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Efficient, profitable and safe banking: an oxymoron? Evidence from a panel VAR approach


  • Koetter, Michael
  • Porath, Daniel


Efficiency is considered a key factor when evaluating a bank's performance. Moreover, efficiency enhancement is an explicit policy objective in the Single Market Directive of the European Commission. But efficiency improvements may come at the expense of deteriorating bank profits and excessive risk-taking. Both the quantitative effects and dynamic reactions of performance in response to efficiency improvements remain often unclear on both theoretical and empirical grounds. We analyze the dynamic relations between efficiency and performance in the German banking market. To this end we use panel data for all German banks for the years from 1993 to 2004 and estimate impulse response functions (IRF) derived from a vector autoregressive model. The IRF estimate the response of a shock in efficiency on profits or default probabilities. The former is estimated with stochastic frontier analysis, the latter is estimated with a hazard rate model. The results indicate that a positive unit shift in efficiency reduces the probability of default and increases profits. On the one hand, we find evidence that the long-run impact of profit efficiency on risk is larger than for cost efficiency. However, cost efficiency impacts with a shorter time lag on the probability of default. On the other hand, cost efficiency has on average a slightly larger impact on profits than profit efficiency.

Suggested Citation

  • Koetter, Michael & Porath, Daniel, 2007. "Efficient, profitable and safe banking: an oxymoron? Evidence from a panel VAR approach," Discussion Paper Series 2: Banking and Financial Studies 2007,02, Deutsche Bundesbank.
  • Handle: RePEc:zbw:bubdp2:5354

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    References listed on IDEAS

    1. Hashem Pesaran & Davide Pettenuzzo & Allan Timmermann, 2007. "Learning, Structural Instability, and Present Value Calculations," Econometric Reviews, Taylor & Francis Journals, vol. 26(2-4), pages 253-288.
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    Cited by:

    1. Saeed, Momna & Izzeldin, Marwan, 2016. "Examining the relationship between default risk and efficiency in Islamic and conventional banks," Journal of Economic Behavior & Organization, Elsevier, vol. 132(S), pages 127-154.
    2. Rossi, Stefania P.S. & Schwaiger, Markus S. & Winkler, Gerhard, 2009. "How loan portfolio diversification affects risk, efficiency and capitalization: A managerial behavior model for Austrian banks," Journal of Banking & Finance, Elsevier, vol. 33(12), pages 2218-2226, December.

    More about this item


    Bank performance; efficiency; bank failure; vector autoregression; performance forecast;

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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