Measuring efficiency and productivity in the Australian banking sector

Abstract

This study investigates the efficiency and productivity of a balanced panel of 10 Australian banks during the period 1995-2005. It begins with a preliminary analysis based on financial indicators (popularly referred to as financial ratios) covering aspects of profitability, operational efficiency and asset utilisation. Financial indicator-specific achievement functions are defined and then aggregated to devise an index of efficiency performance. The proposed achievement functions and aggregate index provide a simple innovation to measuring and benchmarking the efficiency levels of the bank's ratio analysis. The study then proceeds to using the frontier based non-parametric linear programming technique, Data Envelopment Analysis (DEA), to measure technical efficiency. The technical efficiency scores are decomposed into the product of pure technical efficiency and scale efficiency. To ensure a comprehensive analysis, DEA is also applied in conjunction with windows analysis. The difference is that the former does not account for time variancy whereas the latter does. Finally, the Malmquist Productivity Index (MPI) is used to estimate total factor productivity (TFP) change. TFP change is decomposed into the product of technical efficiency change and technological change. Technical efficiency change is further decomposed into the product of pure technical efficiency change and scale efficiency change. By and large, the findings of this study are quite rich and make an important contribution to the limited literature on the performance of Australian banks. The results reveal that the extent of efficiency and productivity change varies across the banks and over the years. There is evidence to suggest that the efficiency and productivity of Australian banks has generally deteriorated over the period of analysis and, more specifically, following the Wallis Inquiry (1997). This is a matter of concern as recent regulatory changes following the Wallis Inquiry (1997) were implemented on the premise of potential efficiency and productivity improvements. The findings demonstrate that the banks need to better control their costs and invest in new technology and capital equipment to raise their efficiency and productivity levels. Based on asset size, it is highlighted that the medium sized banks are on average the most efficient and productive group of banks and have outperformed in terms of efficiency and productivity improvements. They are followed by the large banks while the small banks are found to be the worst performers on average. Further insights into the ongoing debate over the removal of the 'four-pillars' policy are also provided. It is suggested that the removal of such policy in the current environment may lead to lower competition, efficiency and productivity and further increase the disparity between the large major banks and the small regional banks. Greater benefits may arise from encouraging consolidation across smaller banks. The study could help banks in their future strategic plans and the policy makers interested in knowing the effects of deregulation on the efficiency and productivity of Australian banks.

Date of Award	2008
Original language	English