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Inefficient or just different? Effects of heterogeneity on bank efficiency scores

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  • Bos, Jaap W. B.
  • Heid, Frank
  • Koetter, Michael
  • Kolari, James W.
  • Kool, Clemens J. M.

Abstract

In this paper, we show the importance of accounting for heterogeneity among sample firms in stochastic frontier analysis. For a fairly homogenous sample of German savings and cooperative banks, we analyze how alternative theoretical assumptions regarding the nature of heterogeneity can be modeled and the extent to which the respective empirical specifications affect estimated efficiency levels and rankings. We find that the level of efficiency scores is affected in the case of both cost and profitmodels. On the cost side especially, level and rank correlations show that different specifications identify different banks as being best or worst performers. Our main conclusion is that efficiency studies in general and bank efficiency studies in particular should account for heterogeneity across sample firms. Especially when efficiency measures are employed for policy purposes, a careful choice of models and transparency regarding maximization methods are essential to be able to make inferences about managerial behavior.

Suggested Citation

  • Bos, Jaap W. B. & Heid, Frank & Koetter, Michael & Kolari, James W. & Kool, Clemens J. M., 2005. "Inefficient or just different? Effects of heterogeneity on bank efficiency scores," Discussion Paper Series 2: Banking and Financial Studies 2005,15, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdp2:4270
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    Cited by:

    1. Koetter, Michael & Wedow, Michael, 2010. "Finance and growth in a bank-based economy: Is it quantity or quality that matters?," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1529-1545, December.
    2. Francesco Aiello & Graziella Bonanno, 2013. "Profit and cost efficiency in the Italian banking industry (2006-2011)," Economics and Business Letters, Oviedo University Press, vol. 2(4), pages 190-205.
    3. Michael Koetter, 2006. "Measurement Matters—Alternative Input Price Proxies for Bank Efficiency Analyses," Journal of Financial Services Research, Springer;Western Finance Association, vol. 30(2), pages 199-227, October.
    4. Hughes, Joseph P. & Mester, Loretta J., 2013. "Measuring the Performance of Banks: Theory, Practice, Evidence, and Some Policy Implications," Working Papers 13-28, University of Pennsylvania, Wharton School, Weiss Center.
    5. Graziella Bonanno, 2016. "ICT and R&D as inputs or efficiency determinants? Analysing Italian manufacturing firms (2007–2009)," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 6(3), pages 383-404, December.
    6. Sarmiento, Miguel & Galán, Jorge E., 2014. "Heterogeneous effects of risk-taking on bank efficiency : a stochastic frontier model with random coefficients," DES - Working Papers. Statistics and Econometrics. WS ws142013, Universidad Carlos III de Madrid. Departamento de Estadística.
    7. Ramona Busch & Christoph Memmel, 2016. "Quantifying the components of the banks’ net interest margin," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 30(4), pages 371-396, November.
    8. Horst Gischer & Toni Richter, 2014. "Produktivitätsmessung von Banken: die Cost Income Ratio – ein belastbares Performancemaß?," FEMM Working Papers 140008, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    9. Elisabetta Fiorentino & Heinz Herrmann, 2009. "Effizienz und Wettbewerb im deutschen Bankensektor," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 78(1), pages 114-126.
    10. Koetter, Michael, 2006. "The stability of efficiency rankings when risk-preferences and objectives are different," Discussion Paper Series 2: Banking and Financial Studies 2006,08, Deutsche Bundesbank.
    11. Graziella Bonanno, 2014. "The Efficiency of the Italian Banking System over 2006-2011. An Application of the Stochastic Frontier Approach," Rivista italiana degli economisti, Società editrice il Mulino, issue 2, pages 277-306.
    12. Joseph P. Hughes & Loretta J. Mester, 2008. "Efficiency in banking: theory, practice, and evidence," Working Papers 08-1, Federal Reserve Bank of Philadelphia.
    13. Bos, J.W.B. & Schmiedel, H., 2007. "Is there a single frontier in a single European banking market?," Journal of Banking & Finance, Elsevier, vol. 31(7), pages 2081-2102, July.
    14. Bonanno, Graziella, 2012. "L’efficienza del sistema bancario italiano dal 2006 al 2010. Un’applicazione delle frontiere stocastiche [The Efficiency of Italian Banking System over 2006-2010. An Application of the Stochastic F," MPRA Paper 42831, University Library of Munich, Germany.
    15. Joseph P. Hughes & Loretta J. Mester, 2018. "The Performance of Financial Institutions: Modeling, Evidence, and Some Policy Implications," Departmental Working Papers 201805, Rutgers University, Department of Economics.
    16. Bonanno, Graziella, 2014. "ICT and R&D as inputs or efficiency determinants? Analysing the manufacturing Italian firms over the 2007-2009," MPRA Paper 57640, University Library of Munich, Germany.
    17. Ihsen Abid & Mohamed Goaied, 2015. "Consideration of technological and environmental heterogeneity in cost efficiency analysis," International Review of Applied Economics, Taylor & Francis Journals, vol. 29(5), pages 650-676, September.

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    More about this item

    Keywords

    Heterogeneity; X-efficiency; benchmarking; bank production;
    All these keywords.

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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