http://d1c25a6gwz7q5e.cloudfront.net/papers/67.pdf

Efficiency of financial institutions: International survey and directions for future research

Over the past several years, substantial research effort has gone into measuring the efficiency of financial institutions. Many studies have found that inefficiencies are quite large, on the order of 20% or more of total banking industry costs and about half of the industry's potential profits. There is no consensus on the sources of the differences in measured efficiency. this paper examines several possible sources, including differences in efficiency concept, measurement method, and a number of bank, market, and regulatory characteristics. We review the existing literature and provide new evidence using data on US banks over the period 1990–1995.

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Inside the Black Box: What Explains Differences in the Efficiencies of Financial Institutions?

This paper addresses a little examined intersection between the problem loan literature and the bank efficiency literature. We employ Granger-causality techniques to test four hypotheses regarding the relationships among loan quality, cost efficiency, and bank capital. The data suggest that problem loans precede reductions in measured cost efficiency; that measured cost efficiency precedes reductions in problem loans; and the reductions in capital at thinly capitalized banks precede increases in problem loans. Hence, cost efficiency may be an important indicator of future problem loans and problem banks. Our results are ambiguous concerning whether or not researchers should control for problem loans in efficiency estimation.

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Problem Loans and Cost Efficiency in Commercial Banks

This paper examines the efficiency and price effects of mergers by applying a frontier profit function to data on bank ‘megamergers’. We find that merged banks experience a statistically significant 16 percentage point average increase in profit efficiency rank relative to other large banks. Most of the improvement is from increasing revenues, including a shift in outputs from securities to loans, a higher-valued product. Improvements were greatest for the banks with the lowest efficiencies prior to merging, who therefore had the greatest capacity for improvement. By comparison, the effects on profits from merger-related changes in prices were found to be very small.

/pdf/the-effects-of-megamergers-on-efficiency-and-prices-evidence-3z8ydrwyf2.pdf

The Effects of Megamergers on Efficiency and Prices: Evidence from a Bank Profit Function

Foreign-owned U.S. banks have been chronically unprofitable for more than a decade. The authors employ a profit efficiency model introduced by Allen N. Berger, Diana Hancock, and David B. Humphrey (1993), modified to be less sensitive to variations in asset size, to estimate the relative profit efficiency of 62 foreign-owned and 240 U.S.-owned banks between 1985 and 1990. Their results indicate that foreign-owned banks were significantly less profit efficient than were U.S.-owned banks primarily due to foreign banks reliance on expensive purchased funds. For foreign-owned banks, the results are consistent with a strategy of sacrificing profits in exchange for fast growth and increased market share during the 1980s. Copyright 1996 by Ohio State University Press.

https://www.jstor.org/stable/pdfplus/2078074.pdf

Foreign-Owned Banks in the United States: Earning Market Share or Buying It?

Questions of whether the evolution of the financial services industry results in more efficient intermediaries, better prices and service quality for consumers, and greater bank safety and soundness cannot be answered without addressing the cost and revenue efficiencies of the industry. Most studies of the efficiency of financial institutions have used an econometric approach to measure efficiency. This paper tries to address potential econometric problems of previous efficiency studies and suggests a new technique for measuring efficiency. This method is applied to data on U.S. commercial banks from 1984 through 1989. Previous studies used one of four different approaches for estimating X-efficiencies - the econometric frontier approach, the thick frontier approach, data envelopment analysis, and the distribution free approaches. In all four cases, the econometric problem of estimating X-efficiencies is defined simply as one of distinguishing between two components of a random error term added to a cost or profit function. The authors suggest that it is possible that the actual econometric problem of estimating X-inefficiencies is not as simple as the problem of distinguishing between two random components because of the following three reasons: ( i ) the true functional forms of the cost or profit functions of the firms are usually unknown; ( ii ) explanatory variables excluded from the cost or profit function are likely to be correlated with the explanatory variables included in the function; and (iii) inconsistencies may arise if arbitrary error terms are added to a cost or profit function and their corresponding share equations. The authors use a fixed-coefficients model that allows them to address the econometric problems mentioned above. This methodology also allows for the estimation of a separate frontier for each firm as opposed to previous studies that estimate one frontier which is common to all firms. The results of the paper show that the residual which the previous studies attributed to technical inefficiency potentially included the effects of excluded variables, of inaccuracies in the specified functional forms, and of inconsistent parameter estimates. They further show that once these effects are subtracted from the residual, the measured inefficiencies are substantially reduced. The results do support some of the previous studies' conclusions - in general measured technical inefficiencies dominate allocative inefficiencies and that on average large banks are more efficient from both the technical and allocative perspectives than small and medium sized banks.

A general method of deriving the efficiencies of banks from a profit function

This article develops a new method of estimating inefficiencies in joint production and shows that unlike the approaches utilized in the previous studies of inefficiency, this method maintains a consistent relationship between the error term of a profit function and the error terms of its price derivatives. A useful by-product of the method is a proof of a Hotelling-like lemma that relates stochastic input demand and output supply functions to stochastic profit functions. While the previous studies fit a single frontier to data on all firms, this paper estimates a frontier unique to every observed firm to allow each one to have a different potential of achieving maximal levels of profit. The new method is applied in the analysis of annual data, 1984–1989, for U.S. commercial banks. Both the analytical and numerical results of the paper show that the residual that the previous studies attribute to inefficiency includes the effects of excluded variables and of inaccuracies in the specified functional forms. Once accurate estimates of these effects are subtracted from the residual, the distortions in the measured inefficiencies should be considerably reduced. Consequently, this article considers how such estimates might be obtained.

A General Method of Deriving the Inefficiencies of Banks from a Profit Function

This article deals with the construction of plans for two-level factorial experiments in which there are p response variables and each response is affected by one or more factors. The plans are orthogonal for each response variable. Estimates of the parameters in the models for such plans are obtained when Σ, the dispersion matrix of an observation vector, is known. The properties of these estimates indicate how to design the experiment so that the variances of the estimates of the parameters can be influenced by their relative importance. The case when Σ is unknown is discussed briefly.

Stephen B. Taubman

Papers

A general method of deriving the efficiencies of banks from a profit function

A General Method of Deriving the Inefficiencies of Banks from a Profit Function

Some Two-Level Multiple-Response Factorial Plans

Best k of 2k—1 Tests of Hypotheses Involving the Normal Distribution