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Applied Economics
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A comparative study of efficiency in European banking

Barbara Casu & Philip Molyneux
a b a b

Department of Economics, University of Reading, Reading RG6 6AW, UK SBARD, University of Wales, Bangor LL57 2DG, UK

Available online: 04 Jun 2010

To cite this article: Barbara Casu & Philip Molyneux (2003): A comparative study of efficiency in European banking, Applied Economics, 35:17, 1865-1876 To link to this article: http://dx.doi.org/10.1080/0003684032000158109

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Applied Economics, 2003, 35, 18651876

A comparative study of eciency in European banking

B A R BA R A C A S U* and P H IL I P MO L Y NE U Xy Department of Economics, University of Reading, Reading RG6 6AW, UK and ySBARD, University of Wales, Bangor LL57 2DG, UK

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This paper investigates whether there has been an improvement in and convergence of productive eciency across European banking markets since the creation of the Single Internal Market. Using eciency measures derived from DEA estimation, the determinants of European bank eciency are evaluated using the Tobit regression model approach. The established literature on modelling the determinants of bank eciency is then extended by recognizing the problem of the inherent dependency of DEA eciency scores when used in regression analysis. To overcome the dependency problem, a bootstrapping technique is applied. Overall, the results suggest that since the EUs Single Market Programme there has been a small improvement in bank eciency levels, although there is little evidence to suggest that these have converged. The results also suggest that inference on the determinants of bank eciency drawn from non-bootstrapped regression analysis may be biased and misleading.

I. INTRODUCTION One of the major objectives of the EUs 1992 Single Market Programme (SMP) was to facilitate the free movement of goods and services across Member States and to improve economic eciency. As a 1996 European Commission survey noted: Although it is still too early for many Single Market measures to have taken full eect, there is evidence of positive, albeit preliminary eects of the Single Market in triggering the expected reinforcement of integration, competition, economic performance and benets for the consumers (Communication from the Commission to the European Parliament and Council, 1996). An integral part of the SMP was directed at harmonizing regulations and fostering competition in the banking sector. Up until the mid-1980s there had been little progress in removing barriers to trade in nancial services. Typically, European banking systems were characterized by relatively high levels of government controls and restrictions that inhibited competition and maintained a
*Corresponding author. E-mail: b.casu@reading.ac.uk

protected banking environment. Interest rate restrictions and capital controls were widespread, and branching restrictions existed in some countries. There were marked dierences across banking systems: for instance, the United Kingdom, Germany, Denmark and the Netherlands had rather liberal and open banking markets, while regulatory restrictions limited the competitive environment in the remaining EU Member Countries (see European Commission, 1997). The ECs 1985 White Paper (Commission of the European Communities, 1985) on the completion of the Single Market and its incorporation in the Single European Act of February 1986 constituted an important and renewed commitment by the European Commission towards the liberalization of the EU banking market. This culminated in the Second Banking Co-ordination Directive, adopted in 1989, together with the two parallel Directives on Solvency Ratios and Own Funds. This formed a comprehensive framework for regulating all the banking business in the EU. By 1 January 1993 the aforementioned legislation

Applied Economics ISSN 00036846 print/ISSN 14664283 online # 2003 Taylor & Francis Ltd http://www.tandf.co.uk/journals DOI: 10.1080/0003684032000158109

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had created the largest and most open banking market in the world by eliminating or lessening existing barriers and by establishing minimum regulatory requirements across EU banking systems. This paper investigates whether the productive eciency of European banking systems has improved since the creation of the Single Internal Market. The European banking markets between 1993 and 1997 are examined using the non-parametric DEA approach; the aim is to investigate whether there has been an increase and convergence of eciency levels following the process of legislative harmonisation. The determinants of European bank eciency are also evaluated by using the Tobit regression model approach in order to analyse the inuence of various country-specic and environmental factors on bank eciency. To overcome the problem of inherent dependency of DEA eciency scores when used in regression analysis a bootstrapping technique is applied. The paper is set out as follows: Section II illustrates the methodological approach followed in the empirical analysis; Section III describes the sample; Section IV reports the results and the nal section is the conclusions.

B. Casu and P. Molyneux

In their original paper, Charnes et al. (1978) proposed a model that had an input orientation and assumed constant returns to scale (CRS). Later studies have considered alternative sets of assumptions. The assumption of variable returns to scale (VRS) was rst introduced by Banker, Charnes and Cooper (1984). The CRS assumption is only appropriate when all DMUs are operating at an optimal scale. However, factors like imperfect competition and constraints on nance may cause a DMU not to be operating at optimal scale. As a result, the use of the CRS specication when some DMUs are not operating at optimal scale will result in measures of technical eciency (TE) which are confounded by scale eciencies (SE). The VRS linear programming problem can be dened as: min ,
, l

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st yi Yl ! 0 xi Xl ! 0 N10 l 1 l!0 where  is a scalar, l is a N 1 vector of constants and N1 is an N 1 vector of ones. This approach forms a convex hull of intersecting planes which envelope the data points more tightly than the CRS conical hull and thus provide technical eciency scores that are greater than or equal to those obtained using the CRS model. The VRS specication has been the most commonly used specication in the 1990s (see Coelli et al., 1998). In the input-orientated models, the DEA method seeks to identify technical ineciency as a proportional reduction in input usage. It is also possible to measure technical ineciency as a proportional increase in output production. These two measures provide the same value under CRS, but do not equate when VRS is assumed. The choice of orientation has both practical and theoretical implications. In some applications, the choice of the orientation is clear; for example, in industries where the emphasis is on cost-control, the natural choice would be an inputorientation (Ferrier and Valdmanis, 1996). Many studies have tended to select input-orientated measures because the input quantities appear to be the primary decision variables, although this argument may not be valid in all industries. However, some research has pointed out that restricting attention to a particular orientation may neglect major sources of technical eciency in the other direction (Berger et al., 1993). To date, the theoretical literature is inconclusive as to the best choice among the alternative orientations of measurement.

I I . M E T H O D O L O G I C A L I S SU E S The approach to frontier estimation proposed by Farrell (1957) was not given much detailed empirical attention for about two decades, until a paper by Charnes, Cooper and Rhodes (CCR) in 1978, in which the term Data Envelopment Analysis was rst used. Since then there has been a large number of papers which have applied and extended the methodology.1 Data Envelopment Analysis (DEA) is a mathematical programming approach for the construction of production frontiers and the measurement of eciency relative to the constructed frontiers. DEA is based on a concept of eciency very similar to the microeconomic one; the main dierence is that the DEA production frontier is not determined by some specic functional form, but it is generated from the actual data for the evaluated rms. In other words, the DEA frontier is formed as the piecewise linear combination that connects the set of best-practice observations in the data set under analysis, yielding a convex Production Possibility Set (PPS). As a consequence, the DEA eciency score for a specic Decision-Making Unit (DMU) is not dened by an absolute standard, but it is dened relative to the other DMUs in the specic data set under consideration. This feature dierentiates DEA from the parametric approaches, which require a specic pre-specied functional form of the modelled production or cost function.
1

See Lovell (1993) and Seiford (1996) for extensive reviews of this literature.

Eciency in European banking

It is necessary to point out that output- and inputorientated models will estimate exactly the same frontier and, therefore, by denition, identify the same set of ecient DMUs. It is only the eciency measures associated with the inecient DMUs that may dier between the two methods. Although the basic DEA models (CRS and VRS) have been improved in a number of ways in recent years (see Lovell, 1993 and Seiford, 1996), one of the main criticisms faced by researchers using non-parametric methods is the diculty of drawing statistical inference. The more recent literature, however, has been fairly successful in nding ways to overcome this problem (see Grosskopf, 1996). One of the rst tools employed to this end was regression analysis. The basic idea of what has become known as the Two-Step procedure, is to treat the eciency scores as data or indices and use linear regression to explain the variation of these eciency scores. The rst improvement to this model has come with the attempt to account for the fact that eciency scores are censored (Lovell et al., 1995); as a result, a model that accounted for the fact that the dependent variable was limited became preferred to OLS. An important conceptual issue relates to the datagenerating process and the associated issue of distribution of the error terms. Put simply, if the variables used in specifying the original eciency are correlated with the explanatory variables used in the second stage, then the second stage estimates will be inconsistent and biased (Deprins and Simar, 1989; Simar et al., 1994). Another criticism that is sometimes levelled against this approach is that it only considers radial ineciency and ignores the slacks. A possible solution to this has been proposed by Fried et al. (1999) and involves estimating a SUR (Seemingly Unrelated Regression) system of equations for the slacks. Bhattacharyya et al. (1997) pointed out that when employing regression analysis in the second step to explain the variation of the eciency scores, it is likely that the included explanatory variables fail to explain the entire variation in the calculated eciencies and the unexplained variation mixes with the regression residuals, adversely aecting statistical inference. They propose the use of a stochastic frontier regression model, which allows for the decomposition of the variation of the calculated eciencies into a systematic component and a random component. In this study, the basic DEA model will be extended to take into account environmental variables. In this context, the term environment is used to describe factors that could inuence the eciency of a rm, where such factors are not
2 3

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traditional inputs and are not under the control of management (Fried et al., 1999). Such factors can include, for example, ownership dierences (public/private), location characteristics and government regulations. There are a number of ways in which such factors can be accommodated in DEA analysis;2 following Coelli et al. (1998) the so-called Two-Step approach is adopted. This approach involves solving a DEA problem in a rst stage analysis, involving only the traditional inputs and outputs. In the second stage, the eciency scores from the rst stage are regressed upon environmental variables. The sign of the coecients of the environmental variables indicate the direction of the inuence, and standard hypothesis testing can be used to assess the strength of the relationship. This method, which can accommodate both continuous and categorical variables, is conducted by using the Tobit regression model because it can account for truncated data. A new conceptual issue has recently been raised by Xue and Harker (1999): they point out that eciency scores generated by DEA models are clearly dependent on each other in the statistical sense. The reason for dependency is the well-known fact that the DEA eciency score is a relative eciency index, not an absolute eciency index. Because of the presence of the inherent dependency among eciency scores, one basic model assumption required by regression analysis, independence within the sample, is violated. As a result, the conventional procedure, followed in the literature, is invalid. They propose a bootstrap method to overcome this problem. The bootstrap is a computer-based method for assigning measures of accuracy to statistical estimates. It was rst introduced by Efron (1979) and since then it has become a popular and powerful statistical tool. Simar (1992) was possibly the rst to introduce the bootstrap method for computing condence intervals for eciency scores derived from non-parametric frontier methods. Since then, it has been used to provide an empirical distribution of eciency scores for each observation in the sample (Atkinson and Wilson, 1995); to derive the condence intervals and a measure of bias for DEA eciency scores (Ferrier and Hirschberg, 1995); and to analyse the sensitivity of eciency scores to the sampling variations of the estimated frontier (Simar and Wilson, 1998). To summarize, the literature to date has concentrated mainly on estimating the distribution of eciency scores. Xue and Harker (1999), as far as we are aware, are the rst to address the problem of the inherent dependency3 of eciency scores when used in regression analysis. They

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See Rouse (1996) for a survey of alternative approaches to the treatment of environmental factors in DEA. In regression analysis, if the response variables Y1, Y2, . . . , Yn are dependent on each other, or correlated, when one ts the regression ^ ^ model as if they were not correlated, the estimate of the standard error of the regression coecient estimate, sej , which is obtained by tting the regression model, is no longer correct. As a consequence, the t-ratios and P-values for the Hypothesis Tests are no longer correct. Therefore, the conclusions reached through this kind of direct regression analysis may be misleading (Xue and Harker, 1999).

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present the following procedure for the regression analysis of the DEA eciency scores by using the bootstrap method to solve the dependency problem: ^ . Construct the sample probability distribution F by assigning probability of 1/n at each DMU in the observed sample (x1, x2, . . . , xn). . Draw c (c is a constant) random samples of size n with replacement from the original sample (x1,x2, . . . ,xn): Sk xk1 , xk2 , . . . , xkn , k 1, 2, . . . , c 2

B. Casu and P. Molyneux

and compare t to the critical value t/2 from the Student t distribution with degrees of freedom equal to (n m 1). According to its authors, the above procedure, unlike ordinary regression, correctly implement Efrons bootstrap to give appropriate standard errors when the n original DMUs Xi i 1, 2, . . . , n, are independently sampled from F, even though the eciency scores computed from the X s are dependent. In this study, in order to minimize the bias arising from the inherent dependency problem, we substitute the conventional estimators of the Tobit regression coecient estimates with the bootstrap estimators to calculate the standard errors of these estimates.

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where xki (uki, vki), i 1, 2, . . ., n. Sk is the so-called bootstrap sample. . For each bootstrap sample, Sk k 1,2, . . ., c, run the DEA model and recalculate the eciency scores for all n DMUs: ki i uk , i 1, 2, . . . , n, 3

III. DATA AND VARIABLES Denition of the sample and data sources The geographical coverage of this study is as follows: France, Germany, Italy, Spain and the United Kingdom. The choice of the above countries is based as much on their relative economic weight inside the EU as on the size of their respective banking sectors.4 The time span considered is from 1993 to 1997; that is, following the implementation of the Single Market Programme (SMP). A sample of 750 banks from the above countries (the largest banks by asset size in each respective country) was drawn from the London-based International Bank Credit Analysis Ltds Bankscope database. The subsidiaries of foreign banks, the specialized nancial institutions and the central institutions were then excluded. Furthermore, given the need for comparable data from dierent countries, all banks particular to a certain country (for example, special credit institutions in Italy, nance companies in France and ocial credit institutions in Spain) were removed from the sample. The result is a pooled sample of 530 banks. The data were extracted from nonconsolidated income statement and balance sheet data corresponding to the years 19931997. All data are reported in ECU as the reference currency; they are in real 1997 terms and have been converted using individual country GDP deators.5 Table 1 shows some descriptive statistics of the sample. Dierences in the average size of banks are substantial (the average total assets size of UK banks is more than double that of Italian banks and nearly four times that of Spanish banks). Moreover, the average size of commercial banks is nearly ve times bigger than that of

. For each bootstrap sample, Sk k 1,2, . . . ,c, evaluate ^ the bootstrap replication kj , k 1,2, . . . , c, j 0,1, . . . , m, by tting the regression model: ki Gk , vki "ki , i 1, 2, . . . , n, k k0 , k1 , . . . , kj , . . . , km

^ . Estimate the standard error sej by the sample stan^ dard deviation of the c bootstrap replications of j : 8 2 91=2 P  ^ ^ = < k1 kj j >   > c ^ ^ , sec j > > c 1 ; : where ^ kj , j 1, 2, . . . , m 6 j k1 c   ^ ^ We call sec j the bootstrap estimator for the standard ^j . error of  Now we are ready to use a t-test to test the following hypothesis: H0 : j 0, vs: H1 : j 6 0 ^ j   ^ sec j Pc

j 1, 2, . . . , m

Calculate the test statistic according to: t 7

4 In 1998, the total assets of the banking sectors of France, Germany, Italy, Spain and the UK amounted to 16 530 billion USD, representing nearly 80% of the total assets of the banking sectors of the European Union as a whole (20 717 USD) (Banca dItalia, Annual Report, 1998). 5 To convert values in local currencies into a common currency we may use either the ocial exchange rate or the purchasing power parity (PPP) rate as computed by the OECD; the two approaches seem to yield to very similar results (Berg et al., 1993).

Eciency in European banking

Table 1. Descriptive statistics Size (total assets) in million ECU, 1997 Country France Germany Italy Spain UK Euro5 Bank type Commercial Savings and others No. of banks 112 112 116 116 74 530 155 375 Mean 14 657 16 562 9 926 5 962 21 919 13 136 30 367 6 014 Med. 3890 4660 2567 1784 2158 3264 5983 3037 St. dev. 43 014 45 104 19 416 13 190 53 227 36 785 61 748 13 041 Min. 1585 2560 872 283 46 46 312 46 Max. 310 669 376 349 109 076 81 986 335 632 376 349 376 349 170 432 Q1 2906 3230 1537 782 321 1719 2172 1512

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Q3 6 448 9 390 7 071 4 245 16 795 7 062 24 798 5 359

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their savings bank, co-operative bank and real estate bank counterparts. These large discrepancies across countries can be thought of reecting the legacy of dierent banking regulations (Dietsch and Weill, 1998). Input and output denition In the present international setting, the need for comparable data from dierent countries imposes strong restrictions on the type of variables one is able to use, not least because of the various accounting criteria used in the ve countries under investigation. To minimize possible bias arising from dierent accounting practices broad variable denitions have been chosen as presented by IBCA Bankscope.6 Even today, there is no all-encompassing theory of the banking rm and no agreement on the explicit denition and measurement of banks inputs and outputs.7 Berger and Humphrey (1997) pointed out that, although there is no perfect approach, the intermediation approach may be more appropriate for evaluating entire nancial institutions because this approach is inclusive of interest expenses, which often account for one-half to two-thirds of total costs. Moreover, the intermediation approach may be superior for evaluating the importance of frontier eciency to the protability of nancial institutions, since the minimization of total costs, not just production costs, is needed to maximize prots. Following the modern empirical literature (see, among others, Molyneux et al., 1996; Mester, 1996), the intermediation approach is used, which views nancial institutions as mediators between the supply and the demand of funds. The main consequence of the intermediation approach is that deposits are considered as inputs, and interest on deposits is a component of total costs, together with labour and capital costs.
6 7

Accordingly, this study species two outputs: y1 total loans, y2 other earning assets; and two inputs: x1 total costs (interest expenses, non-interest expenses, personnel expenses), x2 total customers and short term funding (total deposits). Environmental variables To further investigate the determinants of European bank eciency we follow the so-called Two-Step approach, as suggested by Coelli et al. (1998). Using the eciency measures derived from the DEA estimations as the dependent variable, we then estimate the following Tobit regression model: i 1 FRA 2 GER 3 ITA 4 SPA 5 UK 6 ETA 7 ROAE 8 COMM 9 QUOT "i where: 1 FRA, GER, ITA, SPA and UK are dummy variables indicating the country of origin of the bank ( 1 if based in the country; 0 otherwise); 2 ETA: Equity/Total Assets; 3 ROAE: Return on Average Equity; 4 COMM 1 if a commercial bank; 0 otherwise; 5 QUOT 1 if the bank is listed on the Stock Exchange; 0 otherwise. Country dummies (FRA, GER, ITA, SPA and UK) are used to distinguish between the country of origin of the banks in the sample. Then the average capital and protability ratios are used. The average capital ratio is measured by equity over total assets (E/TA) while the protability ratio is dened as the Return on Average Equity (ROAE). In the empirical literature, other studies (see 8

Pastor et al. (1999) followed the same approach. One of the main problem faced by researchers investigating banks cost eciency relates to diculties in the denition and measurement of the concept of bank output, mainly as a result of the nature and functions of nancial intermediaries. The most debated issue regards the role of deposits: on one hand, it is argued that they are an input to the production process (intermediation and asset approach); on the other hand, it is suggested that deposits are an output ( production approach), involving the creation of value added, and for which customers bear an opportunity cost (value added approach, user cost approach).

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Table 2. Euro5 (DEA eciency estimates) Variable returns to scale Constant returns to scale Mean 1993 1994 1995 1996 1997 (470) (484) (483) (499) (424) 0.591 0.634 0.567 0.602 0.649 Med. 0.571 0.616 0.547 0.569 0.626 St. dev. 0.125 0.111 0.106 0.137 0.125 Q1 0.507 0.552 0.493 0.496 0.560 Q3 0.648 0.700 0.634 0.670 0.716 Input based Mean 0.619 0.651 0.601 0.630 0.682 Med. 0.595 0.631 0.570 0.585 0.655 St. dev. 0.143 0.125 0.133 0.151 0.134 Q1 0.516 0.558 0.508 0.520 0.591 Q3 0.694 0.719 0.671 0.702 0.753

B. Casu and P. Molyneux

Output based Mean 0.624 0.654 0.609 0.635 0.690 Med. 0.597 0.632 0.585 0.593 0.667 St. dev. 0.144 0.126 0.134 0.153 0.132 Q1 0.522 0.562 0.508 0.522 0.596 Q3 0.701 0.720 0.679 0.726 0.765

Note: The numbers in brackets refer to the number of observations.

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Mester, 1996; Pastor et al., 2002; Carbo et al., 2003) have found positive relationships both between ROE and eciency (i.e., more ecient banks earn higher prots) and between E/TA and eciency (i.e. lower E/TA leads to lower eciency levels, because lower equity ratios imply a higher risk-taking propensity and greater leverage, which could result in greater borrowing costs). The dummy variable COMM is introduced in order to detect whether there are eciency dierences between commercial banks and other types of banks (such as savings and co-operative banks). Finally, the dummy variable QUOT is included to distinguish between quoted and non-quoted banks. To test for dierences between the country dummy coecients, we test the null hypothesis H0: 1 2 3 4 5 is tested against the alternative hypothesis (H1) that one pair at least is unequal in each year. Finally, in order to investigate possible determinants of bank eciency, the following hypothesis is tested at  0.05 signicance level: H0: 6,7,8,9 0 vs. H1: 6,7,8,9 6 0.

100

Frequency

50

0 0.50 0.55 0.60 0.65 0.70 0.75 0.80 0.85 0.90 0.95 1.00

AvEff

Fig. 1. Frequency distribution of average eciency scores

IV. EMPIRICAL RESULTS DEA eciency estimation This section reports the results of the DEA eciency analysis relative to the European common frontier. First, the common frontier is dened following the traditional approach, i.e. building the EU frontier by pooling the data set for the banks in all ve countries in the sample.8

This allows one to compare the banks of each country against the same benchmark. Table 2 illustrates the average eciency scores relative to the whole sample.9 Overall, the results show relatively low average eciency scores; nevertheless, it is possible to detect a slight improvement in the eciency levels through time (6.3% according to the input-based approach and 6.6% according to the output-based approach, between 1993 and 1997).10 Figure 1 illustrates the frequency distribution of average eciency scores over the period of analysis. The majority of DMUs comprising the sample seem to cluster around levels of eciency of around 0.65. This is the same range as those found in other recent studies on European bank eciency using DEA (for example, Berg et al. (1993) found overall average eciency of 0.58 for Finland, 0.78 for

8 It is important to remember that the sample comprises the largest banks in each country and that the number of banks composing the sample changes in dierent years, to allow us to investigate the impact on cost eciency of the restructuring process that has taken place in the ve European countries during the time of analysis. 9 In order to check that the results are not too sensitive to the presence of outliers, the study followed a procedure used, among others, by Resti (1997). After solving the DEA problems using all the observations composing the sample, all banks presenting an eciency score equal to unity were deleted and DEA problems were solved once more on the new sample. The correlation between the eciency scores obtained on the original sample and on the reduced sample is an indicator of the robustness of the results. The Pearson correlation coecient and the Spearman rank correlation coecient were then estimated to detect the sensitivity to outliers and the results were satisfactory (i.e. all correlation coecients were positive and statistically signicant). 10 The non-parametric Mann-Whitney test was used for testing the null hypothesis that the central locations of the two populations are the same against the one-sided alternative that the central location of the 1993 eciency scores is lower than that of 1997: according to the results of the test, the null hypothesis was to be rejected at the 99% condence interval.

Eciency in European banking

Table 3. DEA eciency estimates (VRS input based) France Mean 1993 1994 1995 1996 1997 0.607 0.648 0.589 0.620 0.653 St. dev. 0.179 0.144 0.139 0.136 0.121 Germany Mean 0.697 0.725 0.690 0.724 0.762 St. dev. 0.132 0.109 0.121 0.128 0.118 Italy Mean 0.558 0.567 0.502 0.508 0.553 St. dev. 0.080 0.064 0.066 0.059 0.063 Spain Mean 0.534 0.590 0.540 0.544 0.644 St. dev. 0.096 0.081 0.079 0.071 0.074 UK Mean 0.725 0.763 0.772 0.829 0.819

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St. dev. 0.108 0.089 0.096 0.108 0.114

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DEA Efficiency Estimates

1 0.8 VRS/I 0.6 0.4 0.2 0 1993 1994 1995 Years France Germany Italy Spain UK 1996 1997

Table 4. Composition of the ecient frontier (VRS) No. of ecient banks FRANCE GERMANY ITALY SPAIN UK EURO5 1993 8 7 1 4 20 1994 7 8 3 18 1995 4 7 2 13 1996 6 8 1 6 21 1997 4 7 1 6 18

Fig. 2. DEA eciency scores

Norway and 0.89 for Sweden; European Commission (1997) found average eciency levels in the EU of 0.73; Pastor et al. (2002) report average eciency levels equal to 0.79 and Dietsch and Weill (1998) found average eciency levels in the EU of 0.64 in 1996). It is of interest to analyse the relative position of each country on the European common frontier. These results are summarized in Table 3 and in Fig. 2. The data reveal an improvement in the average eciency scores for almost all countries in the sample over the period of analysis, with the exception of Italy, which records a slight decrease (0.5% over the period). In particular, bank eciency levels in Spain seem to have improved the most (11% over the period) followed by the UK (9.4%) and France (4.6%). Overall, the results show that the eciency gap among countries grew wider over the period (in 1993 the dierence between the banking system showing the highest eciency level (UK) and the one showing the lowest (Spain) was 19.1% while in 1997, the dierence in eciency levels between the UK and Italy was equal to 26.6%). Table 4 illustrates the composition of the European ecient frontier. It is worth remembering that in DEA
11

methodology the ecient frontier is generated by the input/output combination of the best-practice units, i.e. by those DMUs which achieved an eciency score of unity. In other words, DEA establishes a benchmark eciency score of unity that no individual rm can exceed. This benchmark is a linear combination of ecient banks in a sample, which constitute the reference technology for the sample. It can be seen that the inuence of the banks of each country changes slightly, with the importance of French banks in building the frontier decreasing in favour of British banks. Overall, the aforementioned results suggest that, even though it is possible to detect a slight improvement in the overall eciency scores, there are marked dierences in bank eciency levels across EU countries. This seems to be in accordance with the assumption that country-specic characteristics still play an important part in the explanation of bank eciency levels.

Determinants of bank eciency To examine the determinants of bank eciency, the Tobit regression described in Equation 8 is estimated. The results of the Tobit regression for 1997 are summarized in Table 5.11 The coecients 1, 2, 3, 4, 5 of the dummy variables (FRA, GER, ITA, SPA and UK) represent the intercepts for the ve banking systems under study. In order to test the inuence of the geographical location, the null

Results for 19931996 are reported in the Appendix.

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Table 5. Tobit censored regression 1997 data ^ j FRA GER ITA SPA UK ETA ROAE COMM QUOT 0.622509 0.732809 0.500420 0.580022 0.791588 0.357723E-02 0.231090E-02 0.018185 0.037875 Std error 0.017445 0.014637 0.022235 0.021130 0.019954 0.222236E-02 0.641920E-03 0.012959 0.015998 t value 35.6843 50.0659 22.5055 27.4496 39.6707 1.60965 3.59998 1.40322 2.36745 Pr (>|t|) 0.0000 0.0000 0.0000 0.0000 0.0000 0.1075 0.0003 0.1606 0.0179 FRA GER ITA SPA UK ETA ROAE COMM QUOT

B. Casu and P. Molyneux

Table 6. Bootstrap Tobit censored regression with C 1000 samples (1997 data) ^ j 0.622509 0.732809 0.500420 0.580022 0.791588 0.003577 0.002310 0.018185 0.037875 j 0.666153 0.769757 0.565224 0.622903 0.811953 0.004325 0.001906 0.020081 0.034222 ^ ^ se100 j 0.041083 0.031524 0.071447 0.039952 0.025614 0.002895 0.01010 0.015789 0.026283 t value 15.15247 23.24607 7.004073 14.51797 30.90451 1.235579 0.228713 1.151751 1.441046

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Note: FRA France; GER Germany; ITA Italy; SPA Spain; UK United Kingdom; ETA equity/total assets; ROAE return on average equity; COMM commercial banks; QUOTbanks listed on the Stock Exchange.

Note: FRA France; GER Germany; ITA Italy; SPA Spain; UK United Kingdom; ETA equity/total assets; ROAE return on average equity; COMM commercial banks; QUOT banks listed on the Stock Exchange.

hypothesis H0: 1 2 3 4 5 was tested against the alternative hypothesis (H1) that one pair at least is unequal in each year. The results of the F-test allows one to reject the null hypothesis every year.12 The results for 1997 note that although there is a positive sign on the (E/TA) variable it is not statistically signicant at the 5% level. (In fact, only the equity ratio was found to have a positive statistically signicant relation to eciency in the 1996 estimates.) As such, there does not appear to be a strong relationship between variation in bank equity and eciency levels. In contrast, ROAE is positively related to bank eciency; in the 1997 estimates protable banks appear more ecient. However, this relationship is only found to hold in one other year (1995). The results also suggest that commercial banks are no more ecient than their savings and co-operative bank counterparts. The positive and statistically signicant sign on the QUOT variable (a relationship found in all the yearly estimates) indicates that listed banks are more ecient than their non-listed counterparts. However condent one may feel about these results, one needs to take into account the problem of the inherent dependency of eciency scores when used in regression analysis. To recall, the reason for dependency is the well-known fact that the DEA eciency score is a relative eciency index. Because of the presence of the inherent dependency among the eciency scores, one basic model assumption required by regression analysis, independence within the sample, is violated. As noted by Xue and Harker (1999), the conventional procedure, as outlined so far in this paper, may be inappropriate and the results could be misleading. In an attempt to overcome this problem, a bootstrapping technique is applied.
12 13

The bootstrapping procedure13 Following Xue and Harker (1999), the bootstrap method is implemented as follows: ^ . Construct the sample probability distribution F , assigning probability of 1/379 at each DMU in the observed sample.14 . Take c 1000 random samples of size 379 with replacement from the observed sample of 379 European banks. These samples are the bootstrap samples. . Compute the DEA eciency scores for each bootstrap sample. . Within each bootstrap sample, t the following regression model: ^ ^ ^ ^ ^ ^ ki k1 FRA k2 GER k3 ITA k4 SPA k5 UK ^ ^ ^ k6 ETAki k7 ROAEki k8 COMMki ^ k9 QUOTki "ki 9

for i 1, 2, . . . ,379; k 1, 2, . . . ,1000. Here ki is the DEA eciency score for DMU i in boot^ strap sample k and kj j 1, . . . , 9 are the bootstrap ^ replications for j in bootstrap sample k. ^ . Estimate the standard error se(j ) by the sample standard deviation of the c bootstrap replications of ^ j (see Equation 5), where Pc j
k1

^ kj

j 1, 2, . . . , 9

c 1000

10

F-test (df1 4; df2 374): 1993 4730.862; 1994 1588.623; 1995 1682.859; 1996 4730.246; 1997 2640.862. The computer routine to perform the described procedure has been written by C. Verdes, University of Durham, UK. 14 To complete this exercise, the balanced sample on a pooled European basis (379 observations) was considered.

Eciency in European banking

. Calculate the t-statistic according to Equation 7 and then test the individual hypothesis H0: j 0 against the two-sided alternative H0: j 6 0 at  0.05 signicant level. The results of the bootstrapping procedure for 1997 are shown in Table 6.15 Comparing the results of the bootstrap regression to the results of the direct Tobit regression, the rst conclusion that can be drawn is that the bootstrap method helps one to reduce the ambiguity of the responses of the hypothesis testing. In fact, the coecients 1, 2, 3, 4, 5 lead to the same conclusions reached earlier16 (i.e. geographic location inuences average eciency levels), also little evidence is found to suggest that the average capital ratio (E/TA) and the return on average equity (ROAE) inuence bank eciency levels. These latter results contrast with the positive relationship between both ROAE and E/TA and eciency levels found in previous studies (see Mester, 1996; Pastor et al. 2002; Carbo et al. 2003) and the positive statistically signicant relationship between ROAE and eciency presented in some earlier non-bootstrapped results. Overall, these ndings seem to suggest that inference on the determinants of bank eciency drawn from non-bootstrapped regression analysis may be misleading. Note also that in the bootstrap estimates the QUOT dummy is found to be statistically signicant at the 5% level in 1993, 1995 and 1996, compared with the conventional Tobit estimates, where QUOT was statistically signicant in all years under study. (The COMM dummy was statistically signicant for all years using both the conventional and the bootstrap estimations.) Overall, both the bootstrap and the conventional Tobit results presented in this paper suggest that most of the eciency dierences found across European banking systems are due to country-specic aspects of the banking technology. This can be thought of as reecting both the legacy of dierent banking regulations and the dierent managerial strategies implemented to face up to the new challenges brought about by information technology, nancial innovation and greater competition within the European banking market. These results, to a certain extent, conrm previous ndings17 and lead one to conclude that country-specic factors are still important determinants in explaining dierences in bank eciency levels across Europe. In addition, these ndings suggest that the EUs SMP has not had a major inuence in promoting a convergence of bank eciency levels. V. CONCLUSIONS

1873

This paper investigates whether there has been an improvement and convergence of productive eciency across European banking markets since the creation of the Single Internal Market. Using eciency measures derived from DEA estimation, the determinants of European bank eciency were also evaluated using the Tobit regression model approach. The established literature on modelling the determinants of bank eciency was then extended by recognizing the problem of the inherent dependency of DEA eciency scores when used in regression analysis. To overcome the dependency problem, the approach suggested by Xue and Harker (1999) was followed and a bootstrapping technique applied to the Tobit regression analysis. Overall, the DEA results show relatively low average eciency levels; nevertheless, it is possible to detect a slight improvement in the average eciency scores over the period of analysis for almost all banking systems in the sample, with the exception of Italy. However, the results show that the eciency gap among countries grew even wider over the period 19931997. The bootstrap regression results indicate that geographic location inuences bank eciency. Little evidence was found to suggest that the average capital ratio and the return on average equity explain variations in bank eciency levels. These results contrast with the positive relationship between both returns and capital ratios and eciency levels found in some of the non-bootstrapped estimates and in previous studies. This perhaps suggest that inference on the determinants of bank eciency drawn from non-bootstrapped regression analysis may be biased. Finally, both the bootstrap and the conventional Tobit results presented in this paper suggest that most of the eciency dierences found across European banking systems seem to be due to country-specic aspects of the banking technology. This can be thought of as reecting both the legacy of dierent banking regulations and the dierent managerial strategies implemented to face up to the new challenges brought about by information technology, nancial innovation and greater competition within the European banking market. These results lead one to conclude that country-specic factors are still important determinants in explaining dierences in bank eciency levels across Europe. This suggests that the EUs SMP has not had a major inuence in promoting a convergence of bank eciency levels.

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Results for the years 19931996 are reported in the Appendix. Results of the F-test allows one to reject the null hypothesis H0: 1 2 3 4 5 against the alternative hypothesis (H1) that one pair at least is unequal in each year. 17 For example, Pastor et al. (1997) conclude that the country-specic environmental factors exercise a strong inuence over the average eciency score of each country.
16

15

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A C K NO WL E D G E M E N T S Thanks to E. P. M. Gardener for his comments on earlier versions of the paper. We are greatly indebted to C. Verdes for his help in writing the bootstrapping computer routine. We also wish to thank M. Brown, C. Girardone, E. Thanassoulis and J. Williams for their valuable suggestions.

B. Casu and P. Molyneux

Ferrier, G. D. and Hirschberg, J. G. (1995) Bootstrapping condence intervals for linear programming eciency scores: with an illustration using italian banking data, Journal of Productivity Analysis, 8, 1933. Ferrier, G. D. and Valdmanis, V. (1996) Rural hospital performance and its correlates, Journal of Productivity Analysis, 7(1), 6380. Fried, H. O. Schmidt, S. S. and Yaisawarng, S. (1999) Incorporating the operating environment into a nonparametric measure of technical eciency, Journal of Productivity Analysis, 12, 24967. Grosskopf, S. (1996) Statistical inference and non-parametric eciency: a selective survey, Journal of Productivity Analysis, 7, 16176. Lovell, C. A. K. (1993) Production frontiers and productive eciency, in The Measurement of Productive Eciency: Techniques and Applications, (Eds) H. O. Fried, C. A. K. Lovell and S. S. Schmidt, Oxford University Press, Oxford, UK. Lovell, C. A. K., Walters, L. C. and Wood, L. L. (1995) Stratied models of education production using modied DEA and regression analysis, in Data Envelopment Analysis: Theory, Methodologies and Applications, (Eds) A. Charnes, W. W. Cooper, A. Y. Lewin and L. M. Seiford, Kluwer, Boston, 32952. Mester, L. J. (1996) A study of bank eciency: taking into account risk-preferences, Journal of Banking and Finance, 20, 389405. Molyneux, P., Altunbas, Y. and Gardener, E. P. M. (1996) Eciency in European Banking, John Wiley & Sons, Chichester, England. Pastor, J. M., Prez, F. and Quesada, J. (1999) Cost and prot eciency in banking: an international comparison of Europe, Japan and USA, Economics Letters, 63, 3944. Pastor, J. T., Lozano, A. and Pastor, J. M. (2002) An eciency comparison of European banking systems operating under dierent environmental conditions, Journal of Productivity Analysis, 18, 5978. Resti, A. (1997) Evaluating the cost-eciency of the Italian banking system: what can be learned from the joined application of parametric and non-parametric techniques, Journal of Banking and Finance, 2, 22150. Rouse, P. (1996) Alternative approaches to the treatment of environmental factors in DEA: an evaluation, Working paper, University of Auckland. Seiford, L. M. (1996) Data envelopment analysis: the evolution of the state of the art (1978-1995), Journal of Productivity Analysis, 7, 99138. Simar L, Lovell, C. A. K. and Vanden Eeckaut, P. (1994) Stochastic frontiers incorporating exogenous inuences on eciency, Discussion paper 9403, Institut de Statistique, Universit Catholique de Louvain, Belgium. Simar, L. (1992) Estimating eciency from frontier models with panel data: a comparison of parametric, non-parametric and semi-parametric methods with bootstrapping, Journal of Productivity Analysis, 3, 17191. Simar, L. and Wilson, P. (1998) Sensitivity analysis of eciency scores: how to bootstrap in non-parametric frontier models, Management Sciences, 44, 1, 4961. Xue, M. and Harker, P. T. (1999) Overcoming the inherent dependency of dea eciency scores: a bootstrap approach, Working paper 9917, Financial Institution Center, The Wharton School, University of Pennsylvania.

REFERENCES
Atkinson, S. and Wilson, P. (1995) Comparing mean eciency and productivity scores from small samples: a bootstrap methodology, Journal of Productivity Analysis, 6, 13752. Banca dItalia (1998) Annual Report. Banker, R. D., Charnes, A. and Cooper, W. W. (1984) Some models for estimating technical and scale eciency in data envelopment analysis, Management Science, 30, 107892. Berg, S. A., Frsund F. R., Hjalmarsson, L. and Suominen, M. (1993) Bank eciency in the Nordic countries, Journal of Banking and Finance, 17, 37188. Berger, A. N. and Humphrey, D. B. (1997) Eciency of nancial institutions: international survey and directions for future research, European Journal of Operational Research, 98, 175212. Berger, A. N., Hancock, D. and Humphrey, D. B. (1993) Bank eciency derived from the prot function, Journal of Banking and Finance, 17, 31747. Bhattacharyya, A., Lovell, C. A. K. and Sahay, P. (1997) The impact of liberalisation on the productive eciency of Indian commercial banks, European Journal of Operational Research, 98, 33245. Carbo, S., Gardener E. P. M. and Williams, J. (2003) A note on technical change in banking: the case of European savings banks, Applied Economics, 35, 70519. Charnes, A., Cooper, W. W. and Rhodes, E. (1978) Measuring the eciency of decision-making units, European Journal of Operational Research, 2, 42944. Coelli, T., Prasada Rao, D. S. and Battese, G. E. (1998) An Introduction to Eciency and Productivity Analysis, Kluwer Academic Publishers, Boston. Deprins, D. and Simar, L. (1989) Estimating technical ineciencies with corrections for environmental conditions with an application to railways companies, Annals of Public and Co-operative Economics, 60, 1 (Jan-Mar) 81102. Dietsch, M. and Weill, L. (1998) Banking eciency and European integration: productivity, cost and prot approaches, paper presented at the 21st Colloquium of the SUERF (Frankfurt, 1517 October 1998). Efron, B. (1979) Bootstrap methods: another look at the jackknife, Annals of Statistics, 7, 126. European Commission (1996) The impact and eectiveness of the single market, Communication to the European Parliament and Council (30 October 1996). European Commission (1997a), Credit Institutions and Banking, Volume 4, Subseries II, Impact on Services, The Single Market Review, Kogan Page, London. European Commission (1997b), The European Union: key gures, EUROSTAT (Brussels). Farrell, M. J. (1957) The measurement of productive eciency, Journal of Royal Statistical Society, 120, Sec. A, 25381.

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Eciency in European banking

APPENDIX Tobit censored regression estimates
^ j 1993 FRA GER ITA SPA UK ETA ROAE COMM QUOT 1994 FRA GER ITA SPA UK ETA ROAE COMM QUOT 1995 FRA GER ITA SPA UK ETA ROAE COMM QUOT 1996 FRA GER ITA SPA UK ETA ROAE COMM QUOT 0.628416 0.740559 0.565592 0.529152 0.757705 0.0000333 0.0005445 0.0020804 0.0647023 0.722489 0.785564 0.644545 0.654217 0.785788 0.132317E-02 0.295890E-03 0.531899E-02 0.30135 0.643098 0.754802 0.555382 0.585460 0.731742 0.203572E-02 0.0131381E-02 0.33813E-02 0.058225 0.610190 0.719010 0.481954 0.518734 0.783748 0.562716E-02 0.11383E-03 0.469199E-02 0.053910 Std error 0.018059 0.015776 0.024866 0.021563 0.021366 0.0025217 0.0003128 0.0149369 0.0185407 0.0113681 0.011820 0.018974 0.016146 0.016326 0.184337E-02 0.326345E-03 0.011247 0.013720 0.017291 0.014508 0.022040 0.020944 0.019778 0.220280E-02 0.636268E-03 0.012845 0.015857 0.014786 0.012675 0.017506 0.017213 0.016999 0.145072E-02 0.399853E-03 0.013359 0.016660 t value 34.798 46.942 22.745 24.539 35.464 0.013 1.740 0.139 3.490 52.8085 67.3038 33.9692 40.5185 48.1301 0.717801 0.906678 0.472934 2.19645 37.1920 52.0265 25.1992 27.9531 36.9972 0.924154 2.06587 0.263234 3.67186 41.2684 56.7248 27.5314 30.1356 46.1043 3.87887 0.284687 0.351225 3.23599

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Pr (>|t|) 0.0000 0.0000 0.0000 0.0000 0.0000 0.9895 0.0818 0.8892 0.0005 0.0000 0.0000 0.0000 0.0000 0.0000 0.4729 0.3646 0.6363 0.0281 0.0000 0.0000 0.0000 0.0000 0.0000 0.3554 0.0389 0.7924 0.0002 0.0000 0.0000 0.0000 0.0000 0.0000 0.0001 0.7759 0.7254 0.0012

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Bootstrap Tobit censored regression estimates

^ j 1993 FRA GER ITA SPA UK ETA ROAE COMM QUOT 0.628416 0.740559 0.565592 0.529152 0.757705 0.0000332485 0.000544515 0.00208044 0.0647023 j 0.676553 0.776139 0.609849 0.571722 0.788606 0.000501 0.000460 0.005369 0.062147   ^ ^ se1000 j 0.052819 0.033371 0.050313 0.047938 0.029285 0.003321 0.000382 0.016981 0.027051 t value 11.89753 22.19168 11.24147 11.03825 25.87347 0.010012 1.425434 0.122516 2.391862 (continued)

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Bootstrap Tobit censored regression estimates (continued)
^ j 1994 FRA GER ITA SPA UK ETA ROAE COMM QUOT 1995 FRA GER ITA SPA UK ETA ROAE COMM QUOT 1996 FRA GER ITA SPA UK ETA ROAE COMM QUOT 0.722489 0.795564 0.644545 0.654217 0.785788 0.00132317 0.000295890 0.00531899 0.030135 0.643098 0.754802 0.555382 0.585460 0.731742 0.00203572 0.00131381 0.0033813 0.058225 0.610190 0.719010 0.481954 0.518734 0.783748 0.00562716 0.00011383 0.00469199 0.053910 j 0.741347 0.815620 0.665026 0.672066 0.816669 0.001818 0.000326 0.011047 0.032408 0.681423 0.790288 0.598257 0.620156 0.770682 0.001273 0.001092 0.001622 0.057351 0.662319 0.771952 0.551079 0.572392 0.825845 0.004095 0.000241 0.004730 0.053397

B. Casu and P. Molyneux

  ^ ^ se1000 j 0.031735 0.029239 0.040140 0.032637 0.029793 0.002383 0.000575 0.013562 0.017517 0.040642 0.030779 0.051829 0.040030 0.038527 0.002980 0.000790 0.016602 0.025906 0.042511 0.037906 0.062123 0.044392 0.029934 0.003039 0.001016 0.017498 0.025292

t value 22.76631 27.209 16.05742 20.04526 26.37492 0.555254 0.514591 0.392198 1.720329 15.82348 24.52328 10.71566 14.62553 18.99297 0.68313 1.663051 0.20367 2.247549 14.3537 18.96824 7.758061 11.6853 26.18253 1.851649 0.11204 0.268144 2.131504

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