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An analysis of inefficiencies in banking: a stochastic cost frontier approach

  • Simon H. Kwan
  • Robert A. Eisenbeis

This paper examines the properties of X-inefficiency and the relations of X-inefficiency with risk-taking and stock returns for U.S. banking firms. After controlling for scale differences, the average small size banking firm is found to be relatively less efficient than the average large firm. Small firms also exhibit higher variations in X-inefficiencies than their larger counterparts. While the average X-inefficiency appears to be declining over time, the rank orderings of X-inefficiency are found to be quite persistent. Furthermore, less efficient banking firms are found to be associated with higher risk-taking, and firm-specific X-inefficiencies are significantly correlated with individual stock returns for smaller banking firms.

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File URL: http://www.frbsf.org/econrsrch/econrev/96-2/kwan.pdf
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Article provided by Federal Reserve Bank of San Francisco in its journal Economic Review.

Volume (Year): (1996)
Issue (Month): ()
Pages: 16-26

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Handle: RePEc:fip:fedfer:y:1996:p:16-26:n:2
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  1. Berger, Allen N. & Humphrey, David B., 1991. "The dominance of inefficiencies over scale and product mix economies in banking," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 117-148, August.
  2. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
  3. Gary Gorton & Richard Rosen, 1992. "Corporate Control, Portfolio Choice, and the Decline of Banking," NBER Working Papers 4247, National Bureau of Economic Research, Inc.
  4. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
  5. Kane, Edward J & Unal, Haluk, 1990. " Modeling Structural and Temporal Variation in the Market's Valuation of Banking Firms," Journal of Finance, American Finance Association, vol. 45(1), pages 113-36, March.
  6. Ronn, Ehud I & Verma, Avinash K, 1986. " Pricing Risk-Adjusted Deposit Insurance: An Option-Based Model," Journal of Finance, American Finance Association, vol. 41(4), pages 871-95, September.
  7. 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.
  8. Edward J. Kane & George G. Kaufman, 1992. "Incentive conflict in deposit-institution regulation: evidence from Australia," Working Paper Series, Issues in Financial Regulation 92-5, Federal Reserve Bank of Chicago.
  9. Berger, Allen N. & Hunter, William C. & Timme, Stephen G., 1993. "The efficiency of financial institutions: A review and preview of research past, present and future," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 221-249, April.
  10. Flannery, Mark J & James, Christopher M, 1984. " The Effect of Interest Rate Changes on the Common Stock Returns of Financial Institutions," Journal of Finance, American Finance Association, vol. 39(4), pages 1141-53, September.
  11. Jondrow, James & Knox Lovell, C. A. & Materov, Ivan S. & Schmidt, Peter, 1982. "On the estimation of technical inefficiency in the stochastic frontier production function model," Journal of Econometrics, Elsevier, vol. 19(2-3), pages 233-238, August.
  12. Pennacchi, George G, 1987. "A Reexamination of the Over- (or Under-) Pricing of Deposit Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(3), pages 340-60, August.
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