Productive efficiency in Finnish local banking during 1985-1990

Harri Kuussaari

No 14/1993, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: The study is concerned with measuring and explaining producer performance in Finnish local banking. Primary interest is in the production of retail banking services. The main objective is to find out how large and what kind of relative efficiency differences has there been in Finnish local banking. The overall productive efficiency will be decomposed into technical efficiency and scale efficiency. Technical inefficiencies are generally a result of wasteful use of inputs which is due to differences in managerial abilities to control costs and maximize revenues. Scale inefficiency on its half occurs when a bank's size is not optimal i.e. average costs are not minimized. Total productivity of local banks is studied with Malmquist-indices. Productivity growth will be decomposed into effects of technological advancement and to change of technical efficiency. One purpose of this study is to empirically look at the implications of bank mergers for efficiency and productivity. Time period under study is from 1985 to 1990. The data includes all Finnish cooperative and savings banks. Relatively efficient production frontier is constructed using a non-parametric linear programming method called data envelopment analysis (DEA). The main result of the efficiency analysis is that technical inefficiencies dominate scale inefficiencies in Finnish local banking. Distributions of technical inefficiencies are similar for cooperative and savings banks, but savings banks were found to be slightly more scale inefficient. Since it is possible that an average bank is continuously about 20 % more inefficient than the best practice banks, it appears that there is not much competitive pressure to control costs. The large and persistent cost efficiency differences between banks of similar size and product mix suggest that greater competition within the banking industry would be beneficial. The main result of the productivity analysis is that average productivity growth was found to be totally due to technological progress rather than improvements in relative efficiency.

Date: 1993
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