The efficiency and the conduct of European banks: Developments after 1992

Abstract

We assess the efficiency of the European banking sector in the 5-year period following the implementation of the Second Banking Directive of the European Union (EU). We first determine the degree of cost efficiency of EU banks in 1993–1997. After that, we explore to what extent efficient European banks are managed differently than their inefficient peers. Our datasets comprise 5 years of observations on 1347 savings and 873 commercial banks. We use the new recursive thick frontier approach (RTFA) method to establish our results. We find that structural factors, such as technological progress or increased bank competition, have lowered the cost base of banks by about 5% annually during the sample period. Managerial inability to control costs (X-inefficiency) is with 17–25% the main source of bank inefficiency in the EU. Managerial efficiency varies a great deal within Europe, and there seems to be no tendency towards convergence. We find that small savings banks can exploit economies of scale. The EU savings bank sector would cut costs by about 3% if small savings banks merged.