Does Bank Efficiency Change with the Business Cycle? the Relationship between Monetary Policy, Economic Growth, and Bank Condition

The goal of this essay is to examine estimates of individual bank X-efficiency across time. First, we estimate a translog flexible function specification of bank efficiency during the period 1988-1997. Then, we estimate a time-series/cross-sectional model with independent variables that reflect business cycle and monetary policy conditions that may affect bank performance. Like Calomiris and Mason (1997, 2000), we find that leading business conditions are positively related to bank performance. Though this result suggests that regulators should attempt to anticipate business cycle downturns and influence bank portfolio risk accordingly, the business condition elasticity of bank X-efficiency is low enough to suggest that the banking sector is not significantly susceptible to a systemic event due to business cycle conditions alone. Lead and lag relationship between large and small banks are also examined. Like Gilbert (1997), the entrance of large banks into the local financial market does enhance small bank efficiency simultaneously.