aggregation scheme of the standard formula. In the section 4 we provide a mean variance model for the RORAC to evaluate the underwriting and reinsurance policies and to define the risk appetite on each sub-portfolios by solving an optimization problem. Follows the conclusion and the perspectives for future research.

Theoretical framework
We consider an insurance company whose portfolio of insurance contract is composed by q-homogeneous sub-portfolios. We define a set of random variable Γ in the probability space [Ω, , P]. The risk of the sub-portfolio s-th (s = 1...q) is modelled by means of the generic random variable X s ∈ Γ . The total risk of the company is described with the random variable X = q s=1 X s . The company calculates its regulatory capital requirement by means of a risk measure defined as π(X) : Γ → . Note that the risk variables X s are dependent so there exist a diversification effect implied in the calculation of the capital requirement π(X). Artzner (1999) [3] introduced the definition of coherent risk measure by means of the following axiom: Definition 1.1.1. A risk measure π is considered coherent if satisfies the following property:

Coherence of risk measure
• Traslation invariance: for a riskless deterministic portfolio L with fixed return α and for all X ∈ Γ we have π(X + L) = π(X) − α • Subadditivity: for all (X 1 , X 2 ) ∈ Γ we have π(X 1 +X 2 ) ≤ π(X 1 )+π(X 2 ) • Positive Homogenity: for all λ > 0 and all X ∈ Γ, π(λX) = λπ(X) • Monotonicity: for all X, Y ∈ Γ with X ≤ Y , we have π(X) ≤ π(Y ) Denault (2001) [8] extends the concept of coherence to the allocation principle establishing a set of definitions and axioms. We consider a set of q portfolios. The relative allocated risk measures to be calculated represent a set A of allocatoin problem. The following definition holds:

Coherence of allocation principle
1. An allocation principle is a function Π : A → q that maps each allocation problem into a unique allocation: π(X s |X) where π(X s |X) is the allocated risk measure for the sub-portfolio s − th.
2. An allocation principle Π is coherent if, for every allocation problem satisfies the followings three properties: 2. Symmetry: if by joining any subset M ⊆ Q i, j, portfolios i and j both make the same contribution to the risk capital, then K i = K j .
3. Riskless allocation: for a riskless deterministic portfolio L with fixed return α we have that π(L) = −α

Euler allocation principle and RORAC compatibility
As in definition 1.2.1 π(X) = q s=1 π(X s |X) where, from an economic point of view, π(X s |X) (s = 1, ..., q) is the risk contribution net of diversification effect of the q-sub-portfolios. The knowledge of the risk contribution π(X s |X) enables to evaluate the risk return profile of each sub-portfolio by defining the random variables RORAC s (Return on Risk Adjusted Capital). • the Return on Risk Adjusted Capital of the wide portfolio of the company as: • the Return on Risk Adjusted Capital of the sub-portfolio s-th of the company as: It is important to note that the denominator of the RORAC must represent a capital net of diversification, if is not, the RORAC have not any economic sense. This depends on a particular property of the allocation methodology used to calculate the variables π(X s |X) named RORAC compatibility introduced by Tasche (1999) [17]. Definition 1.3.2. A risk capital contribution π(X s |X) to the overall risk contribution π(X) is RORAC compatible if there are some > 0 such that: for all 0 < h < . Tasche (1999 and) find that ( [17] and [18]), if a RORAC compatibility capital allocation exists, it is uniquely determined by the Euler's principle 3 . Lemma 1.1 (Euler's principle). Let π(X) be a risk measure and assume that it is a 1-degree homogeneous and continuously differentiable function. If there are risk contributions [π(X 1 |X), ..., π(X q |X)] that are RORAC compatible, they are uniquely determined as: This is called Euler's allocation principle of the risk measure π(X) among the q-sub-portfolios.
From a mathematical point of view, the Euler allocation principle derives from the application to the risk measures considered of the well known Euler's Homogeneous Function Theorem.

On the coherence of Euler allocation principle
The Euler's allocation principle described in the previous subsection, is one of the most popular allocation method proposed in the literature. This is due for its suitable properties. In this way, a very important contribution is that of Buch et G. Dorfleitner (2008) [5]. From an axiomatic point of view, they study the relation between the properties of the Euler's allocation principle and those of the risk measure to which the allocation is applied. What they find is resumed in the following proposition.
Proposition 1.2. The Euler's allocation principle applied to a coherent risk measure has the properties of full allocation, "no undercut" and riskless allocation" so it is coherent in the sense of Denault (2001) [8].
This result has a main role for our research because we will use it to prove that the allocation methodology that we find to calculate the allocated SCR in the Solvency II Standard Formula framework by means of the Euler's principle, is coherent in the sense of Denault (2001) [8].
This, united to the RORAC compatibility ensured by the Euler's principle 4 , and the closed formulas implies very suitable properties and practical implications for our results. 3 Note that we provide a version of the Euler's theorem slightly different to that of Tasche because we refer to a risk measure, the SCR, that is a differentiable function 4 see Tasche (2008) [18] 2 Solvency II standard formula: hypothesis and framework The Solvency II directive 5 provide that the insurance companies have to calculate their regulatory capital requirement, named Solvency Capital Requirement (hereafter referred as SCR), by means of a risk based methodology. From a practical point of view, they can choose between a standard formula provided by EIOPA or to produce him self an internal model. In the following we take into account only for the case that the SCR is calculated with the standard formula (hereafter referred as FS). The FS provides that the Company should calculate the SCR through the modular approach that will be defined.
The risk-based modular approach considered in the Solvency II framework provides that the company has to consider the global risk which is exposed to by dividing it into single components. These components are related with different sources of risk (hereafter named "risk") like reserve risk, mortality risk, interest rate risk e so on. The modular scheme considers n macro risks. The generic macro risk i − th (i = 1, ..., n) is composed by m i micro risk. We use the following notation for all variables will be defined: the first digit of the subscript identifies the macro-risk and is from 1 to n, the second one identifies the micro-risk and is from 1 to m i (where i identify the overlying macro-risk).
We define a set of random variable Ψ on the probability space [Ω, , P]. Let L ij ∈ Ψ (with ij = i1, ..., im i ) the random variable that describe losses, over an annual time horizon, associated with the micro-risk ij − th and let Y ij = L ij − E(L ij ) the respective r.v. unexpected losses. The generic macro risk i − th depends of a random variable Y i = mi j Y ij . The total risk of the Definition 2.0.1 (Standard Formula). The solvency II capital requirement of the company is defined by means of the specific risk measure on Y following defined: I SCR ij is the capital requirement referred to the ij − th micro-risk defined as: is approximated by means of specific formulas provided by EIOPA.
II SCR i is the capital requirement referred to the i − th macro-risk calculated by aggregating the underlying micro-risk: where ρ ix,iy represents the linear correlation coefficients provided by EIOPA.
III SCR is the overall capital requirement of the company and is calculated by aggregating the underlying macro-risk: where ρ i,w represents the linear correlation coefficients provided by EIOPA.
Note that the square-root aggregation formula (7 and 8) implies that the r.v. Y ij (j = 1, ..., m i ) are jointly normal distributed and linearly correlated 7 so that the SCR is a coherent risk measure. 7 For the sake of clarity, some further specification are needed. In the FS there is not any explicit hypothesis for the distribution of the losses for the micro and macro risk, but the underlying assumption of linear correlation and normal distribution is needed. These assumptions are very strong because, in the insurance problems, the linear correlation and the non skewed distribution hypothesis are not always consistent with the nature of the phenomena considered. Indeed, Sandstrom (2007) [16] specified that, for skewed distribution, the normal approximation can implies an incorrect estimation of the SCR and propose a method to transform, by Cornish-Fisher expansion, the quantile distribution from a skewed into a standard normal distribution. Instead, from a practical point of view, the standard formula of Solvency 2, avoid this problem through a very strong and prudential simplification that is by overestimating the confidence level for the calculation of the value at risk for some micro-risk variable. In particular, for a normal distribution holds that: X (0.995) = 2.576 with F the cumulative distribution function of standard normal random variable. In the standard formula, e.g. for the premium-reserve risk for non-life portfolios, α = 3 that corresponds to a V aR 99.87% (Y ) avoiding in this manner the skewness under estimation due to normally assumption. Furthermore EIOPA itself has specified that the correlation parameters provided for the FS, are estimated to reduce the distorting effect through the following formulation:

Capital allocation
With reference to the SCRs of the macro-risk and micro-risk, moving from Lemma 1.1 the allocation formulas are obtained.
Theorem 3.1 (SCR macro-risk allocation). In the case of Solvency II Standard Formula, the RORAC compatible allocation of the overall SCR among the constituents macro-risk is uniquely determine as: where SCR(Y i |Y ) is the allocated i-th macro-risk.
Proof. From Lemma 1.1 (Euler's allocation principle) holds that: where the partial derivative is: and so: Moving from theorem 3.1 it is possible to reach a similar result for the microrisk allocation. It is useful to define the variable Allocation Ratio as: Theorem 3.2 (SCR micro-risk allocation). In the case of Solvency II Standard Formula, the RORAC compatible allocation of the macro-risk SCR i − th (i = 1, ..., n) among the micro-risk ix − th (x = 1, ..., m i ) is uniquely determined as: where the variable SCR(Y ix |Y, Y i ) is the allocated ix − th (x = 1, ..., m i ) microrisk.
Proof. From Lemma 1.1 (Euler's allocation principle) we have that: By means elementary algebra holds that: so that: The theorems 3.1 and 3.2 enables to conclude that, under assumptions (2.0.1), the RORAC compatible and coherent allocation of SCR is uniquely determined by means the Euler's principle and can be expressed by means of the closed expressions reported.

Procedure for underwriting policy evaluation and risk appetite measurement
The risk based approach for the Solvency II capital requirement calculation enables insurance companies to evaluate their profitability taking into account for the capital absorption of the each sub-portfolio. Furthermore, the Solvency II directive requires that insurance undertaking have to evaluate their underwriting and reinsurance policies and to define the limits for the risk appetite. In order to do it, we propose to lead back the problem to the classical portfolio theory.
In this way we show that it is possible to use the same integrate framework for all the named evaluation. In particular, we consider a mean-variance model on the sub-portfolios RORAC 8 .
To evaluate different underwriting and reinsurance strategies according with the defined risk appetite, we propose the following optimization problem: -P is the vector of LoBs premium. δ and are the contraints for the premium depending on the commercial strategy of the Company -R is reisurance program subjected to qualitative and quantitative contraints α is risk appetite limit β and γ are the bounds imposed to the overall SCR to limit the solution to wich compatible with the capital availabilities of the Company From a practical point of view it is sufficient to test the realistic scenario of underwriting (given the commercial power) and reinsurance (given the market offer) and choose the global strategy that are optimal. In the following table, we show a numerical example based on a risk profile measurement RORAC compatible derived from an anonymous non-life company data base: 8 In the previous section RORAC compatible SCR allocation among risk are provided. To evaluate the sub-portfolios' RORAC, it is necessary to allocate the micro-risk among subportfolios. We not consider this problem in the paper but it can be done starting from the specific methodologies provided in the standard formula for the calculation of the several SCR ix . The data above can be reported in the figure 2 that represents the contribution of each LoB risk performance to the company's risk situation.

Conclusion
In this paper we have shown that, under solvency II standard formula framework, is possible to obtain a Solvency Capital Requirement allocation among micro and macro risks that is coherent in the sense of Denault [8] and RORAC compatible [17]. We demonstrated the results by means of the Euler's allocation principle. Then, given the allocated SCR, we have provided a procedure to evaluate the underwriting and reinsurance policies and to determine the risk appetite of the stakeholder by means of a RORAC index and collocating the argument under the classical portfolio theory. Some possible developments can be the construction of a model for the micro risk allocation among sub-portfolios for all the case in which is not possible to apply the formulas we provided (eg. the allocation of the interest rate risk among life LoBs etc.). This may have a very strong effect in the real analysis due for its straightforward possibility of application eg. the valuation of underwriting strategy and reinsurance strategy.


Cross-sectoral Cooperation vs. Cluster Development at European Level

Abstract One of the most actual instrument used by the European Institutions for encouraging and supporting in the same time the entrepreneurs is the promotion of industrial entities to organize themselves in different consortia named clusters and to apply further under this form to European calls for obtaining the necessary funds for industrial development of their SMSs and regions where they are located. The mentioned funds are dedicated more often to those clusters which were in advance evaluated by an accredited institution. Is there only an unique institution in charge with this or it is allowed that the clusters evaluation is made by different organizations? For the moment the evaluation technique consist mainly in clusters evaluation done by the European Secretariat for Cluster Analysis (ESCA), with the means of a set of indicators, on the basis of which the quality of cluster management is eventually certified, after obtaining the “gold label”. The use, at an European level, of cluster benchmarking has become more and more necessary, in the context of internationalization and of the tough competition that clusters have to face. The paper will highlight also the need for cluster policies and smart specialization strategies (SS3) in order to promote economic growth and regional competitiveness.

Introduction
Motto: "In today's creative economy, the real source of economic growth comes from the clustering and concentration of talented and productive people." (Florida R., 2008) The increasing popularity of clusters is reflected in the growing number of policies and initiatives supporting them. The analyses carried out so far indicate that clusters are drivers of competitiveness and innovation, of economic growth and jobs. This paper has been drawn up in the context of a more intense activity of the European Commission to support economic clusters, considered as important instrument of the new European industrial policy and also of the Regional & International Strategies for Smart Specialization (RIS3).
The paper is underlining the benefits of the cluster policy which defines the very cluster policy as an extensive set of specific government policies whose aim is to strengthen the existing clusters or facilitating the emergence of new ones. This part of the paper examines mainly two types of policies summarizing actually the multitude of current policies, namely: policies that support the development of current clusters or clusters that are now in a process of formation and policies that use the information on how the industrial development in clusters takes place in order to substantiate and develop various general policies. In this context there will be discussed the methodology of clusters benchmarking. The last part of the paper is dedicated to the potential for clustering of the activities in the Romanian manufacturing industry branch, as well as cluster mapping.

Clusters
During their evolution industrial clusters have gone through a series of development phases which have been brilliantly summarized in the works of Markusen, and the evolution is shown in the table below:

Clusters / networks and Governance
In literature governance is considered as utterly important, while clusters have a regional/local dimension which requires democratic relations among the economic players that form the cluster chains. In reality, there has been a trend, both of the national authorities and of the local/regional ones, to grant assistance to cluster managers / cluster organizations in the sense of bringing to their knowledge both the needs/wishes of people in the region/locality and an overall vision of the competent institutions in the region. That is why, for the purpose of efficient governance, it is necessary to understand the relations among the players in a certain cluster in a given locality, on the one hand, and on the other hand, among the partner players, but from other localities (including companies and institutions in the cluster in other localities). In other words, the goal of good governance is therefore to identify strategic decisionmakers; they can be in the locality or outside of the locality where the cluster is based, within a nation or outside of the nation's borders. In this situation, the approach is different from the traditional one, limited geographically or from the point of view of belonging to an industrial branch, avoiding in this way the limitations imposed by the usual methodologies of cluster analysis related to the internal economic growth. This approach is required especially in the situation of a "globalized" economy, since the spatial dispersion of productive activities and industrial networks in the context of globalization has become a reality that cannot be challenged. The key question is whether the power of making strategic decisions is also dispersed? The current analysis of the cluster -case by case -should be carried out from a multidisciplinary perspective. As is known, relations are not only of an economic nature, but also of a social-political nature, based on the spatial, cultural or mental proximity. Such a multi-disciplinary analysis can serve the impact analysis in the region of the clusters and cluster policies initiated around them. Cooperation, or on the contrary, conflicts between the cluster members have an impact on the strategic decision-making; cluster/network governance can rely on a broad participation of members or on the contrary, on a dominating group making the decisions.
In the opinion of more specialists, the principles of good governance are based on the identification of real strategic decision makers or centers and correlating their decisions with the aims and goals of the local communities in their proximity. Such an approach from the perspective of economic development policy at a national and regional level might sometimes be different in real life. For instance, according to some methodologies applied in some areas, the national and local authorities lay stress on the support of industry infrastructure in order to attract more companies, thus facilitating the development of local clusters; however, other methodologies lay stress on the role of institutions in providing the funding, training and consulting services. However, we consider that the best decisions on the model of governance are based on the cluster analysis in a very well defined context (where there are different stakeholders at local/national/international level) and by collecting information specific for each and every case. Eventually, the efficiency of the chosen governance model is reflected in the impact that the cluster activities has on the level of economic development at local/regional level. The chosen structures and forms of governance are reflected also on the results of cooperation and competitiveness of production in the region. In this respect, the individual capacity to get involved in the decision-making process regarding local development should be better used. Good practices prove that there is a long process of learning involving people, companies and institutions which interact, a process which fosters every player to give an input to governance.
As it is argued in the literature the essence of governance is its focus on 'strategic decision-making' power and processes; worth mentioning is that the process is strongly influenced by the policies in the field.
Research into the cluster policies indicates that basically there are two types of policies • policies that support the development of current clusters or clusters in the making • policies which use the information on how industrial development in the clusters is going on in order to substantiate and develop various general policies.
These two types of policies have certain characteristics: • The cluster policy means a change of perspective from individual companies to systems of local/regional companies and the environment is also added to the value of the company (Păuna C.B. &All, 2014); • The cluster policy means also a smaller support for big companies and a bigger interest in the local agglomerations of SME-s.

•
This type of policy is also focused on the indigenous processes of growth and less on the efforts to attract investment; • The concept of "regional clusters" brings to the forefront a policy based on the idea of the strengths, since stress is laid on stimulating the strong points or potentially strong points of the regional industry. This could be organized as a process from top to bottom, which involves the local authorities, the industry and the experts; • The notion of a cluster also leads to the stimulation of social processes, for instance, encouraging interaction based on trust, in order to increase the inflow of knowledge between the local players and the lesser use of interventions via financial facilities, for instance; • Clusterisation brings to the forefront the role of public authorities as facilitators or brokers among companies and between companies and the cognitive infrastructure.
According to Boekholt and Thuriaux (1999) "the cluster policy lies in stimulating the connections with the local business environment by means of a public-private dialogue, defining the common needs for research, relations of "co-development" between contractors and suppliers, etc". One of the most actual instrument used by the European Institutions for encouraging and supporting in the same time the entrepreneurs is the promotion of clusters through participation to European calls for obtaining the necessary funds for industrial development of their SMSs and regions where they are located. The mentioned funds are dedicated more often to those clusters which were in advance evaluated by an accredited institution. As it is known for the moment there is only an unique institution in charge with this, namely the European Secretariat for Cluster Analysis (ESCA) which uses a set of indicators (see table 3), on the basis of which the quality of cluster management is eventually certified, after obtaining the "gold label" (there are actually three phases of evaluation, that include also the bronze and silver labels besides the gold one -depending on the development level of cluster organization). The use, at an European level, of cluster benchmarking has become more and more necessary, in the context of internationalization and of the tough competition that clusters have to face. We wondering if it is appropriate to have only one institution in charge with clusters benchmarking or it should be taken into consideration the specificity of regions and it should be established some other similar institutions in charge with clusters benchmarking from different parts of Europe: South East European area, Baltic Area, etc.
The cluster benchmarking covers 36 indicators which analyse the cluster and the cluster management organization taken into consideration six factors (see table 3): the structure of the cluster, governance and strategy of the cluster, financing of the cluster management organization, services provided by the cluster management organization, contacts and interaction with relevant players. Table 3 Overview of clusters benchmarking indicators used by ESCA Source: ESCA, www.cluster-analysis.org

Potential of economic clustering in Romania
To develop the SME sector the Government of Romania drafted an Action Plan (early in the 2000) whose aim was to remove the obstacles from the demand and increase business (registration of companies and authorization procedures, legal framework and taxation system, access to financing and information). The strategic lines of action were: • creating a friendly environment for business to facilitate the creation and development of SMEs; • improve access of SMEs to foreign markets • develop productive and innovative activities of SMEs and increase in SMEs competitiveness on various markets; • promote entrepreneurship The last two lines of action are directly linked to the clustering policy which the national government intended to develop and implement.
Preoccupations in this respect went on, besides the projects developed on this topic a more active involvement of national/local authorities being noticed.

Ministry of Economy, Trade and Business Environment is responsible for drafting and implementing the industrial policy.
A national cluster policy with very well defined goals and a subsequent action plan has become visible as of 2009. The current document of industrial policy 2010-2013 has a capital devoted to innovative clusters which was drafted in partnership with the Federal Ministry for Economic Cooperation and Development of Germany (represented by GTZ) and is based on the benchmarking analysis of cluster policies in France, Germany and Sweden. The Romanian cluster policy has a "top-bottom"" approach al regional level.
The National Reform Program 2011-2013, in its chapter on Industrial Policy identifies programs and measures for developing clusters financed both from public funds and European funds.
The Ministry of Economy, Trade and Business Environment facilitates the good practices of clusters with EU members countries, candidate countries, Norway, Japan etc.
For the future, the Ministry of Economy, Trade and Business Environment -the Industrial Policies Directorateintends to involve the Regional Development Agencies and the Romanian Association of Clusters -Clustero -in promoting the cluster development program.
As many other concentration at a world level, the Romanian cluster model has the following characteristics: The presence of a third party supplier of services (which provides services which are relevant for the cluster).
The intensity of the above mentioned factors is different from cluster to cluster but as a general trend it is noticeable that as to the concentration of companies and labour force, the Romanian clusters are somewhat different as compared to the European ones, like the smaller number of members in a cluster and the existence of some catalyzing organizations (chambers of commerce, development agencies, local authorities) in the cluster (the model of the clover with a fourth leaf, mentioned for the first time by D. Cosnita in the analysis conducted by GTZ in Romania in 2010).
In this context our paper presents the aspects related to the potential for clustering of the activities in the Romanian manufacturing industry branch, as well as cluster mapping. In identifying the potential for clustering of activities in the Romanian manufacturing industry both quantitative and qualitative methods have been used. The quantitative methods used in the first stage were: calculation of the location coefficient, of the specialization rate, of the Herfindhal index and of the Gini coefficient. In the second stage, the clustering Sternberg & Litzenberger index has been calculated, which takes into account several factors that may influence the formation of clusters. Subsequently, following the correlation of the results obtained from the afore mentioned methods the first information has been extracted regarding the regional potential for clustering of the companies that operate in certain Romanian manufacturing industry branches. Since the research institutes/universities represent some basic components of a cluster next there has been an identification of such units for every branch of the manufacturing industry, mentioning also the regions and counties that they belong to. In this way an inventory has been made of all the research institutes (national institutes, research institutes in universities and also in the Romanian Academy). From among these, the paper focused on those research units located in the big industrial centers or in their proximity, in order to be easily attracted and integrated into the activities of an industrial cluster.
The information obtained from quantitative methods has been added and enriched with information from qualitative methods. These methods included interviews with politicians, representatives of the local authorities and of the business sector, referring to the frame and climate of business, ways of inter-institutional collaboration and cooperation, as well as among businesses, the intensity of links of collaboration among companies, current joint projects and/or future projects, the level of confidence of partners etc. The results obtained from the qualitative methods brought in additional information on the existing clusters and on the potential for clustering of the Romanian manufacturing industry. The quantitative and qualitative methods used have eventually led to identification of many domains of the manufacturing industry, with a potential for clustering: textile and footwear, wood processing, oil extraction and processing (oil equipment, including off-shore platforms), mining equipment, products of precision mechanics, electronic and electro technical products, transportation means (cars, wagons), chemical products, building materials (cement, glass, ceramics). These domains include all the components necessary for the existence of clusters, namely, the geographical proximity of companies, the adequate density of companies, special research units of the industry, relations of collaboration between the local stakeholders etc. All this information has been transposed on maps with the help of special software. We further present an example in this respect, namely, a map showing a clear and synthetic representation of the potential for clustering of some domains of the Romanian manufacturing industry, by counties and regions of development. The cluster mapping exercise is a relatively new approach, which has emerged from the very need of having a better and direct image on clustering and its economic performances.
Worth mentioning is also the fact that the domains identified (see Fig. 1) as having a potential for clustering are validated by reality, since in the Association of Clusters in Romania "CLUSTERO", set up in 2011, a series of clusters were already registered during 2013 and they belong to the afore mentioned domains (see http://clustero.eu/). Also worth mentioning is that the economic agglomerations continue to emerge, many of them being stimulated by the direct foreign investments, which are good pre-requisites for the emergence and development of clusters.

Conclusions
According to our results one can say that Romania has an obvious potential for clustering in important industrial domains. However, up until now, clusters have a small share in the country's economy, both because the authorities only recently got involved in the process of guidance and support for clustering but also because the economic environment -companies, business persons, local authorities and, to a lesser extent, the academic and research environment -show a limited availability for association and collaboration within the clusters. In spite of this, the responsibilities of local and national authorities in creating the adequate environment for the very operation of clusters is expected to increase since the strategic national documents have recently been drafted, in agreement with the regional policy of the EU, and they establish clear guidelines to support and promote clusters, as an important part of the process of implementation of the new industrial policy of the country.
In the end there are to be mentioned some general conclusions but also practical ones related to the problems of clusters in this country and to the need to further continue research in the field of identifying the potential for clustering in the Romanian manufacturing industry; in order for the main drivers of regional specialization and geographical concentration of industry in Romania to be better and more extensively explored, for the purpose of creating regional and national clusters capable to enter into interregional and transnational collaboration for increasing the competitiveness and efficiency of the Romanian industry.


Processes and Technologies for Identifying Illegal Financial Operations

The aim of the paper is to discuss law requirements and computer technology related to the processes carried out at identifying clients of banks and other financial institutions. Customer identification is an essential element of an effective customer due diligence programme which banks need to put in place to guard against reputational, operational, legal and other risks. There are mentioned in the paper the law requires that identification must be carried out inside any financial institution which negotiates the new account with the client. The paper describes several approaches to identification. Various scientific and research results are available in printed information. It shows that the illegal operations of clients in these days usually identify bank employees. Communication technologies and computer equipment however has developed so much, and therefore computers could play a new role in money laundering. Illegal operations could currently be detected by a computer. Rapid development of banking technology has changed the way banking activities are dealt with. In conclusion, the present text identifies some problems that lie ahead of financial market in connection with a huge flow of money from black market economies. The paper has been prepared within the project "Current trends in development of financial markets", supported by the Institutional support for long-term strategic development of research organization University of Finance and Administration in 2016.

Introduction
The topic of preventing a misuse of the financial system for money laundering was published as a Directive of the European Parliament and of the Council in 2005. In the Czech Republic, the topic of money laundering is addressed by a law from 2008. It prescribes financial institutions to verify the identity of clients and simultaneously gives them an opportunity of identification at a distance. Further, the law contains provisions on when the client's identification needs not to be done. In parallel with the development of the legislative environment, rapid developments can be seen in technologies and computer capacity. A technological point of view on the possibility to identify a client correctly also deserves our attention (Thalassinos et al., 2013;.
The purpose of the paper is to analyse the current legal regulations and amendments to the "Fourth Directive" as regards anti-money-laundering measures. Another aspect that is discussed in the paper is banks' technological possibilities in relation to client identification.

Methodology
There exists an interest in using computers in processes oriented at anti-moneylaundering measures; however, it is not significantly growing among theoreticians and their publications. The ProQuest database displayed only 65 results concerning the "financing and (money laundering)" entry in 2000-2015, of which only 26 were reviewed works and all of them were published in scholarly journals. Territorially, they were focusing on America and the EU, Jamaica, but also e.g. on Hong Kong.

Analyses of legal and supranationally adopted documents
One of the methodical approaches used by De Koker (2009) analysed the Recommendations of FATF (Financial Action Task Force) in detail. In another text, Clunan (2007) emphasized that combatting financing of terrorism is comprehensive and requires measures both international among individual countries and internal among agencies controlled by individual governments. She sees the source of money for subsequent "laundering" in thefts, drug sales or human trafficking. Nevertheless, she also mentions the fact that money can come from humanitarian organisations and charity activities. And donors are often totally unaware that their money finances terrorism.

Computers and computer models in the AML process
Suspicious transactions on accounts can be indicated by computer systems. According to Tang, Jun and Lishan Ai. (2013), it is possible to design integration of a customer relation management system and a system of registering suspicious data reported in commercial banks. The designed system consists of several layers and can be used for the purpose of client identification and reduction of error messages about money laundering. The most important layer can be considered the analytical one which provides an in-depth analysis of client informationtransaction historyand categorises customers by income, analyses risks and other connections. It uses a data storage for analyses and can conduct analyses from different points of view.

Discussion
The discussion in the presented paper is divided into the legislation-related topic and technological issues.

Legislation
Misuse of financial institutions for money laundering mostly occurs due to cooperation of entities that need to legalise funds with natural persons who, for a certain payment, conclude contracts with banks, open accounts, acquire other banking products that are subsequently used for legalisation of proceeds of crime activity.
Banks have to defend themselves against such misuse, as prescribed to them in the Czech Republic by the Act No. 253/2008 on some measures against legalisation of proceeds of crime activity and financing of terrorism. The basis for implementing the process of combatting money laundering and combatting financing of terrorism is a proper identification of clients. In the context of the Czech Republic, it is the Act No. 253/2007 on some measures against legalisation of proceeds of crime activity and financing of terrorism that deals with the client identification most comprehensively. It specifies the basic duties that must be performed at identifying the client as a party to a banking transaction.

Identification in connection with the type of transaction
The law provides for a general obligation to identify the party to a transaction if the transaction exceeds EUR 1,000, always before it is carried out. Then, following provisions of the law specify the method how the client identification is carried out. The identification attributes for natural persons are as follows: -All the names and surname -Birth certificate number (if not assigned, then the date of birth), -Place of birth -Gender -Permanent or other residence -Citizenship For entrepreneurs, it is necessary, in addition to the above attributes, to verify their company name, place of business and the company registration number.
These facts must be checked against an identifying document if stated there. Moreover, in the information system or records financial institutions are obliged to enter the number of the identifying document, the country and the authority that has issued it and the period of its validity. The employee that carries out this identity verification is obliged to check sameness of the person's appearance with the photo in the identifying document. Various questions are raised because of these obligations already. One of them can be e.g. what to do when not all the data are included in the identifying document. For example, the identifying document of persons born outside the Czech Republic includes the country of birth instead of the place of it. Passports, being the basic identifying document for nationals from non-EEA countries, do not show permanent residence or domicile, etc. In practise, the missing data are thus replaced by the requirement of the person's statutory declaration on e.g. where he or she was born or what is his or her place of permanent residence.
In case of a stricter approach, it would be possible to require a production of the birth certificate, which is, however, omitted in practice. Nevertheless, the law at last does not provide for an obligation to require a statutory declaration or other actions by the identifying entity. It is thus an action that the law does not require, but it does not ban it either.

Taken-over identification
The bank must identify the client, but it is not necessary for the bank to verify the client's identity by itself. It may work with a taken-over identification. According to Schlossberger (2013) it basically means that another obliged person verified the client's identity and the third party thus supposes in a good faith that its client has already undergone a proper identification process. Which obliged persons can use the taken-over identification is clearly specified by law. It concerns e.g. persons with a certificate to provide investment services except for investment intermediaries, investment companies, investment funds, pension companies, pension funds, payment institutions, small-scale payment service providers, electronic money institutions, small-scale electronic money issuers, persons certified to provide leasing, guarantees, credits or money loans and so on. Of the above-mentioned it is evident that it concerns a wide range of persons who can use the taken-over identification. With regard to the above-mentioned facts, the authors will regard all the above-mentioned entities as "financial institutions" in the following text of this section.
At first sight it may seem that taking over clients' identification for the needs of a financial institution is highly advantageous for clients themselves. They need not undergo the entire identity verification procedure although it is not demanding for clients. Proof of identification attributes can be done very easily, as already mentioned above, i.e. for natural persons by showing an identifying document which is the ID card for citizens of the Czech Republic and the passport for foreign nationals and possibly another official document recognised by the state (e.g. driving licence, birth certificate, etc.) from which all the necessary identification attributes will be evident.
Nevertheless, the law also takes into consideration the situation when the requesting entity is not sure whether the information received from the other entity is relevant. In such case the obligation is basically not to take over the data and not to use this method of client identification.
An even more risky situation can be seen when a financial institution is in the position that it is requested to provide data about its client. This institution "runs a risk" of giving information about its client to someone who is not entitled to it. It is mainly the situation when communication can run also by e-mail.
Telephone inquiries or requests to provide client information should not be responded to. A provable and objective communication should always take place, while the risk of the adverse party is always to be eliminated. Basically it means that the requested financial entity has to be a hundred per cent sure that the requesting party falls into the category of entities that are entitled to work with the taken-over identification data and that this entity really exists.
For the purposes of use of the taken-over identification data and mutual positive communication between two financial entities it would be ideal if representatives of both parties knew each other from previous cooperation, from business contacts, which would essentially eliminate the risk of the adverse party.
Taken-over identification data are also connected with another fact that a financial institution takes over identification data and subsequently finds out that the data are spurious, false or related to a completely different person (e.g. misused personal data of another natural person). Then there is a question who would be liable e.g. for damage that could be caused to the financial institution that took over such data from another institution in a good faith that they are correct. At this point it is impossible to foresee what court judgement would be in case of disputes between these two institutions; however, it is evident from the above-mentioned that it is impossible to rely on the taken-over identification data, especially if an active (e.g. credit) deal is to be made. How to prevent this situation? Simply by not using the possibility of taken-over identification data. Financial institutions can be fully recommended to verify clients' identity by themselves and use the taken-over identification data as little as possible, since in the presence of the client, being a natural person, or the statutory representative or the authorised agent in case of a legal person, the client identification process is not that complicated and lengthy.

Regarding identification carried out at a distance
The final section of this text deals with client identification carried out at a distance. It is basically a method when the client who wants to become a client of a financial institution can, if permitted by the financial institution, use the offer to carry out his or her identification in a remote way. In the Czech Republic, the law terms it identification carried out at a distance. The law specifies the obligations which a given financial institution has to meet and for which it has to prove that its potential client has performed them. To summarise it briefly, it is the client's obligation to make a true copy of his or her ID and to send this copy to the new financial institution and subsequently to make the first payment towards the newly opened payment or equated account with this financial institution from any credit institution (i.e. only from a bank or savings and credit cooperative, not from an account of a payment institution) and to make copies of documents about this account which again he or she sends to a given financial institution.
This fact can be assessed as a high risk, especially if it is a natural person whose literacy is not sufficient. Here, the risk of adverse party is so high for the client that a general recommendation can be given not to use it expect for a highly reputable financial institutions. Possible frauds and subsequent misuse of personal data were dealt with in the book by Kyncl (2012) "Poznej svého klienta" ("Get to know your client"). Therefore, it is possible to state also here that the method of identification at a distance has to be approached even more carefully than the taken-over identification. The reason is that in case of taken-over identification two professional and financially erudite entities are involved, whereas in case of identification at a distance there is a completely non-professional party on one part and a professional party to the deala financial institutionon the other part. If the part of the professionals is taken by institutions at least registered with the Czech National Bank, "instinct of self-preservation" can be expected and therefore these institutions, or more precisely their employees will not carry out activities that would be contrary to law. An internal control and inspection system of a given institution should discover such conduct immediately. However, if it involves a financial entity or even any obliged person within the meaning of the law who are not subject to supervision by a state authority, the risk increases substantially. Therefore, it would be useful to call for an amendment to the current law and rule out some of the entities from the option of identification at a distance.

Simplified identification process
Some constraints of the identification process has been already discussed in the section above, but one important fact was omitted deliberately, specifically consideration of a possible approach to apply "simplified" identification. Why this fact can be considered at all will be briefly explained in the following section. Processes and Technologies for Identifying Illegal Financial Operations 28 The Directive of the EP and of the Council (EU) No. 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing (hereinafter referred to as the "Fourth Directive") does not speak about identification of entities directly, but it does speak about identification of risks related to the possibility of money laundering taking into account "risk factors" such as the factors related to clients, countries, etc. The Directive does not mention client identification and identification attributes directly, as mentioned above, nor describes how the client's identity should be verified; however, it mentions verification based on the documents or even information received from reliable and independent sources. This provision is too wide for practical use, since it is a matter of interpretation what independent sources mean. The area of documents is, according to the authors, quite known. They will continue to include ID cards, passports, various extracts from official registers (business register, trade register, etc.). Nevertheless, the Fourth Directive, Article 25, mentions a possibility to rely on third parties at client due diligence, but it emphasises that the final responsibility for meeting the requirements of performing it correctly remains on the obliged person who should perform this due diligence itself. This indirectly allows further use of the above-mentioned taken-over identification, however, with emphasis on responsibility of the entity that has decided to use this option.

Impact of the Fourth Directive on client identification
When applying the Fourth Directive it would be good to consider, with knowledge of the client's risk category whether it were not really clearer and more understandable at transposition of the Directive to apply the simplified identification, or more precisely identity verification. It can justifiably expected that in the simplified due diligence of the client the current practices will continue, that means the client will be identified at distance or by means of the taken-over identification. According to the authors, it is not good to continue with these practices in the long run. However, it depends on the member states how they resolve the above situation.

Computers
The experience of financial institutionsbanks in particularis that there might be clients whom the bank does know, verifies their identity and no suspicion of illegal intentions is raised at the identification process. However, when working with the bank account, they start requesting transactions that do not match the life style of the household (account holder) or the existing method of undertaking by the company. It can be one of the payment services that are discussed in detail by Schlossberger (2012).
There is little probability that bank employees would be able to monitor their clients' transactions in detail. We must take into account the data mentioned by the Czech National Bank in its most recently published report (2015): -One bank employee is allotted 268.8 citizens, on average; -One point of sale (bank office) attends to 5,000 citizens, on average; -One bank provides services to 233,900 citizens, on average.
If high-performance computer systems are implemented in banks, they may alert banks to suspicious activities on which particular accounts. According to Karttunen, Ammanda and O´Keefe, Rae, Lynn (2015), the algorithms are based on the knowledge that suspicious are such accounts for which a financial institution records many small deposits transferred to other accounts shortly after their depositing. These accounts often have a high overall depositing activity and minimum balances.
Analyses also point out that money laundering suspicion should be also raised when the account receives deposits from many different natural and legal persons and often from many territories and from non-banking entities. Suspicious should be also accounts with many deposits from many sources (i.e. cash, cheques, electronic payments, etc.).
Money laundering suspicion is also indicated by situations when: -Immigrants open accounts in a given country and then transfer money to another country (often electronically); -When deposits are withdrawn or transferred elsewhere immediately (in 1 or 2 days); -Accounts receive anonymous deposits from domestic depositors followed by rapid withdrawals abroad.
In such cases, it is mostly an activity of natural persons. Suspicious methods of account usage can be also employed by companies, i.e. legal persons. It is manifested, for example, as follows: -Accounts show such financial activities that do not correspond to the business activity or employment of their holder, -Accounts show a rapid change in activity.
Both natural and legal persons may try to use individual branches of financial institutions for purchasing securities and other products of financial markets with the purpose of masking connection of the deposited money with cross-border transfers.
The above-mentioned processes are routinely being evaluated already now. However, it is impossible to check all the clients' operations systematically and every day. Based on signals from the computer model, an experienced employee or a forensic analyst can rapidly specify a potentially suspicious account, its holder and identify potential evidence.

Conclusion
The aim of this paper was to characterise different ways of client identifying clients of financial institutions. The authors came to the conclusion that based on practical experience it would be useful to limit or entirely cancel the possibility of taken-over identification or identification carried out at a distance, especially for such financial entities that are not banks. Based on the analysis of the current legal regulation of the identification process, amendment to the law with respect to the possibility to use the "simplified identification" for selected deals can be recommended. The new Fourth Directive reckons with such alternative as part of the simplified due diligence of clients. Consequently, it would more than desirable to use this opportunity and include the above proposals to the amendment to the national legislation at transposition of the Fourth Directive.
Implementation of high-performance computer systems may facilitate and give precision to detection of suspicious activities on client accounts, as well as in situations when employees do not have a possibility of everyday personal monitoring of deposits, withdrawals and transfersoften carried out electronicallyon client accounts.


extfieldsofstudy: Business Economics

text:
Assessing the performance of the Latin American and Caribbean banking industry: Are domestic and foreign banks so different?

Abstract This paper studies the relative performance of domestic and foreign banks in the Latin American and Caribbean banking industry. Data Envelopment Analysis is used to compute technical efficiency scores for the years 2001 and 2013. Our main contribution is twofold. On the one hand, we assess performance at the level of the management of specific production factors. On the other hand, we distinguish program efficiency from managerial efficiency, which allows us to evaluate whether the differences in technical efficiency between national and foreign banks are due to the use of different technologies (program efficiency) or, conversely, differences in the managerial capacities of managers in both categories of banks (managerial efficiency). The results show that foreign banks are more efficient than domestic ones, and provide evidence that the greater efficiency of foreign banks is mostly due to the superior technology they use.

PUBLIC INTEREST STATEMENT
The financial crises experienced by the Latin American and Caribbean region in the 1980s and the first half of the 1990s boosted reforms in the banking system aimed at adapting banks to international solvency standards, liberalizing their operational capacity, opening to international competition, and increasing their efficiency and productivity. Foreign banks were encouraged to enter these countries and were also meant to play a leadership role in the process of modernization; however, the role they actually played still remains a cause for debate. This paper contributes to this ongoing debate by analyzing performance in the regional banking industry. Our results show that foreign banks are managed more efficiently than their domestic counterparts; furthermore, this superiority is determined to a great extent by the use of more efficient technologies. Accordingly, our results appear to support the opening up of the Latin American industry, and the positive role of foreign banks in its modernization.

Introduction
It is well known that the Latin American and Caribbean (LAC) countries began to overhaul their banking systems from the mid-1990s onwards, in order to adapt them to international solvency standards, liberalize their operational capacity, open them to international competition, and increase their levels of efficiency and productivity (De Carvalho, De Paula, & Williams, 2015). The financial crises experienced by the region in the 1980s and the first half of the 1990s boosted these reforms, which counted on the full support of international organizations, such as the International Monetary Fund and the World Bank, in the context of the increasing globalization that the world economy was experiencing (World Bank, 2008). Foreign banks were encouraged to set up operations in these countries and were expected to play an important role in the modernization of LAC banking, within the framework of the privatization process initiated by many governments in the region (Chortareas, Garza-Garcia, & Girardone, 2011;Yildirim & Philippatos, 2007).
The process of liberalization and the opening up of the sector to foreign competitors appear to have had positive results in the light of the financial stability achieved by the region over the last few years, the growth and extension of financial services to a broader section of society, and the overall performance of LAC banks over this period (Manuelito & Jiménez, 2010). Nevertheless, the role that foreign banks have played in this process of modernization in both LAC and in other emerging regions has been and continues to be a point of contention, especially in the context of the controversy of "competition-efficiency" versus "competition-inefficiency" (see Schaeck & Čihák, 2008; also Bang, Pía, & Wu, 2011;Levy & Micco, 2007).
Advocates of the introduction of foreign banks argue that increased competition in local markets leads to improvements in the operational efficiency of domestic entities in a number of different ways, i.e. the implementation of more modern technologies, and the development of new products and services lead to reduced margins and lower costs for financial services (CEPAL, 2012). Furthermore, they argue that foreign banks tend to act more cautiously than their domestic counterparts and they also boost economic growth by improving resource allocation efficiency as well as making the sector less vulnerable to internal and external disturbances (Olivero, Li, & Jeon, 2011). Lastly, they also contend that foreign banks have greater access to capital markets, the loans they provide tend to be more stable, and they are less dependent on national economic cycles (Chortareas et al., 2011;Clarke, Cull, Martínez Pería, & Sánchez, 2003;Dages, Goldberg, & Kinney, 2000;Wu, Bang, & Luca, 2010).
Conversely, other authors maintain that foreign banks develop selective strategies to penetrate target markets, leaving the least profitable and least solvent customers to the local banks, which in turn makes these entities less efficient and less competitive (CEPAL, 2003;Green, Murinde, & Nikolov, 2004;Moguillansky, Studart, & Vergara, 2004). Furthermore, it is said that foreign banks encourage capital outflows and that the integration of international financial markets increases the impact of exogenous shocks on credit or domestic interest rates. Lastly, foreign banks tend to apply greater margins, thus making the whole of the domestic banking market less competitive (de la Torre, Martínez Pería, & Schmukler, 2010;Galindo, Izquierdo, & Rojas-Suárez, 2010). This paper contributes to this ongoing debate by analyzing the performance of the banking industry in LAC countries, and by assessing the relative technical efficiency of national and foreign banks in the region using non-parametric Data Envelopment Analysis (DEA) techniques. The contribution of this paper to existing literature is twofold. On the one hand, by accounting for slacks in the calculation of efficiency scores, we assess performance at the level of the management of specific production factors. On the other hand, we distinguish program efficiency from managerial efficiency, which allows us to evaluate whether the differences in technical efficiency between national and foreign banks are due to the use of different technologies (program efficiency) or, conversely, differences in the managerial capacities of managers (managerial efficiency) in both categories of banks. Our main finding is that foreign banks perform better than national ones, and the difference is statistically significant; moreover, this difference is based to a great extent on the superior technology that the foreign banks use.
The paper is structured as follows: following the introduction, Section 2 describes the recent trends in costs and margins of the banking industry in LAC countries; Section 3 reviews the literature on the assessment of banking efficiency in the LAC region; Section 4 describes the data and the methodology; Section 5 presents and discusses the results, while the final Section 6 contains summaries and conclusions.

Background information about the LAC banking sector
Although it is by no means homogeneous, the LAC banking market does have certain common features that are specific to developing economies. Even though the regional banking market is still not sufficiently mature, it has experienced high rates of expansion and has multiplied its activities over the last decade, diversifying its range of financial services and progressively penetrating new sectors of Latin American society. Moreover, after almost two decades of opening up to foreign competitors, regional banks are notably more stable, with significant improvements to their efficiency and profitability indicators (Bank for International Settlements, BIS, 2007).
The strong economic performance of the region has led to a growth in financial activity of a similar intensity to that observed in other emerging regions and much greater than the growth registered in any developed countries. The growth in banking activity has been accompanied by a very significant improvement in the indicators of access to financial services. Therefore, the number of customers and banking branches has increased substantially with a diversification in the channels used to offer products and services, although again, these indicators are far removed from the levels seen in more advanced countries (World Bank, 2012).
The role played by foreign entities in this process may represent one of the most noteworthy features of the evolution of the Latin American banking market during the last two decades. At the end of the 1980s, the international banking sector began to expand into emerging markets all over the world and particularly in LAC. Within a short period of time, the biggest banks in the USA, the UK, Spain, Canada, and the Netherlands had strengthened their presence in the Latin American banking market. The local authorities in LAC countries, with strong support from different international financial organisms, expected the arrival of foreign banks to contribute to the recapitalization of those local entities that had been badly damaged by previous crises, to encourage competition in the sector and to facilitate the incorporation of new technologies and more advanced management procedures, all of which would help to ensure stability and improve the efficiency and productivity of regional banks (Minda, 2007).
At the beginning of the twenty-first century, the process of implantation of foreign banks in LAC was practically complete. However, after nearly a decade in which foreign banks had obtained over 50% of the market share in most of the countries in the region, from 2001 onwards, there has been a gradual yet irregular recovery of market share by domestic banks (Figure 1).
The slow but continued fall in the power of foreign banks can primarily be explained by a sharp increase in the activity of domestic banks, which in the period 2001-2013 managed to increase their assets more quickly than foreign banks. Foreign banks, in turn, have started to reorganize their  subsidiaries in the region and, since the financial crisis that began in 2007, have partially returned to their original markets in order to strengthen the liquidity and solvency of the parent companies (Fender & McGuire, 2010).
Despite the strategies developed by foreign entities, it is primarily the strong performance of domestic banks that is behind the positive evolution of their market share (CEPAL, 2012). Costs, margins, and profits are the most important variables where competition has had an impact, and reflect the main changes to have taken place in banking.
The arrival of foreign banks to LAC was expected to bring about significant reductions in intermediation costs and margins (Jeon, Olivero, & Wu, 2011). 1 It was estimated that increased competition accrued from the process of opening up to foreign companies and the supposedly superior technological and management skills of these companies would guarantee this [Levy and Micco (2007) and Bang et al. (2011) analyze competition and concentration in the LAC banking sector]. Regarding margins, with the exception of specific cases such as Mexico, the interest differential of lending and deposit rates has remained relatively high throughout the period, at levels which are far removed from the narrower margins observed in advanced economies such as the USA or the Eurozone (Table 1). 2 Consequently, it seems that, in this respect, increased competition has not significantly affected regional banking practices (Gelos, 2009). It is also striking that foreign entities have displayed higher interest differentials than those of domestic entities', except for the years in the middle of the decade (Figure 2(a)).
On the other hand, operating costs have been significantly reduced in terms of the total assets for the period, which could be explained, among other reasons, by the increase in competition and technological, organizational and managerial modernization that took place after the arrival of foreign banks (Carvallo & Kasman, 2005). The reduction in costs has been particularly intense in the case of domestic banks, which have outperformed foreign ones and have displayed a great ability to adapt to the new institutional framework and a more competitive scenario (Figure 2(b)). Nevertheless, the levels of relative costs among Latin American banks are still notably higher than those observed in the USA and especially those in the Eurozone (see Table 1).
Regarding profitability performance, the growth of the banking business in the region and the increases in efficiency and productivity should boost profit levels, although the increase in competition could also negatively influence these levels due to the narrowing of margins (Claessens, Demirgüç-Kunt, & Huizinga, 2001). Nevertheless, as has been noted, banking margins remained relatively high during the 2000s, and therefore one would expect the opening up of the sector to foreign competitors to have led to an increase in profit levels derived from the growth of business as well as improvements in efficiency. Indeed, over the period analyzed, the rate of return on assets in the LAC banking market increased substantially, while it fell considerably in the USA and even more so in the Eurozone (see Table 1). The profiles of the rate of return of domestic and foreign banks are very similar, although the financial crisis that started in 2007 has had a greater impact on the profits of foreign entities (Figure 2(c)).
In summary, the different indicators analyzed above show that the LAC banking industry has evolved favorably between 2001 and 2013; furthermore, domestic and national banks have performed in a very similar way. This would seem to suggest that the presence of foreign banks has boosted Source: BankScope and own elaboration.
competition and modernization in the regional banking system, which was the original aim behind the decision to liberalize and open up the sector.
Given the similarity of the developments observed, it might be worthwhile asking if there are currently any significant differences in the comparative levels of efficiency and, therefore, if it is reasonable to expect even greater changes in the LAC banking scenario over the coming years. The next sections aim to provide partial answers to these questions.
Regarding studies specifically focused on the banking industry in LAC countries, several papers over the last decade have assessed the relative performance of domestic and foreign banks. The results obtained using different methodological approaches are mixed, although many papers indicate that the performance of domestic and foreign banks is currently very similar (CEPAL, 2012). Using regression analysis, Micco, Panizza, and Yañez (2007) found that foreign banks in developing countries have higher profit margins and lower costs than domestic banks. Furthermore, Figueira, Nellis, and Parker (2009) estimated several stochastic and non-stochastic frontiers and found only slight differences in performance between domestic and foreign banks in LAC countries.
In the case of Brazilian banks, Tecles and Tabak (2010) estimated both stochastic and nonparametric frontiers and found that large foreign banks are somewhat more efficient than domestic banks. Moreover, using non-parametric DEA techniques, Staub, da Silva e Souza, and  showed that Brazilian state-owned banks are more efficient than foreign banks and private domestic banks, with or without minority foreign participation. Nevertheless, these results should be no surprise, given the functions of the wholesale banking sector and the important role that public banking plays in this emerging economy. Garza-García (2012) conducted a two-stage performance analysis for Mexican banks and concluded that GDP growth, loan intensity, and foreign ownership are the main factors that influence banking efficiency. Finally, Sanchez, Hassan, and Bartkus (2013) measured allocative, technical, and scale efficiency in seven Latin American banking industries, and suggested that the source of inefficiency is regulatory (allocative), rather than managerial (technical), and that financial liberalization has led to productivity increases throughout Latin America as a consequence of technological progress, rather than enhanced technical efficiency.
In summary, literature in this field of research suggests that the origin of capital, either domestic or foreign, might be one of the factors that influence banking efficiency. In the following sections, we go one step further by assessing the technical efficiency of foreign and domestic LAC banks in terms of how they manage specific production factors. We also investigate the relative efficiency of the production technologies used by foreign and domestic banks.

Data and sample
In order to evaluate the efficiency of the banking industry in LAC countries, we use data from the BankScope database, a widely used source of accounting and financial statistics in recent years (Soares, 2011). Our data-set includes banks from Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru, Paraguay, Trinidad and Tobago, Uruguay, and Venezuela. To avoid any distortions that productive specialization (commercial or investment banks) or the legal status of institutions (banks, saving banks, and cooperative banks) might have on our analysis, the sample only includes commercial banks. We assess the relative efficiency The characterization of the production technology in the banking industry is based on the financial intermediation approach (Sealey & Lindley, 1977), according to which banks use basic production factors (physical capital and labor) and gain resources through different means, such as deposits or capital (inputs), to invest in different financial products, including credits, loans, or securities (outputs). This approach has been widely used in previous literature (see Berger, Hasan, & Zhou, 2009;Chiu, Jan, Shen, & Wang, 2008;Koutsomanoli-Filippaki, Margaritis, & Staikouras, 2009, among others). More specifically, the inputs considered in our analysis are staff costs as a proxy of labor, non-profitable assets as a proxy of physical capital, and customer deposits and own resources as financial inputs. On the other hand, outputs are gross loans, interbank credits, and investment in securities (Ray & Das, 2010). Table 2 shows some descriptive statistics.

Methodological issues
For the methodology, let us assume that the k = 1, … , N, banks in our sample, either 164 in 2001 or 145 in 2013, use a vector of inputs x ik (i = 1, … , 4), i.e. non-profitable assets, customer deposits, own resources, and staff costs, to produce a vector of outputs y rk (r = 1, … , 3), i.e. gross loans, interbank credits, and investment in securities, through a technology that is given by: (1) T = (x, y) | | x can produce y This reference technology provides a complete description of all feasible relationships between inputs and outputs, and it is assumed that it satisfies the standard axioms proposed by Shephard (1970). These properties include the possibility of inaction, no free lunch, free disposability of inputs, and strong disposability of outputs; furthermore, outputs and inputs are assumed to be non-negative.
Based on this characterization of the production technology, the technical efficiency of banks in our sample is assessed using DEA techniques. DEA is a well-known approach to measuring efficiency based on mathematical programming that was pioneered by Charnes, Cooper, and Rhodes (1978), and it has been used in hundreds of empirical papers (see Cook & Seiford, 2009 for a review). In essence, this technique allows the comparison of the position of each bank in our sample, i.e. its input and output vectors, with the best observed practices in the sample in terms of a performance indicator (the details are in Cooper, Seiford, & Tone, 2007). 3 Formally, assessing the technical efficiency of bank 0 requires solving the following program: where x i0 and y r0 stand for the observed values of input i and output r for bank 0, and λ k represents the weighting of each bank k in the sample in the composition of the efficient frontier. Moreover, all inputs are assumed to be variable, which means that we carry out an analysis of long-run performance; constant returns to scale are also imposed (see Banker, Charnes, & Cooper, 1984).
The solution to program (2) assesses the maximum feasible proportional reduction in all inputs that bank 0 could achieve without decreasing its outputs, thus providing a measure of conventional Farrell-type input-oriented technical efficiency, i.e. it assesses technical efficiency in a Farrell-Debreu sense (Farrell, 1957). This score ranges from zero to one, with one indicating best performance. For instance, a figure of 0.85 would mean that bank 0 could produce the same vector of outputs using only 85% of inputs; in other words, all inputs could be proportionally reduced by 15%.
However, once the maximum proportional reduction of all inputs has been attained, additional reductions may still be feasible for some particular inputs while maintaining the vector of outputs; the so-called input slacks measure these input-specific potential reductions. The existence of slacks means that the extent of inefficiency cannot be fully assessed by simply computing radial measures, as non-radial reductions also need to be considered in order to provide a complete picture of efficiency (Torgersen, Førsund, & Kittelsen, 1996). Formally, these additional shrinkages are measured for bank 0 from the solution to the following program (Ali & Seiford, 1993): with S i0 and S r0 standing for the slacks in inputs and outputs, respectively, i.e. input excesses and output shortfalls; * 0 is the solution for proportional efficiency obtained for bank 0 from program (2).
(2) Minimize 0 , k Technical efficiency = 0 subject to: S i0 , S r0 ≥ 0 i = 1, … , 4 and r = 1, … , 3 Potential proportional reductions in inputs computed from mathematical program (2) and inputspecific slacks arising from program (3) can be used to assess Pareto-Koopmans input-specific technical efficiency (Koopmans, 1951). Accordingly, the Pareto-Koopmans efficient use of input i on behalf of bank 0 is computed by subtracting its aggregate potential reduction, i.e. proportional plus input-specific reduction, from its observed use: Finally, slack-adjusted scores for the input-specific technical efficiency of bank 0 in the management of input i are computed as the quotient between the Pareto-Koopmans efficient level of that input and its observed level: The input-specific efficiency scores are, by construction, always equal to or lower than the radial scores and have a similar economic interpretation. Furthermore, as input slacks enter expression (5) as a percentage of observed inputs, input-specific measures of technical efficiency are unit invariant. While the inclusion of information on input-specific reductions when assessing technical efficiency reveals the full potential of banks in our sample to reduce inputs while maintaining outputs, the importance of slacks in explaining inefficiency can be evaluated by calculating the weight of potential input-specific reductions on aggregate potential input reductions. Formally, for input i: Once both proportional and input-specific technical efficiency of all banks in our sample have been evaluated, the statistical significance of differences between domestic and foreign banks can be assessed using a number of non-parametric tests of hypotheses. A standard test is the Kolmogorov-Smirnov distribution test (see Conover, 1999); in addition, we also use the Simar-Zelenyuk-adapted-Li test (Li, 1996;Simar & Zelenyuk, 2006), which is more appropriate to our case study because it is specifically designed for statistical inference with efficiency scores computed with DEA.
Nevertheless, some possible differences in technical efficiency between domestic and foreign banks in LAC countries might be due either to the fact that they are using different production technologies or to what we might call a concentration of good/bad managers in a given category of banks. In order to distinguish between these two sources of inefficiency in the case of our radial technical efficiency scores, in the second stage of our research, we use the program approach first proposed by Charnes, Cooper, and Rhodes (1981) and later further developed by authors, such as Silva Portela andThanassoulis (2001) andO'Donnell, Rao, andBattese (2008). Essentially, this approach suggests that production units belonging to different programs or groups within the same economic activity might have access to different production technologies. Furthermore, in our case study, it would allow us to assess managerial or intra-program efficiency by comparing banks in our sample to best observed practices in the group they belong to, either domestic or foreign banks, and also to assess inter-program efficiency, or simply program efficiency, which identifies differences in performance between both groups that stem from technological differences.
In practice, assessing program efficiency in the LAC banking industry requires the following four steps to be taken. Firstly, all banks in the sample need to be grouped according to their type, either domestic or foreign, and then program (2) must be run separately for each group K h (h = 1, 2) in order to assess managerial efficiency, namely φ managerial ; i.e. banks are compared to best observed practices in the group they belong to. Secondly, observed data on inputs are projected onto the technological frontier of their own group in order to clean up managerial inefficiencies. This can be formally done for bank k in group K h and input i by means of the expression: The third step requires solving program (2) again using the joint sample of banks and the projected data obtained in the previous step instead of the original observed data. This provides an estimation of program efficiency, represented by φ program , which, for each group, is equivalent to the distance between the technological frontier of this group and the joint technological frontier. Finally, the significance of differences in program efficiency between domestic and foreign banks needs to be tested using appropriate statistical procedures, such as those mentioned above.
In summary, the aforementioned procedure allows us to decompose scores for radial technical efficiency into the result of the product of scores for managerial efficiency and program efficiency. Formally:

Results and discussion
Using the characterization of the technology in the banking industry described in Section 4.1, we have assessed the performance of the LAC banks in the years 2001 and 2013 separately. To do so, we firstly computed radial or proportional scores of technical efficiency from mathematical program (2) using the joint sample of banks as the reference to construct the technological frontier. The results are shown in Table 3.
Computed scores of efficiency in 2013 suggest that, on average, in the long run, the banks in the sample could reduce their use of inputs by almost 27%, while maintaining their levels of outputs, i.e. the average radial efficiency is 0.731. This potential proportional reduction of inputs reaches 28% for domestic banks and 25% for foreign banks, i.e. technical efficiency scores are 0.719 and 0.750, respectively; furthermore, results from the Kolmogorov-Smirnov and Simar-Zelenyuk-adapted-Li tests show that this difference is statistically significant at standard confidence levels. Accordingly, a first conclusion from our results is that, from a technical point of view, foreign banks in the LAC banking industry are more efficiently managed than their domestic counterparts. These results contradict those of Figueira et al.'s (2009), which found that in LAC countries, the local banks are slightly more efficient; however, they are similar to those of Garza-García (2012) and Berger et al.'s (2009), which found that foreign banks were more efficient than domestic ones in Mexico and China, respectively.
However, a relevant issue is whether or not higher efficiency of foreign banks in LAC countries holds true when it comes to the management of specific production factors. In order to answer this question, we have computed input-specific technical efficiency scores according to expression (5) using figures on input excesses from program (3). The results appear in Table 3. The averages for all banks are 0.511, 0.727, 0.723, and 0.645 for non-profit assets, customer deposits, own resources, and staff costs, respectively. Moreover, the weight of slacks in explaining potential input-specific reductions, which is assessed from expression (6), ranges from scarcely 1% for customer deposits to nearly 47% for non-profitable assets, highlighting the relevance of taking them into consideration when assessing the technical efficiency of the LAC banking industry.
Regarding the economic interpretation of the averages of input-specific efficiency, the greatest inefficiencies arise in the management of non-profitable assets and staff costs, i.e. basic production factors, while the best-managed production factors are customer deposits and own resources, i.e. financial inputs. Furthermore, the higher performance of foreign banks holds true for the specific Technical efficiency ( k ) = managerial efficiency managerial k × program efficiency program k management of all inputs included in the analysis, with the exception of staff costs, where the difference with domestic banks is not statistically significant according to the results from the Kolmogorov-Smirnov and the  In addition to the above-mentioned results for 2013, we also assessed efficiency of the LAC banking industry in 2001. The results appear in Table 3. Before commenting on them, let us point out that the efficiency scores, whether radial or input-specific, computed in 2001 and 2013 are not directly comparable to each other. The reason for this is that efficiency is a relative concept that is assessed with respect to a technological frontier constructed from observations of best practices in a given data-set of observations (see Cooper et al., 2007), and the 2001 and 2013 data-sets are different. 5 That said, efficiency scores computed with data for 2001 also point to the greater efficiency of foreign LAC banks compared to their domestic counterparts; for instance, while the average radial efficiency is 0.699 for foreign banks, i.e. they could maintain their output levels with a 30% reduction in inputs, for domestic banks this figure stands at 0.620, with the difference being statistically significant. Our results also reveal that in 2001, foreign banks were more efficient than domestic ones in the specific management of all production factors considered in our analysis, with the differences being statistically significant in all cases. Lastly, it is worth noting that in 2001, both domestic and foreign LAC banks were operating further away from their contemporaneous technological frontiers than in 2013.
As previously noted, the differences in performance between domestic and foreign banks within the LAC banking industry may be due to differences in the capabilities of their respective managers and/or to differences in the technology they use. In order to shed some light on this issue, we have considered that domestic and foreign banks belong to different groups or programs and have decomposed radial efficiency into the product of managerial efficiency and program efficiency, which, in our case study, might also be referred to as ownership efficiency, since it identifies differences in performance between domestic and foreign banks. The results for years 2001 and 2013 appear in Table 4.
On the one hand, the average managerial efficiency score of domestic banks in 2013 is 0.818, which means that when compared to the best observed practices in their group, they could proportionally save around 18% of their consumption of inputs. Average managerial efficiency for foreign banks is 0.773, suggesting a potential reduction of inputs of almost 23%. However, the managerial efficiency scores of domestic and foreign banks are not directly comparable because they have been obtained in relation to different technological frontiers and, as mentioned above, efficiency is a relative concept.
On the other hand, program efficiency averages 0.916 for domestic banks and 0.969 for foreign ones, indicating that, on average, the group of foreign banks performs closer to the joint technological frontier than the group of domestic banks. Moreover, the difference between both distributions is statistically significant according to both the Kolmogorov-Smirnov and the Simar-Zelenyuk-adapted-Li tests. In addition, Figure 3 represents the Kernel density estimation functions of the radial technical  efficiency scores for the groups of domestic and foreign LAC banks, providing a graphical illustration of the difference between both distributions. These results suggest that the technology used by foreign banks in LAC countries is more technically efficient than that used by domestic banks. In 2001, the group of domestic banks was also operating further away from the contemporaneous joint frontier when compared to the group of foreign banks; however, in 2013, their distance from that year's joint frontier decreased noticeably.
In terms of the relative efficiency of domestic and foreign banks in LAC countries, the results appear to partially support the policy measures taken in the 1980s by the national governments in the region aimed at opening up the banking industry to international competition. Accordingly, our empirical evidence supports the hypothesis that foreign banks, equipped with more advanced technologies, greater experience, and management capacity, in addition to having better access to financial international markets, are more efficiently managed than their domestic counterparts, and could potentially have contributed to the modernization of the LAC banking sector.

Summary and conclusions
The LAC banking industry opened up to international competition in the mid-1980s. Judging by the financial stability and the expansion that the banking sector in the region achieved in the years after first opening up the market to foreign competitors, it seems that the arrival of foreign banks had a positive effect. Nevertheless, there is no consensus in the literature as to the role played by foreign banks in this process. In the context of this debate, this article studies the performance of domestic and foreign banks in LAC countries, analyzing their levels of relative efficiency. One of the most relevant contributions made is the assessment of efficiency related to the management of specific production factors; moreover, analysis is carried out in order to determine whether or not the differences in efficiency between domestic and foreign banks are due to the difference in abilities between their managers and/or the restrictions imposed by the use of different technologies.
Firstly, the performance of the banking industry in the region during the period 2001-2013 showed a significant improvement in cost and profit indicators. In this sense, it seems that domestic banks adapted quickly to the new competitive environment and even recovered a good proportion of the market share that they lost in the years immediately following the arrival of foreign banks. The performance indicators analyzed also show a certain convergence between domestic and foreign banks, particularly in terms of costs; nonetheless, these indicators are still more favorable for foreign banks.
Secondly, the efficiency analysis results show that foreign banks are more efficient in their technical management than their domestic counterparts, and the difference is statistically significant. Furthermore, a noteworthy result of the research is that the superiority of foreign banks in terms of technical efficiency is determined to a great extent by their technology, which is more efficient than that used by domestic banks. Finally, in 2013, domestic banks were closer to their contemporaneous joint technological frontier than they had been in 2001.
On balance, the results obtained from this research appear to support the position adopted by LAC governments when they decided to open up their banking markets to international competition. In this sense, the empirical evidence provided supports the hypothesis that foreign banks, with more advanced technology, greater experience and management ability, and better access to international financial markets, might well have played an important role in the process of modernization of the LAC banking industry.
Finally, we would like to highlight some limitations of our research, as well as several topics that, in our opinion, merit further investigation. Firstly, commercial banks produce good outputs but also bad outputs, such as impaired loans, and for these to be reduced requires increased expenditure on evaluating customers' credit risk; however, this issue is not accounted for in our efficiency analysis.
Concerning areas for further research, it might be interesting to explore differences in performance between foreign commercial banks and foreign investment banks. In addition, using dynamic modeling to assess the contribution of changes in efficiency to productivity growth of LAC banks, or using multidirectional efficiency analysis techniques to examine in more depth the nature of inefficiencies relative to input-specific improvement potentials are also interesting methodological challenges that could be dealt with in future research.