Credit risk and efficiency in the European banking system: A three-stage analysis

Increased competition and the attempts of European banks to increase their presence in other markets may have affected the efficiency and credit risk in the banking system. The first aspect is the incentive in reducing costs in order to gain in competitiveness. The second is associated with their lack of knowledge of such markets and/ or acceptance of a higher risk in order to increase their market share. Despite the importance of these aspects, banking literature has usually analysed the effects of competition on the efficiency of banking systems without considering these aspects. The few studies that attempt to obtain risk adjusted efficiency measures do not consider that part of the risk is due to exogeneous circumstances. This article proposes a new three-stage sequential technique, based on the DEA model and on the decomposition of risk into its internal and external components, for obtaining efficiency measures adjusted for risk and environment. It is seen that the technique allows the use of any existing technique of incorporation of environmental variables in DEA analysis.