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

  • Claudia Girardone
  • Philip Molyneux
  • Edward Gardener

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.

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Article provided by Taylor & Francis Journals in its journal Applied Economics.

Volume (Year): 36 (2004)
Issue (Month): 3 ()
Pages: 215-227

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Handle: RePEc:taf:applec:v:36:y:2004:i:3:p:215-227
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  1. Altunbas, Yener & Liu, Ming-Hau & Molyneux, Philip & Seth, Rama, 2000. "Efficiency and risk in Japanese banking," Journal of Banking & Finance, Elsevier, vol. 24(10), pages 1605-1628, October.
  2. Allen N. Berger & Loretta J. Mester, 1997. "Inside the black box: what explains differences in the efficiencies of financial institutions?," Finance and Economics Discussion Series 1997-10, Board of Governors of the Federal Reserve System (U.S.).
  3. Altunbas, Yener & Evans, Lynne & Molyneux, Philip, 2001. "Bank Ownership and Efficiency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(4), pages 926-54, November.
  4. Paul W. Bauer & Allen N. Berger & Gary D. Ferrier & David B. Humphrey, 1997. "Consistency conditions for regulatory analysis of financial institutions: a comparison of frontier efficiency methods," Financial Services working paper 97-02, Federal Reserve Bank of Cleveland.
  5. Berger, Allen N. & DeYoung, Robert, 1997. "Problem loans and cost efficiency in commercial banks," Journal of Banking & Finance, Elsevier, vol. 21(6), pages 849-870, June.
  6. 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.
  7. Joseph P. Hughes & Loretta J. Mester, 1991. "A quality and risk-adjusted cost function for banks: evidence on the " too-big-to-fail" doctrine," Working Papers 91-21, Federal Reserve Bank of Philadelphia.
  8. Mitchell, Karlyn & Onvural, Nur M, 1996. "Economies of Scale and Scope at Large Commercial Banks: Evidence from the Fourier Flexible Functional Form," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(2), pages 178-99, May.
  9. Battese, George E. & Corra, Greg S., 1977. "Estimation Of A Production Frontier Model: With Application To The Pastoral Zone Of Eastern Australia," Australian Journal of Agricultural Economics, Australian Agricultural and Resource Economics Society, vol. 21(03), December.
  10. 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.
  11. McAllister, Patrick H. & McManus, Douglas, 1993. "Resolving the scale efficiency puzzle in banking," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 389-405, April.
  12. Allen, Linda & Rai, Anoop, 1996. "Operational efficiency in banking: An international comparison," Journal of Banking & Finance, Elsevier, vol. 20(4), pages 655-672, May.
  13. Allen N. Berger & John H. Leusner & John J. Mingo, 1994. "The efficiency of bank branches," Finance and Economics Discussion Series 94-26, Board of Governors of the Federal Reserve System (U.S.).
  14. 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.
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