Analysing the determinants of bank efficiency: the case of Italian banks

This study investigates the main determinants of Italian banks' cost efficiency over the period 1993-1996, by employing a Fourier-flexible stochastic cost frontier in order to measure X-efficiencies and economies of scale. Quality and riskiness of bank outputs are explicitly accounted for in the cost function and their impact on cost efficiency levels is evaluated. The results show that mean X-inefficiencies range between 13 and 15 per cent of total costs and they tend to decrease over time for all bank sizes. Economies of scale appear present and significant, being especially high for popular and credit co-operative banks. Moreover, the inclusion of risk and output quality variables in the cost function seems to reduce the significance of the scale economy estimates. Following Spong et al. (1995) a profitability test is undertaken that allows for the identification of banks that are both cost and profit efficient. The results suggest that the most efficient and profitable institutions are more able to control all aspects of costs, especially labour costs. Finally, the data are pooled to carry out a logistic regression model in order to examine bank- and market-specific factors that influence Italian banks' inefficiency. Confirming Mester (1993, 1996), inefficiencies appear to be inversely correlated with capital strength and positively related to the level of non-performing loans in the balance sheet. The analysis also shows that there is no clear relationship between asset size and bank efficiency. Finally, it is possible to infer that quoted banks seem to be on average more efficient than their non-quoted counterparts.