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Costs, Competitiveness and the Changing Structure of European Banking

George Sheldon

The forces acting to mold European banking into a single market are increasing. A major factor supporting the convergence process is the Second Banking Directive, which went into effect in January 1993. The Directive allows financial institutions that are licensed in one EU country to operate in other member countries, thereby ob-viating the need to obtain a license from the regulatory authorities in the guest coun-try. Non-EU countries are also affected by the Directive as non-EU institutions oper-ating or seeking to establish a subsidiary in the EU must also comply with the Direc-tive in order to receive a Single Banking License. In addition, their home countries must grant reciprocal banking arrangements to EU countries in which non-EU insti-tutions operate. Further impetus to the integration process has come through the in-troduction of the Euro, which increased price transparency and created a single, large capital market in Europe.

The increasing cross-border competition accompanying the convergence process raises the question as to the future structure of European banking. Will large, univer-sal banks come to dominate the industry, or will small, specialized banks find greater opportunity? Since, as a rule (cf. PANZAR, 1989), the most cost effective market structure prevails under free competition (a natural monopoly being a case in point), the effect increased competition will have on the future development of individual institutions and the industry as a whole depends to a large extent on the sources of cost variation among banks.

Cost variations across firms emanate essentially from two sources: inefficient op-eration, representing deviations from a best-practice frontier (frontier inefficiency1), and unexploited economies of scale and scope, which the best-practice frontier may provide. Scale and scope economies confer cost advantages on large, diversified banks or - in the case of diseconomies - on small, specialized firms, whereas frontier inefficiency is not, as a rule, linked to firm size or output mix. If unexploited econo-mies of scale and scope were the main source of cost variation across banks in Europe, then one could expect large, full-service banks to eventually dominate the industry. Increased concentration would be the consequence.

Knowledge of the size and sources of cost variation among banks is important for policy makers. Such information helps them to understand the forces lying behind the current restructuring in banking and to anticipate future changes, thus aiding them in forging appropriate policies. For example, if frontier inefficiency were the main source of cost variation among banks, then this could point to insufficient competi-tion suggesting policies geared to decreasing regulation and fostering competition. If, on the other hand, unexploited economies of scale and scope underlay these cost dif-ferences, then this could signal increasing concentration, perhaps suggesting policies aimed at tightening regulation.

To assess the relative efficiency of banks across Europe, cross-country studies are needed. National studies are useless because efficiency is a relative concept, pertain-ing solely to the banks in a given sample. Unfortunately, few international studies exist. Of the 130 bank efficiency studies that BERGER and HUMPHREY (1997) cite in their survey, only six are cross-country and, of these, three pertain solely to Scandi-navian countries.

The following study attempts to right this imbalance by exploring the cost effi-ciency of a sample of 1783 commercial and savings banks that were operating in the EU, Norway or Switzerland (i.e. Western Europe) in the period 1993-97. This spans the years directly following the introduction of the Second Banking Directive, which is thought to have provided added support to the integration process. The study em-ploys a non-parametric frontier method, data envelopment analysis (DEA), and in-corporates recent methodological advances in the bank efficiency literature with re-spect to the handling of revenues and risk.

 

  • Three questions stand in the forefront of this study:
  • How large is the cost differential among banks in Europe?
  • What are the sources of the cost differential?
  • What implications do the results have for future structural change and policy stance?

 

1Frontier inefficiency is sometimes loosely termed X-inefficiency, an expression coined by Leiben-stein. However as originally conceived, X-inefficiency only pertained to technical efficiency, which refers to the excessive use of factor inputs to achieve a given output level (deviations from a pro-duction frontier), and excluded allocative efficiency, which pertains to the use of factor combina-tions that conflict with relative factor prices. Together, technical and allocative inefficiency con-stitute deviations from a minimum cost frontier (LEIBENSTEIN, 1966).

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publication
Costs, Competitiveness and the Changing Structure of European Banking
  • Publié le 03/11/1999
  • 45 page(s)
  • EN
  • PDF (182.48 Ko)
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Mis à jour le : 19/03/2019 16:57