Efficiency of Banks: Recent Evidence from the Transition Economies of Europe

This study examines the cost and profit efficiency of banking sectors in twelve transition economies of Central and Eastern Europe (CEE) over the period 1993-2000, using the stochastic frontier approach (SFA) and the distribution free approach (DFA). The managerial inefficiencies in CEE banking markets were found to be significant, with average cost efficiency level for 12 countries of 72 and 77 percent by the DFA and the SFA, respectively. The alternative profit efficiency levels are found to be significantly lower relative to cost efficiency. According to the SFA, approximately one-third of banks’ profits are lost to inefficiency, and almost one-half according to the DFA. The results of the second-stage regression analyses suggest that higher efficiency levels are associated with large and wellcapitalized banks. The degree of competition has a positive influence on cost efficiency and a negative one on profit efficiency, while market concentration is negatively linked to efficiency. Finally, foreign banks are found to be more cost efficient but less profit efficient relative to domestically owned private banks and state-owned banks.