Abstract
A large number of bank failures took place in transition countries during the 90s and at the beginning of the 2000s, which were related to increases in non-performing loans and deteriorated cost efficiency of banks. This paper addresses the question of the causality between non-performing loans and cost efficiency to know whether one of these factors would be the deep determinant of bank failures. We extend the Granger-causality model developed by Berger and De Young (1997) by applying the GMM dynamic panel estimators on a panel of Czech banks between 1994 and 2005. Our findings support the bad management hypothesis, according to which deteriorations in cost efficiency precede increases in non-performing loans, and to a lesser degree the bad luck hypothesis which predicts the reverse causality. Banking supervision should consequently focus on enhanced cost efficiency of banks to reduce the likelihood of bank failures in transition countries.
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