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

Michael Koetter and Daniel Porath

No 2007,02, Discussion Paper Series 2: Banking and Financial Studies from Deutsche Bundesbank

Abstract: 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.

Keywords: Bank performance; efficiency; bank failure; vector autoregression; performance forecast (search for similar items in EconPapers)
JEL-codes: C33 C53 D21 G21 G33 L25 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-ban and nep-eff
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Citations: View citations in EconPapers (7)

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