Cost Efficiency Analysis in the Banking Industry: Empirical Case From Western Balkan

Cost Efficiency Analysis in the Banking Industry: Empirical Case From Western Balkan

Gazmend Nure (Freie Universität Berlin, Germany)
Copyright: © 2020 |Pages: 20
DOI: 10.4018/IJCFA.2020070101
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Abstract

The efficiency of commercial banks is essential for the stability of banks by implying that banks that take higher risks are more inefficient. This paper builds on a stochastic heteroscedastic boundary model, where one will analyze a sample of 70 banks in Western Balkan countries such as Albania, Northern Macedonia, Serbia, Kosovo, and Montenegro for the period 2007-2017, highlighting determinants of bank cost efficiency. Banks with less liquidity, with a lower solvency rate and a higher credit risk, are more ineffective than prudent credit institutions. The paper also aims to address the relative lack of studies on the efficiency of banks in the region through the use of the stochastic frontier analysis (SFA).
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Introduction

The economies of the Western Balkan countries are still fragile, following the 1990s transformation, where they shifted from a socialist system to a market-oriented system. The financial system is represented in more than 90% from the banking system, as the most important financial intermediary in a country and which influences the economic growth promoter. The transformation of the banking industry in the Western Balkan countries has been one of the most difficult and influential processes in the transition process as a whole (Kraft, 2005). During this transition, the banking system transformation process was a complex process, due to the influence and mix of several factors such as (Mehl et al., 2006):

  • 1.

    The weak institutional and legal environment has led to a reduction in the effectiveness of the implementation of new legislation, especially in the field of liquidation, bankruptcy and collateral.

  • 2.

    Lack of human capital and credit technology. In general, banks were not yet accustomed to credit risk assessment, management risk or credit monitoring.

  • 3.

    Inappropriate banking supervision - As banking regulation and supervision had to be set up at a zero level, most supervisory departments were unable to set and enforce international standards that guaranteed a sound system. financial institutions, in particular with regard to provision for loan losses, exposure limits and related loans.

  • 4.

    Poor regulation of licensing of new private banks and related loans - In order to strengthen competition and efficiency, the authorities liberalized the banking market.

  • 5.

    Inadequate restructuring and poor governance of state-owned banks - In the early 1990s, the general consensus was to prioritize restructuring and privatization of state-owned commercial banks (Bokros, 2002).

The process of restructuring of state-owned banks was accompanied by high costs, especially in the former Yugoslav republics, due to the high level of bad credit Also in Albania, the banking financial system has gone through fluctuations caused by the lack of adequate system infrastructure and its instability. In this context, increased attention has been paid to studying the efficiency of the banking system. Efficiency and cost optimization have be- come essential for commercial banks. Moreover, in developing countries, the existence of a sound and efficient banking system is an important condition for sustained economic growth. The literature developed in this area suggests the study of efficiency and inefficiency respectively in two main directions: estimating the profit function as well as the cost function. Market liberalization led to increased foreign investment in the banking system in the Balkans, which was also accompanied by rapid growth of private sector lending (Cetkovic, 2011). There is a need to conduct studies on the structure of production, services that banks provide, in order to ensure the stability of the financial and economic system of a country. Very few studies have been conducted to analyze the efficiency of banks operating in the Balkan countries, addressing the impact that bank ownership has on the performance and efficiency of its activity. This study considers the differences and similarities between the financial markets of the countries and the long period of study.

The purpose of this study is to study the performance of banks in the countries of the Western Balkans, in the context of cost-effectiveness, aiming to fill in the relative lack of studies on the efficiency of banks in Albania through the use of parametric Boundary Model. Stochastic (Stochastic Frontier analysis, SFA).

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