Abstract
This study examines the cost efficiency of the banking industry in Canada. Utilizing 12 years of data (i.e., 2006 to 2017), and a two-stage data envelopment analysis (DEA), it provides insight on the determinants of the industry’s cost efficiency. It finds that the industry is cost inefficient, and that it could reduce costs by 11.52 percent. The cost inefficiency is due to technical and allocative inefficiencies, with technical inefficiency playing a dominant role. The technical efficiency decomposition shows that pure technical efficiency improved, but the scale efficiency deteriorated. The analysis of the determinants of cost efficiency reveals that deposit conversion into loans, high capitalization, and managerial tolerance for increase in administrative expense drive cost efficiency. On the other hand, market power and diversification diminish cost efficiency. In addition, the impact of profitability and credit risk are inconsequential to cost efficiency. This study contributes to literature by providing insights unique to Canada. Managers in the industry, policy makers, and regulators can point to these findings as empirical evidence supporting measures aimed at increasing the industry’s competitiveness and resilience.
Highlights
The banking industry plays an important role in the economy, creating liquidity, and facilitating the movement of funds from depositors to borrowers (Ouenniche & Carrales, 2018)
This study examines the determinants of cost efficiency in the Canadian banking industry
Given that technical efficiency is dictated by managerial effectiveness and operational scale (Kumar & Gulati, 2008), the finding that pure technical efficiency improved while scale efficiency deteriorated highlights the precarious nature of the suboptimal operating scale of banks in the industry
Summary
The banking industry plays an important role in the economy, creating liquidity, and facilitating the movement of funds from depositors to borrowers (Ouenniche & Carrales, 2018). OSFI oversees and regulates financial institutions (i.e., banks, insurance, and trust and loan companies), whereas FCAC protects customers by ensuring that banks comply with market conduct requirements (FCAC, 2016). In addition to the roles of OSFI and FCAC, the Bank of Canada (BOC) and the Canadian Deposit Insurance Corporation (CDIC) monitor the industry for stability. While the BOC makes liquidity available to banks and ensures functional payment and settlement clearing systems, the CDIC insures deposits held in federally regulated banks and financial institutions (Department of Finance Canada, 2016). Given that efficiency centres on how inputs are used to generate outputs (Coeli et al, 2005), a cost efficient banking industry will produce better outcomes, converting inputs to outputs at minimum costs than an inefficient one (Spulbar, Nitoi, & Anghel, 2015). Despite withstanding the 2008 financial crisis, the threat of global economic uncertainties, competition, technological advancement, new regulatory framework, and changing needs of customers are generating concerns about the industry’s competitive position, ijbm.ccsenet.org
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