Short-Run Cost Inefficiency of Commercial Banks: A Flexible Stochastic Frontier Approach

We adopt the intermediation approach, and use a flexible stochastic frontier to examine the cost efficiency of United States commercial banks with total assets in excess of & Million. We find an average overall inefficiency of just under 10 percent, a level somewhat lower than found in previous work. Our analysis of intra-industry variation concludes that inefficiency generally rises with bank size. Further, banks that have branching networks, either domestic or foreign, have higher inefficiency, on average; but, at the same time, inefficiency falls as the number of offices in the branch network expands. State level data on the ease of serviceing the market, competition from savings institutions, and the financial sophistication of depositors significantly affect bank inefficiency, generally with the expected signs. Finally, our findings suggest that regulatory changes that increase capital requirements may lead to increased bank efficiency in the short run. Copyright 1994 by Ohio State University Press.