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Consistency conditions for regulatory analysis of financial institutions: a comparison of frontier efficiency methods

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Author Info

  • Paul W. Bauer
  • Allen N. Berger
  • Gary D. Ferrier
  • David B. Humphrey

Abstract

We propose a set of consistency conditions that frontier efficiency measures should meet to be most useful for regulatory analysis or other purposes. The efficiency estimates should be consistent in their efficiency levels, rankings, and identification of best and worst firms; consistent over time and with competitive conditions in the market; and consistent with standard nonfrontier measures of performance. We provide evidence on these conditions by evaluating and comparing efficiency estimates on U.S. bank efficiency from variants of all four of the major approaches--DEA, SFA, TFA, and DFA--and find mixed results.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1997-50.

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Date of creation: 1997
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Handle: RePEc:fip:fedgfe:1997-50

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Keywords: Bank supervision ; Bank management;

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References

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  1. Allen N. Berger & Anil K. Kashyap & Joseph M. Scalise, 1995. "The Transformation of the U.S. Banking Industry: What a Long, Strange Trips It's Been," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 55-218.
  2. Berger, Allen N. & Humphrey, David B., 1997. "Efficiency of financial institutions: International survey and directions for future research," European Journal of Operational Research, Elsevier, vol. 98(2), pages 175-212, April.
  3. DeYoung, Robert & Hasan, Iftekhar & Kirchhoff, Bruce, 1998. "The Impact of Out-of-State Entry on the Cost Efficiency of Local Commercial Banks," Journal of Economics and Business, Elsevier, vol. 50(2), pages 191-203, March.
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  6. Leamer, Edward E & Leonard, Herman B, 1983. "Reporting the Fragility of Regression Estimates," The Review of Economics and Statistics, MIT Press, vol. 65(2), pages 306-17, May.
  7. Allen N. Berger & J. David Cummins & Mary A. Weiss, 1995. "The coexistence of multiple distribution systems for financial services: the case of property-liability insurance," Finance and Economics Discussion Series 95-22, Board of Governors of the Federal Reserve System (U.S.).
  8. Allen N. Berger & David B. Humphrey, 1992. "Measurement and Efficiency Issues in Commercial Banking," NBER Chapters, in: Output Measurement in the Service Sectors, pages 245-300 National Bureau of Economic Research, Inc.
  9. Fecher, F. & Kessler, D. & Perelman, S. & Pestieau, P., 1991. "Productive performance of the french insurance industry," CORE Discussion Papers 1991025, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  11. Borger, Bruno De & Ferrier, Gary D. & Kerstens, Kristiaan, 1998. "The choice of a technical efficiency measure on the free disposal hull reference technology: A comparison using US banking data," European Journal of Operational Research, Elsevier, vol. 105(3), pages 427-446, March.
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  13. Allen Berger & Timothy Hannan, 1994. "The Efficiency Cost of Market Power in the Banking Industry: A Test of the 'Quiet Life' and Related Hypotheses," Center for Financial Institutions Working Papers 94-29, Wharton School Center for Financial Institutions, University of Pennsylvania.
  14. Allen N. Berger & Robert DeYoung, 1995. "Problem Loans and Cost Efficiency in Commercial Banks," Center for Financial Institutions Working Papers 96-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
  15. Berger, Allen N. & Leusner, John H. & Mingo, John J., 1997. "The efficiency of bank branches," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 141-162, September.
  16. Kumbhakar, Subal C., 1990. "Production frontiers, panel data, and time-varying technical inefficiency," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 201-211.
  17. Charnes, A. & Cooper, W. W. & Rhodes, E., 1978. "Measuring the efficiency of decision making units," European Journal of Operational Research, Elsevier, vol. 2(6), pages 429-444, November.
  18. Andrew M. Yuengert, 1993. "The measurement of efficiency in life insurance estimates of a mixed normal-gamma error model," Research Paper 9308, Federal Reserve Bank of New York.
  19. Ferrier, Gary D. & Grosskopf, Shawna & Hayes, Kathy J. & Yaisawarng, Suthathip, 1993. "Economies of diversification in the banking industry : A frontier approach," Journal of Monetary Economics, Elsevier, vol. 31(2), pages 229-249, April.
  20. Giokas, DI, 1991. "Bank branch operating efficiency: A comparative application of DEA and the loglinear model," Omega, Elsevier, vol. 19(6), pages 549-557.
  21. Allen N. Berger & David B. Humphrey, 1990. "The dominance of inefficiencies over scale and product mix economies in banking," Finance and Economics Discussion Series 107, Board of Governors of the Federal Reserve System (U.S.).
  22. Seiford, Lawrence M. & Thrall, Robert M., 1990. "Recent developments in DEA : The mathematical programming approach to frontier analysis," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 7-38.
  23. FERRIER, Gary & KERSTENS, Kris & VANDEN EECKAUT, Philippe, 1994. "Radial and Nonradial Technical Efficiency Measures on a DEA Reference Technology : A Comparison using US Banking Data," CORE Discussion Papers 1994023, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  24. Sherman, H. David & Gold, Franklin, 1985. "Bank branch operating efficiency : Evaluation with Data Envelopment Analysis," Journal of Banking & Finance, Elsevier, vol. 9(2), pages 297-315, June.
  25. Knox Lovell, C. A. & Pastor, Jesus T., 1997. "Target setting: An application to a bank branch network," European Journal of Operational Research, Elsevier, vol. 98(2), pages 290-299, April.
  26. Aigner, Dennis & Lovell, C. A. Knox & Schmidt, Peter, 1977. "Formulation and estimation of stochastic frontier production function models," Journal of Econometrics, Elsevier, vol. 6(1), pages 21-37, July.
  27. A. Charnes & W. W. Cooper & T. Sueyoshi, 1988. "A Goal Programming/Constrained Regression Review of the Bell System Breakup," Management Science, INFORMS, vol. 34(1), pages 1-26, January.
  28. Léopold Simar & Paul W. Wilson, 1998. "Sensitivity Analysis of Efficiency Scores: How to Bootstrap in Nonparametric Frontier Models," Management Science, INFORMS, vol. 44(1), pages 49-61, January.
  29. Parkan, Celik, 1987. "Measuring the efficiency of service operations: An application to bank branches," Engineering Costs and Production Economics, Elsevier, vol. 12(1-4), pages 237-242, July.
  30. Bauer, Paul W., 1990. "Recent developments in the econometric estimation of frontiers," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 39-56.
  31. Cebenoyan, A Sinan & Cooperman, Elizabeth S & Register, Charles A, 1993. "Firm Efficiency and the Regulatory Closure of S&Ls: An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 540-45, August.
  32. Bauer, Paul W. & Hancock, Diana, 1993. "The efficiency of the Federal Reserve in providing check processing services," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 287-311, April.
  33. Ferrier, Gary D. & Lovell, C. A. Knox, 1990. "Measuring cost efficiency in banking : Econometric and linear programming evidence," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 229-245.
  34. Kenneth Spong & Richard J. Sullivan & Robert DeYoung, 1995. "What makes a bank efficient? : a look at financial characteristics and management and ownership structure," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 1-19.
  35. Yuengert, Andrew M., 1993. "The measurement of efficiency in life insurance: Estimates of a mixed normal-gamma error model," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 483-496, April.
  36. DeYoung, Robert, 1997. "A diagnostic test for the distribution-free efficiency estimator: An example using U.S. commercial bank data," European Journal of Operational Research, Elsevier, vol. 98(2), pages 243-249, April.
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