Efficiency in Banking: Theory, Practice, and Evidence

This article outlines the different approaches used to examine the efficiency and overall performance of banks. It outlines various structural and nonstructural approaches to efficiency measurement. The structural approach requires a choice of the underlying production features of banking (intermediation, production, value-added, or other) and the specification of cost, profit, or revenue functions, from which one can derive relative performance measures. It is emphasized that the role of capital and risk is important in the production features of banks and therefore should be included in structural evaluations of bank performance. Non-structural approaches simply relate to the use of accounting/financial ratios to measure bank performance. The article highlights the growing interest in using structural approaches to examine corporate governance and ownership issues, whereas non-structural indicators are widely used as indicators of the value of a bank's investment opportunities (or charter values). It concludes with a brief discussion on how consolidation has impacted bank performance.