X-inefficiency, Moral Hazard, and Bank Failures

Inefficient management is considered as a major factor responsible both for bank failures and X-inefficiency. Using data from financial statements of largest Russian banks for the period immediately preceeding the August 1998 crisis, we tested the hypothesis that the past level of X-inefficiency predicted the probability of failure of a financial institution after August 1998 financial crisis. Our probit/logit regressions suggest that X-inefficiency in the past does not help to predict bank failures, at least, in the August 1998episode. We obtained some indirect evidence that moral hazard from the part of bank owners was among the reasons why bank went bankrupt in the afteemath of August 1998 financial crisis in Russia. The captiveness, or affiliation of a bank with a financial-industrial group exagerrated the adverse effects on failure caused by primary factors such as a high level of foreign debt, the exposure to FX risk, etc. In some sense, more captive banks were more “willing” to fail ceteris paribus, which is consistent with the abundant anecdotal evidence about tunneling and asset stripping by “oligarch” banks in the aftermath of 1998 crisis.