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This article examines bank cost efficiency for five new EU Member States from Central and Eastern Europe and the three Baltic States for the period 1996 -2006. The banking sectors in the selected set of countries had undergone a remarkable transformation before they achieved EU membership in 2004. We study cost efficiency differences between countries as well as efficiency improvements fostered by intense legislative and regulatory changes and extensive structural and institutional reforms carried out simultaneously. By employing the SFA approach an improvement in cost efficiency was discovered in the period investigated. Some noticeable differences in average cost efficiency among banking sectors can be detected as well. Empirical results also reveal certain significant associations of cost efficiency with country level macroeconomic characteristics, structure of the banking industry, and individual bank features. Analysis of correlating factors shows that the level of competition in the banking sector plays a more important role for cost efficiency improvements than the ownership structure itself. These results might be of interest to policy makers and regulatory authorities as they may provide help in detecting policy measures to create a business environment which would further enhance the cost efficiency of CEE banks.

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In this article, we investigate the significance of the heterogeneity problem in banking efficiency research by using stochastic frontier techniques. The cost frontier function is estimated on a sample of banks from new European Union members from Central and Eastern Europe and the Baltics (CEEB) for the 1998-2007 period. The results imply that environmental variables can only partly control for the presence of heterogeneity in the sample. By employing the 'true' random-effects model as originally proposed by Greene (2005aGreene ( , 2005b, the unobserved heterogeneity that is typically associated with the complexity of the banking environment is additionally taken into account. This approach is found to result in considerably smaller differences in average country efficiency levels, which implies that CEEB countries represent a relatively homogeneous group in terms of bank performance.JEL classifications: C23, D24, G21, P34.

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