Productive efficiency in banking
In this article we discuss the concept of
efficiency in production, define its various
aspects and the means to measure it, and review
the relevant literature concerning inefficiency
in the banking industry. Our major conclusion
is that there appears to be significant inefficiency
in banking. Inefficiency resulting from
operating at an inappropriate scale of operation
is probably in the range of 10-20 percent of
costs. However, by emphasizing the role of
scale, researchers have essentially overlooked a
major portion of bank inefficiency. The evidence
suggests that inefficiencies resulting
from the suboptimal utilization of inputs is
larger than that resulting from other factors.
According to a majority of studies, banks
operate relatively efficiently with respect to the
optimal combination of inputs, yet many are
very inefficient in converting these inputs into
outputs. This inefficient utilization of inputs
accounts for an additional 20-30 percent of
costs. This is particularly interesting because it
implies that, to a great extent, the future viability
of an individual bank is under its own control.
To the extent that bank inefficiency can be
accurately measured, it appears that the largest
inefficiencies are not the result of regulation or
technology, but result directly from an underutilization
of factor inputs by bank management.
This inefficiency will most likely decline
in the future as bankers respond to increased
competitive pressures and strive to become
more efficient. Failing this, the inefficient firms
will become prime merger candidates to be
acquired and restructured.