The efficiency and the conduct of European banks: Developments after 1992

Abstract

This paper addresses the efficiency of the European banking sector in the five-year period following the implementation of the Second Banking Directive of the European Union (EU).We first determine the degree of cost efficiency of EU banks in the period 1993-1997. After that we explore to what extent efficient European banks are managed differently than their inefficient peers. Our datasets comprise 5 years of observations on 1347 savings banks and 873 commercial banks, and we use the new Recursive Thick Frontier Approach method to establish our results. We find that structural factors such as technological progress or increased bank competition have lowered the cost base of banks by about 5 percent annually in the sample period. Managerial inability to control costs is at 17-25 percent the main source of bank inefficiency in the EU. Managerial efficiency varies a great deal within Europe, and there seems to be no tendency towards convergence. We detect economies to scale for small savings banks The savings bank sector as a whole can cut costs by about 3 percent through mergers of small savings banks. JEL: D20, G21, Lll, L23. Keywords: banking, cost efficiency, economies of scale, W+ technological progress.frontier analysis we study developments in X-efficiency, returns to scale, and the impact of structural developments of EU banks in the period 1993-1997. We pay special attention on the questions whether, as predicted above, bank efficiency has increased due to increased competitive pressure, and whether the cost base for banks has come down due to structural factors. Secondly, we identify possible differences between the strategies of efficient and inefficient banks. We perform our study on two different bank samples, namely EU savings banks and EU commercial banks. This choice is inspired by initial findings that demonstrate important differences between these two bank types, and by Altunbas and Chakravarty (1998)'s point that different types of banking institutions play a distinct role in the financial system of the EU.Our findings are the following. First, structural developments such as technological progress, or increased competition in banking, have had a notable impact on the EU banking sector. After accounting for changes in output levels and input prices, we find that both EU savings banks and EU commercial banks lowered their cost base in the period 1993-1997 at an annual pace of about 5 percent. This result confirms the recent findings of Altunbas, Gardener, Molyneux, andMoore (2001) andWilliams (2001). US evidence on structural developments in the same time period reveals small or even negative effects of structural developments.3 Second, we confirm the standard result for both EU and US banks that managerial ability to control costs (X-inefficiency) is at 17-25 percent the main source of inefficiency.' By contrast, the savings bank sector can reduce costs by about 3 percent by exploiting potential economies of scale.5 Managers of large commercial banks are on average sln particular, in his study o...

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