Efficiency in European banking

Abstract

This paper extends the established literature on modelling the cost characteristics of banking markets by applying the flexible Fourier functional form and stochastic cost frontier methodologies to estimate scale economies, X-inefficiencies and technical change for a large sample of European banks between 1989 and 1997. The results reveal that scale economies are widespread for smallest banks and those in the ECU 1 billion to ECU 5 billion assets size range. Typically, scale economies are found to range between 5% and 7%, while X-inefficiency measures appear to be much larger, between 20% and 25%. X-inefficiencies also appear to vary to a greater extent across different markets, bank sizes and over time. This suggests that banks of all sizes can obtain greater cost savings through reducing managerial and other inefficiencies. This paper also shows that technical progress has had a similar influence across European banking markets between 1989 and 1997, reducing total costs by around 3% per annum. The impact of technical progress in reducing bank costs is also shown to systematically increase with bank size. Overall, these results indicate that Europe's largest banks benefit most from technical progress although they do not appear to have scale economy advantages over their smaller counterparts.