Detecting skimping in bank production process with non-performing loans: A distance minimization approach

We propose a minimum-distance efficiency model that incorporates material-balance constraints and treats non-performing loans (NPLs) as an explicit, undesirable output. Unlike radial distance functions, our non-radial formulation lets each input and output adjust independently. This flexibility uncovers latent inefficiencies most notably skimping. Skimping arises when managers cut loan-monitoring costs today at the expense of future asset quality. Applied to U.S. commercial banks over 2003–2017, the model shows that institutions reporting high short-run cost efficiency often experience a subsequent rise in NPLs, suggesting potential skimping behavior. For every bank, the estimator delivers a tailored vector of adjustments for assets, staff, loans, securities, and NPLs that would move it to the best-practice frontier, thus supplying managers with concrete, risk-aware performance targets. By linking operating choices, credit-risk outcomes, and overall efficiency within a single framework, the study offers regulators and practitioners a more informative tool for diagnosing performance shortfalls and designing corrective strategies.