Journal of Banking and Finance 17 (1993) 349-366.

North-Holland

Output allocative and technical efficiency

of banks*
M. English
Department qf Economics, DePauw University, Greencastle, IN 46135, USA

S. Grosskopf
Department I$ Economics, Southern Illinois University, Carbondale, IL 62901, USA

K. Hayes
Department of Economics,
Southern Methodist University, Dallas, TX 75275-0496, USA

S. Yaisawarng
Department of Economics, Union College, Schenectady, NY 12308, USA

Final version received November 1992

In this paper we calculate output allocative and technical efficiency for a sample of small banks
operating in 1982. We do so by estimating a Shephard type output distance function as a
deterministic frontier. In general we find that the banks in our sample are output ineflicient.

1. Introduction

Dramatic changes have taken place in the US banking industry. In 1991

more than 500 banks announced plans to merge. Consolidation and mergers
in 1991 were valued at over $20 billion, up from $4.3 million in 1990.’ The
structural change is not limited to the US. The trend in the European
Common Market is also toward fewer banks.
Given these structural changes, one would like to know if there has been
an improvement in bank performance. Typically we think that merger

Correspondence to: Mary English, Department of Economics, DePauw University, Greencastle,

IN 46135, USA.
*We would like to thank Allen Berger and Diana Hancock for helpful comments on an earlier
draft of this paper.
‘These figures are from ‘Bank Mergers Do Not Guarantee Cost Savings’, Economic Update,
Federal Reserve Bank of Atlanta, 5, 2 (April-June 1992).

037%4266/93/$06,00 K> 1993-Elsevier Science Publishers B.V. All rights reserved

350 M. English et al., Output allocative and technical efficiency
of banks

activity and consolidation lead to the reduction of competition and increased

market power. This could result in a welfare loss if the remaining firms
exploit that power and set prices above marginal cost. This is the view
associated with the traditional structure, conduct and performance view.
On the other hand, one could argue that mergers and consolidations can
lead to enhanced efficiency. Not only might there be economies of scale or
diversification, but also there may be gains to the consumer due to newly
merged banks being able to take advantage of new technologies or better
management. Many of the recent mergers have occurred between a profitable
bank and bank(s) which are struggling. If the more profitable bank is more
efficient and imposes its production structure on the less efficient bank(s),
then not only does the consumer gain, but the bank owners are also winners.
This view is consistent with the efficient market structure view, see Demsetz
(1973) and Peltzman (1977).
In this paper, we determine whether individual banks are operating
efficiently in terms of technical and allocative efiiciency. As opposed to earlier
studies which assess the input technical and allocative efficiency of banks, we
focus on output efficiency. Our approach relies on defining a production
relation for the decisionmaker at the micro level. In particular we estimate a
frontier output distance function. The value of the output distance function is
equivalent to a Farrell type output measure of technical efficiency.
Using the duality between the output distance function [due to Shephard
(1970)] and the revenue function, we also derive shadow prices of outputs for
individual banks. We compare the ratio of these shadow prices to the ratio
of observed prices to test whether banks are providing the allocatively
efficient mix of outputs. Our paper proceeds by briefly reviewing the
efficiency literature as it relates to the banking industry in section 2. In
section 3 we develop our methodology and provide a brief discussion of the
advantages of the technique. Section 4 details the data and discusses the
result.

2. Banking and efficiency

Numerous efforts have been made to estimate the efficiency with which
banks utilize resources in a cost function framework. In this approach, the
researcher has assumed that the bank is attempting to minimize costs and
that managerial mistakes are made in input usage. Perhaps more import-
antly, the cost function approach requires the assumption that outputs are
determined exogenously.
There are four basic techniques that have been used in these efforts. Data
envelopment analysis assumes there is no random error [e.g., Rangan et al.
(1988) Aly et al. (1990) Elyasiani and Mehdian (1990), and Ferrier and
 M. English et al., Output allocative and technical efficiency of banks 351

Love11 (1990)]. The econometric stochastic frontier approach assumes a two

part or composed error term [e.g., Ferrier and Love11 (1990), Bauer et al.
(1992)]. The third general approach is based on econometric estimation of
cost functions that are not explicitly frontiers. The thick frontier approach
allows for cost differences within cost quartiles which represent random
error, while cost differences across these quartiles reflect efficiency differences
[e.g., Berger and Humphrey (1991, 1992a), Bauer et al. (1993)]. A fourth cost
function approach has been dubbed the ‘distribution-free’ approach by
Berger (1993). This approach employs the average residuals of the cost
function estimated with panel data to construct a measure of cost of X-
efficiency. This approach was also employed in Berger and Humphrey
(1992b) to analyze the effects of mergers in banking.
Our technique focuses on the revenue rather than the cost side of the
picture. This allows us to look explicitly at the output efficiency of banks.
This includes testing for revenue maximizing behavior, testing for allocative
efficiency (which also tells us whether banks cross-subsidize various loan
types), and testing for output technical efficiency.

3. The theoretical model

The main analytical tool we employ in this paper is the output distance
function, introduced by Shephard (1970). This function is defined on the
output set P(x) as

D0(x,y)=inf{6):(y/6)EP(x)}. (1)
Here y refers to the vector of outputs and x to the vector of inputs. In
words, the distance function seeks the greatest proportional expansion of
observed outputs possible while remaining in the feasible output set, P(x).
The distance function will attain a value of less than or equal to one. (Values
of one reflect efficient production.) The output distance function has several
advantages over more traditional means of representing technology such as
the production function. In contrast to the scalar-valued production function,
the distance function models joint production of multiple outputs. It also
directly provides a measure of technical efficiency. In addition, the duality
between the output distance function and the revenue function allows us to
retrieve the shadow prices of output. These can in turn be used to test for
allocative efficiency, revenue efficiency and eventually could be employed to
test for competitive pricing at the bank level.
The general idea can be illustrated in a diagram. Consider fig. 1 which is
based on a simple two-output case. P(xA) is the traditional output or
production possibilities set. Suppose bank A produces the output bundle
352 M. English et al., Output allocative and technical ejjiciency of banks

ym’
t

Fig. 1. Output distance function and shadow prices.

labeled A. Although this bank is employing the same input level as all other
feasible points in the output set, it is not producing maximum feasible output
with those inputs. The value of the distance function gives the maximum
radial expansion of bank A’s output bundle given feasible technology P(xJ.
That is equivalent to OA/OA’ for bank A, which is less than one, i.e., bank A
is technically inefficient.
As mentioned above, the distance function can be used to calculate
shadow prices of output as well. Again referring to fig. 1, notice that at the
projection of A into the frontier of technology, A’, we can construct an
implicit isorevenue line p * p * , tangent to the frontier. The implicit isorevenue
can be thought of as the shadow revenue maximized by the firm at its
observed output mix. Thus the (negative of the) slope of p*p* is the ratio of
shadow prices at A’. If the ratio of observed prices is not equal to the ratio
of shadow prices (the marginal rate of transformation) as is the case of bank
A, the bank is judged to be allocatively inefficient. In order to maximize
revenues with observed relative prices (as at point B in the diagram), banks
must be both technically efficient (operating on the production possibilities
frontier) and allocatively efficient (producing the revenue maximizing mix of
outputs). We now turn to a more technical discussion of the distance
function and the derivation of shadow prices.
Let output prices be denoted by p =(pl,. . . , pni) and assume that p 2.0, i.e.,
 M. English et al., Output allocative and technical efficiency of banks 353

prices are assumed nonnegative.2 The revenue function is defined in terms

of the distance function as

wx,PI= sup {Py:D,(x, Y) 5 1 I. (2)

In words, the revenue function seeks the maximum revenue given output
prices p and technology. In fig. 1 maximum revenue given observed relative
prices is achieved where the isorevenue line pp is tangent to the production
possibilities set at B.
If the technology has convex output sets P(x), for all XE R”,, then the
following duality holds [see Shephard (1970) or Fare (1988)]

Rx, P) = sup {PY:D,(x, Y) 5 1)

(3)
D&, Y) = sup IPYm% P) 5 119
P

where py is the inner product of the output price and quantity vectors. The
revenue function is derived from the output distance function by maximiza-
tion with respect to outputs, and the output distance function is obtained
from the revenue function through maximization over output prices.
Following Fare and Grosskopf (1990), we can derive the marginal rate of
transformation of the distance function by solving for the shadow prices of
output. Assuming that the revenue and distance functions are differentiable,
Fare and Grosskopf show that

p = Nx, P) . ~,D,(x, Y). (4)

That is, the vector of shadow prices of outputs, p, is the product of maximum
revenue R(x,p) and the gradient vector P,D,(x, y). Utilizing the second part
of the duality theorem (3), and applying Shephard’s dual lemma yields

~yDo(x, Y)=P*b YL (9

where p*(x, y) denotes the revenue maximizing output price vector given
outputs and technology. Substitution of (5) into (4) and rearranging yields

P$(X, Y) = P/W-% P), (6)

Thus p*(x, y) derived from Shephard’s dual lemma may be interpreted as a

vector of normalized (revenue deflated) output shadow prices. For further

*This assumption is not necessary. Fare et al. (1993) use this same approach to estimate
shadow prices of undesirable outputs, which are negative.
354 M. English et al., Output allocative and technical efficiency of banks

details see also F&-e et al. (1993), Fsre and Zieschang (1991), and Fixler and
Zieschang (1992a, b).
Our test of allocative efficiency is based on the shadow prices. Essentially,
we compare the ratios of shadow prices with those of observed prices. Since
we are interested in relative prices, the R(x,p) terms cancel, allowing us to
use the revenue deflated prices from (6).3
In order to implement our shadow price expression, we need to parameter-
ize and calculate the parameters of an output distance function. Here we
choose to parameterize D,(x,y) as a translog function, which is the functional
form often employed to model bank technology:

lnD,(xk,yk)=uO+ 2 /I,1 nxi+ f cc,lnyk,+t f i B,n,(lnx~)(lnx~z)

II=1 Wl=l n=l n’=l

+:f g hdln yk,)(ln

A) + i ? rAlnxk,)(lnY”,) (7)
m=l m’=1 n=l In=1

We compute the parameters in (7) using the linear programming formulation

suggested by Aigner and Chu (1968),4 which estimates the output distance
function as a deterministic frontier. This is accomplished by solving the
problem

max 5 [ln DO(xk, yk) -In l] (8)

k=l

subject to

(i) In DO(xk,yk) 2 0, k=l,...,K,

(ii) Do(xk,
8111 ~~1, o
m=l >..‘, M,
alnyk, = ’

(iii) 3 In D&K j) so
?l=l,...,N,
dlnx, ’

where homogeneity of degree plus one in outputs and symmetry are also
imposed. The superscript k = 1,. . . , K indexes individual observations, X and y

‘Testing for equality of individual shadow prices with observed prices would require
calculation of the undeflated shadow prices. This in turn requires identification of R(x,p). See
Fare et al. (1990) or Fare and Zieschang (1991) for a discussion of how to obtain absolute
(undeflated) shadow prices for individual observations.
%ee also Nishimizu and Page (1982) and Forsund and Hjalmarsson (1987) for other
applications of parametric, deterministic frontiers.
 M. English et al., Output allocative and technical efficiency of banks 355

are input and output vectors of the average bank, and lnD,(x,y) has an
explicit functional form as in (7). The objective function ‘minimizes’ the sum
of the deviation_s_of individual observations from the frontier of technology.
Since the distance function takes a value of less than or equal to one,
In D,(.xk,yk) -In 1 is less than or equal to zero; hence the ‘max’. The first set
of constraints labelled (i) restrict individual observations to be on or ‘below’
the frontier of the technology, i.e., this is a frontier approach. The constraints
in (ii) ensure that the outputs have nonnegative shadow prices. The
constraints in (iii) restrict the derivatives of the distance function with respect
to inputs to be nonpositive at the mean of the data. One of the advantages
of this approach is the ease with which inequality constraints can be
included, allowing us to impose some global regularity on the translog
function. This approach also allows us to sidestep the issue of specifying a
‘left-hand side dependent variable’ for the distance function.5
We calculate output technical efficiency as the estimated value of the
distance function, i.e., we calculate

EFFk = [exp (In B,,(.x~,yk)] (9)

for all observations based on estimates of the set of parameters in (7) and (8).
For output allocative efficiency, we test for equality between ratios of
shadow prices and of observed prices. If a bank is providing a revenue
maximizing mix of outputs, the slope of the production set at the observed
output mix (the marginal rate of transformation or ratio of shadow prices)
should equal the ratio of relative output prices for all pairs of outputs. In
order to check whether this condition is satisfied for all pairs of outputs,
define the following ratio of observed to shadow relative prices

K -‘“,l’>
mm’- jj;i/y%.,’
q&-l,..., M,
(10)
m#m’,

where @$/fi$ is our estimate of the slope of the production set, i.e., the ratio
of the derivatives of the distance function derived from (8).
If K,,,,! equals one for all pairs of outputs, then the bank is producing a
revenue maximizing output mix, i.e., it is allocatively efficent. If K,,,,, does not
equal one, then the bank is allocatively inefficient. In a two-output world, if
K ,,,,,,, < 1, then we have the situation in fig. 2, in which the ratio of observed
prices is less than the ratio of shadow prices (the slope of pap” is less than

‘See Fixler and Zieschang (1992a, b) for alternative techniques for estimating output distance
functions in the banking sector.
356 M. English et al., Output allocative and technical efficiency of‘banks

urn’

I ä
0 ym
Fig. 2. Allocative inefticiency: ti,,,,, < 1; overprovision of yrn relative to y,,

p*p*) at A’. This implies that bank A would not be maximizing revenues at
A’ given observed relative prices. Maximum revenue is achieved at B with
observed relative prices. Note the difference in output mix at A’ and B; at A’,
the bank provides more of output y, and less of output y,, than at the
revenue maximizing point B. The case where K,,, > 1 is left to the reader.

4. Data and results

We used 1982 data from the Federal Reserve’s Functional Cost Analysis
(FCA) program. Banks voluntarily report expense and revenue information.‘j
Our study requires information on quantities and prices of outputs
and quantities of inputs. Following the asset approach of Sealey and Lindley
(1977) we include as outputs (1) real estate loans, (2) commercial loans, (3)
consumer installment loans and (4) investments in US securities, federal

‘In 1982, 625 banks participated in the FCA program. Banks were deleted when the
information provided was inconsistent. Observations were dropped when the sum of allocated
expenses did not equal the total expense figure reported by the bank or if the bank reported
paying (earning) interest on deposits (loans) while also reporting that the quantity of that type of
deposit (loan) was zero. Banks were also deleted if their observed output prices were more than
2.5 standard deviations from the mean, which left a sample of 442 observations. For a discussion
of possible selectivity bias due to the voluntary participation in FCA, see Heggestad and Mingo
(1978).
 144.English et al., Output allocative and technical efficiency of banks 357

Table 1
Summary statistics: Banks operating in 1982.

Variable Mean St. dev.

Outputs (in million S)
Investment income (p,) 55.80 65.15
Real estate loans (yz) 29.48 36.33
Consumer loans (yj) 11.29 24.28
Commercial loans (y4) 34.54 53.73
Inputs
Labor (I,) 39.52 55.01
Capital (.x2) (thousand S) 134.16 239.38
Deposits (xs) (million $) 84.80 91.22
Borrowing (x4) (million $) 25.80 48.27
Output prices
Investment income (p,) 0.1024 0.0098
Real estate loans (pz) 0.1 126 0.0150
Consumer loans (p3) 0.1418 0.0174
Commercial loans (ad) 0.1531 0.0127
N=442

funds sold and assets in trading accounts. The output quantities are
measured as the annual average dollar value. Output prices were constructed
from the data by taking the ratio of interest income to output quantity.
Four inputs were used: (1) interest bearing small deposits (deposits less
than $lOO,OOO), (2) labour, (3) occupancy expense and (4) purchased or
borrowed funds which includes federal funds purchased, borrowings from the
Fed and deposits greater than $100,000. Descriptive statistics of the raw data
are presented in table 1. Note that these banks are relatively small.
In order to indirectly assess the impact of outliers on our results, we
followed a procedure suggested by Timmer (1971) in which the frontier is
estimated, technically efficient (frontier) firms are deleted and the frontier is
reestimated sequentially until the parameters ‘stabilize’. We estimated the
distance function four times. We present results based on our second
iteration: the estimated function satislied the regularity conditions (such as
correct curvature)7 at the mean of our data whereas the lirst iteration did
not. The estimated coefftcients of all four versions of the translog distance
function are available on request.
Although our technique allows us to retrieve point estimates of the value
of the distance function, shadow prices, etc., for every observation, we begin
by looking at summary statistics of our results for the sample as a whole, see
table 2. Beginning with technical efficiency, we find that on average banks in

‘These conditions include appropriate monotonicity and convexity/quasi-convexity of the

output distance function in its arguments.
358 M. English et al., Output allocatiae and technicul ejjiciency oj” banks

Table 2
Summary of empirical results.

Variable Mean St. Dev. N c-Stat.”

Technical efficiency 0.754 0.145 422 -
Relative price resultsb
Inv/Real estate (K,~) 0.803 0.887 418 - 4.54*
InvConsumer (K,~) 1.661 0.972 418 13.90*
Inv/Commercial (K,~) 1.042 0.321 418 2.68*
RE,‘Consumer (xz3) 2.835 I.531 416 24.45*
RE/Commercial (xz4) 2.060 1.546 417 14.00*
Consumer/Commercial (tij4) 0.753 0.676 417 - 7.46*
“*Significant at the 1Y/0level.
**Significant at the 5”,, level.
“Each relative price ratio is tested based on the following
hypotheses:
H,: Mean relative price ratio equals one.
H,,: Mean relative price ratio is different from one.

our sample are technically inefficient; i.e., on average banks could increase
outputs dramatically (almost twenty-five percent) if they eliminated technical
inefficiency.8
Our test of allocative efficiency (rcmm,= I) for all m#m’ also suggests
violation of allocative efficiency on average. Mean values of the ratios of
relative observed to relative shadow prices displayed in table 2 are signifi-
cantly different from 1 for all cases at the 1”/0 level. On average, we find
ratios between investment income and real estate to be less than one,
whereas ratios between investments and both consumer and commercial
loans exceed one. This would suggest, ceteris paribus, that banks could
increase revenues by increasing investment income at the expense of a
decrease in both consumer loans and commercial loans, and by increasing
real estate loans relative to investments on average. Since the IC,,,,, between
real estate loans and both consumer and commercial loans is significantly
greater than one on average, banks could increase revenue on average by
changing their mix toward more real estate and fewer consumer and
commercial loans. Our results for consumer loans relative to commercial
loans suggest underutilization of commercial loans given observed relative
prices on average.
The results at the mean mask some wider variation in the data at the

‘We note that since we have estimated a deterministic frontier distance function, our technical
efftciency measure captures all deviations from the frontier, including any deviations which may
be due to measurement error, for example. One way of addressing this problem is to estimate
the distance function as a stochastic frontier. This requires, however, that some assumption be
made concerning the distribution of technical inefbciency. Another alternative is to employ panel
data and the ‘distribution free’ approach suggested by Berger (1993).
 M. English et al., Output allocative and technical eficiency of banks 359

Table 3
Summary of frequency distribution results

<l >l
Variable Mean St. dev. N t-Stat. Mean St. dev. N t-Stat.”
Inv/Real estate (K,J -0.536 0.209 345 -41.24* 2.063 1.550 73 5.86*
Inv/Consumer (K~J 0.759 0.221 66 -8.86* 1.830 0.966 352 16.12*
Inv/Commercial (K,J 0.812 0.147 214 - 18.71* 1.282 0.274 204 14.70*
RE/Consumer (Key) 0.627 0.242 28 -8.16* 2.994 1.460 388 26.90*
RE/Commercial (K~J 0.633 0.259 81 -12.75* 2.404 1.530 336 16.82*
Consumer/Commercial (K~J 0.640 0.173 368 - 39.92* 1.600 1.704 49 2.46*
“Each relative price ratio is tested based on the following hypotheses:
H,: Mean relative price ratio equals one.
H,: Mean relative price ratio is less (greater) than one.

Table 4
Results evaluated at the mean of data.

Maximum number Technical

of banks efficiency K12 K13 K14 K23 x24 K34
442 0.644 0.452 1.677 0.839 3.710 1.856 0.500
422 0.733 0.728 1.714 1.008 2.357 1.386 0.588
419 0.736 0.721 1.637 1.089 2.270 1.510 0.665
415 0.737 0.833 1.997 1.238 2.396 1.486 0.620

disaggregated level. This is apparent in the frequency distributions of the K,,,

around the value of one (see table 3). No banks in our sample exhibited K,,,
equal to one for any combination of outputs. Comparison of tables 2 and 3
suggest that our sample average results reflects (qualitatively) the pattern for
most of the banks in our sample with the exception of our results for ~~~
(between investment and commercial loans). For slightly over half (214) of
our banks ~~~ is less than one, suggesting relative overuse of investments
relative to commercial loans. The remaining 204 banks are consistent with
the average results reported in table 2 suggesting underutilization of invest-
ments relative to commercial loans.’
In order to pursue a type of sensitivity analysis, we also calculated
technical efficiency and K,,, for the average bank in our sample (proxied by
a hypothetical bank with the mean values of inputs and outputs) for all four
estimated versions of the distance function. These appear in table 4. There is
(generally) qualitative agreement across all versions with respect to the
average K,,.. The mean values also appear to be fairly ‘stable’. As expected,

‘Note, however, that the mean values of all the K,,,,, in table 3 are significantly less (greater)
than one even for the ‘minority’ banks. This suggests to us that care should be taken not to
make simple generalizations of these results.
360 M. English et al., Output allocative and technical efficiency of banks

average technical efficiency ‘improves’ when frontier observations are deleted.

These results tell the same story as table 2: the average bank should move
toward a portfolio with relatively more real estate loans and fewer consumer
loans.
We also broke out our disaggregated results by bank type: national or
state chartered and by branching characteristics. Mean values are summar-
ized in table 5. The same qualitative results appear for state and national
banks as well as for branching and unit banks.
Although all of our banks are relatively small, we suspected that very
small banks may not have the managerial expertise of relatively larger banks,
resulting in lower efficiency for such small banks.” To investigate this
hypothesis, we disaggregated our results by eight asset size classes. Mean
disaggregated results appear in table 6. We find that the correlation
coefftcient between the technical efficiency score and value of total assets,
0.219, is significant at the lo/, level. This translates into a 0.219 basis point
improvement in technical efficiency with a one basis point increase in assets.
This is confirmed by the pattern of technical efficiency in table 6: banks with
greater assets are more technically efficient than those with relatively low
assets. Turning to allocative efficiency by size class, we find that average IC,,,,,
values are generally consistent with our previous results, with some excep-
tions. Perhaps the biggest ‘surprise’ is the pattern of average lclZ (between
investments and real estate loans). Whereas banks with assets below $200
million overutilize investment relative to real estate loans on average, banks
with assets over $200 million do not. As illustrated in table 7 (which displays
the portfolio composition of banks by asset size), very small banks rely more
heavily on investments than do the larger banks in our sample (43.5(x versus
38.9% on average). Given that investments represent a safe way for banks to
hold assets, this may reflect attempts by small banks to offset the increased
risk of their relatively small portfolios.’ I
We regard these results as suggestive. We note that our sample is not
representative of all banks; our banks are small and they are all members of
the Federal Reserve. Even though they are all members of the Federal
Reserve and enjoy protection under FDIC, we note that we have not
explicitly accounted for risk. We suspect that one of the reasons we find such
pervasive distortions between relative observed and relative shadow prices is
due to differences in risk by loan type and uncertainty concerning market
interest rates. In our sample, the variance of three year average net loan
losses per average annual dollar value of loans are higher for consumer loans

“‘We do not calculate scale efficiency here. The distance function was not restricted with
respect to returns to scale, however.
“Alternatively, small banks may not be able to market real estate loans due to demand side
considerations.
 Table 5
Mean disaggregated by bank type.”
~ ~~ ___ - ~_ ___ ~
State charter National charter Unit branch Branching
Variable Mean St. dev. N t-Stat. Mean St. dev. N t-Stat. Mean St. dev. N t-Stat. Mean St. dev. N t-Stat.
___~ ~~
Technical
efficiency 0.737 0.147 213 _ 0.771 0.142 209 0.750 0.149 158 0.756 0.143 264 _
K12 0.795 0.930 211 - 3.20+ 0.811 0.844 201 - 3.22* 0.985 1.055 156 -0.96 0.694 0.752 262 - 6.59*
K13 1.576 1.024 210 8.15* 1.746 0.912 208 11.80* 1.670 1.252 155 6.66* 1.655 0.763 263 13.92*
K14 1.055 0.324 209 2.48** 1.028 0.318 209 1.27 1.022 0.325 156 0.85 1.053 0.318 262 2.70*
h’23 2.847 1.606 210 16.67* 2.822 1.454 206 17.99* 2.448 1.552 153 11.54* 3.059 1.476 263 22.62*
K24 2.192 1.601 210 10.79* 1.926 1.480 207 9.00* 1.818 1,563 155 6.52+ 2.203 1.521 262 12.80*
K34 0.757 0.334 209 ~ 10.52* 0.749 0.898 208 - 4.03* 0.803 0.999 154 - 2.45** 0.724 0.376 263 - 11.90*
~_~
“See notes on table 2.
 Table 6
Mean disaggregated by bank size.”
__~ ___ ___~__
Total assets
-____ ~~ ___-- -- ___
Variable <40M 40M-60M 60Mp80M 80M~lOOM IOOM-/50M 15OM-2COM 2OOMp3OOM >3OOM
~___ __-___ __~__ ___~~_ __~__
Technical efficiency 0.717 0.668 0.740 0.709 0.757 0.801 0.773 0.863
k’l2 0.552* 0.668* 0.532* 0.681* 0.792** 0.724* 1.039* 1.415*
x13 I .300* 1.628* 1.345* 1.464 1.517* 1.749* 2.059 2.298
h‘14 1.188* 1.197* 1.028 1.013 0.937** 1.010 1.056 0.951
x23 3.085* 3.519* 2.945* 2.951* 2.479% 2.770* 2.965* 2.191*
x24 3.061* 3.125* 2.464* 2.078* 1.595* 1.586* 1.614% 1.087
k34 1.012 0.865** 0.883 0.706* 0.661* 0.613* 0.834 o.s15*
0/ 12.1 13.3 11.6 10.2 19.2 10.9 9.7 13.0
haximum number of banks 51 56 49 43 81 46 41 55
~___ ~-__~--__ ___ ~____ ___ ~___~
a* and ** indicate that the mean value of the relative price ratio is significantly different from one at the 1% and the 5% level,
respectively. Details of the test statistics are available from the authors upon request.

Table 7
Portfolio composition by bank size.
~__~__~ .- __ ~ __~
Total asset size classes
__~___~ __~ ~___ _- _~___ __-___
Variable < 40M 40M-60M 60Mm80M 80M-1OOM IOOM- 150M 150M-200M 2OOM~3OOM > 300M
__ ~~ ~~__~__._~
Investment income (y/J 43.5 43.3 43.4 39.9 42.1 __ ~ __
41.6 43.0 ~ ~ 38.9 -
Real estate loans (7,) 21.6 24.4 23.8 24.5 21.6 22.4 22.8 21.3
Consumer loans (“4) 15.6 11.6 13.3 14.1 13.2 12.4 10.8 12.4
Commercial loans (%) 19.3 20.7 19.5 21.5 23.1 23.6 23.4 27.4
Total 100.0 loo.0 loo.0 100.0 100.0 100.0 loo.0 100.0
~-- ~____~__ ____~ ___~_
 M. English et al., Output allocative and technical efficiency of banks 363

than for commercial and real estate loans,” which may not be reflected in
our shadow prices (since losses were not explicitly included as ‘outputs’). The
way we defined observed prices (as revenue in the particular activity divided
by our output measure) is also imperfect: the level of aggregation masks
considerable variation.
Keeping these caveats in mind, we tentatively conclude that our sample of
banks operating in 1982 were generally not revenue maximizers. Consistent
with the input efficiency studies, we find considerable technical inefficiency.
This is also broadly consistent with the results in Berger et al. (1993). We
also find our banks to be allocatively inefficient on average, i.e., their mix of
outputs is not revenue maximizing given observed relative prices. Revenues
(and profits) would have been increased if banks had provided relatively
more real estate loans and relatively fewer consumer loans on average in
1982 based on our results.
In terms of further research, we would like to see this approach modified
to account for risk, perhaps following that suggestion by McAllister and
McManus (1993). We would also like to be able to better exploit one of the
major advantages of our approach, namely, that our technique yields bank
specific efficiency and shadow prices. Our current results yield point esti-
mates, but we do not have information as to the precision of those point
estimates. Bootstrapping techniques could be used to address this problem.

“The variance of the consumer loan loss rate, 0.579, is slightly larger than the variance
associated with commercial loans. Real estate loans have the lowest variance in the loan loss
rate in our sample. The variances vary across bank sizes. Banks with total assets less than $60
million and those with total assets between $150 million and $300 million experience a much
larger variance in the consumer loan loss rate than that associated with commercial loan. Using
the current year net loan loss to construct that loan loss rate, we find the reverse ordering
between consumer and commercial loan loss rates. The variance of the commercial loan loss
rate, 1.7, is twice as large as the variance of the consumer loans. These rank orderings are also
found across bank sizes.
364 M. En&~h rt ul.. Output allocatine and technical efficiency oj’hanks

Appendix

Table A.1
Coefficients of translog distance function: N =442.

Coefficient Estimate Coefficient Estimate Coefficient Estimate

- 96.444 0.001 712 - 0.050
-2.851 0.079 713 0.116
- 0.927 - 0.087 YI4 0.078
1.519 0.098 “I’2L -0.019
3.259 - 0.694 722 0.002
- 12.937 0.053 ).‘23 0.006
0.606 0.820 ;124 0.01 1
11.676 -0.005 73 L 0.224
0.070 - 0.002 j132 0.065
0.008 - 0.022 733 - 0.098
- 0.006 - 0.023 734 -0.192
0.010 -0.838 741 - 0.007
-0.012 0.011 Y42 -0.001
0.008 -0.013 ?‘a3 0.005
~ 0.003 -0.145 0.003
_ ~~ ~~~ ~~ Y44 ~ ~~~~~ ~~~ ~_ ~_

Table A.2
Coefficients of translog distance function: N = 422.

Coefficient Estimate Coefficient Estimate CoeNicient Estimate

no - 5.229 %4 0.020 )112 0.012
II ~ 1.038 a33 0.094 YI3 0.052
XI - 0.090 334 - 0.064 Y14 0.026
m3 0.815 x44 0.136 ‘r’z1 -0.017
a4 1.313 ;:: 0.280 )‘22 0.004

;: - 0.797
0.885 - 0.055
0.043 “I’24
723 0.009
0.004
113 1.159 ;:: -0.147 731 0.099
114 - 1.466 /I22 - 0.002 1’32 0.013
“II 0.142 lb3 0.050 i’33 - 0.047
a12 - 0.034 0.003 734 - 0.064
a13 -0.016 ;;: -0.236 j141 - 0.0001
x14 - 0.092 ;:: 0.103 Y42 - 0.005
222 0.028 - 0.006 743 0.003
a23 - 0.014 ‘;I1 - 0.090 Y44 0.00 1
 M. English et al., Output allocatice and technical efficiency of banks 365

Table A.3
Coefficients of translog distance function: N =419

Coenicient Estimate Coefficient Estimate Coefficient Estimate

a0 -4.861 x24 0.015 YIZ 0.027
Xl -0.888 a33 0.093 Y13 0.074
X2 0.117 x34 -0.077 Y14 0.004
x3 1.105 a44 0.161 Y21 -0.013
Q 0.666 ;:: 0.301 Y22 0.005

;: - 0.664
1.144 - 0.037
0.053 Y24
Y23 0.006
0.002

;: - 1.142
1.615 B
;::22 -0.167
-0.001 Y32
Y31 0.085
0.005
x11 0.131 ;5: 0.043 Y33 - 0.065
@I2 -0.030 0.000 Y34 -0.025
a13 - 0.002 1:: -0.239 *J41 0.007
a14 -0.100 0.111 Y42 -0.013
a22 0.031 44 -0.001 Y43 0.004
do? -0.015 YI I -0.105 Y44 0.001

Table A.4
Coefficients of translog distance function: N ~415.

Coefficient Estimate Coefficient Estimate Coefficient Estimate

% 1.456 % -0.001 1112 0.013
UI 0.211 r33 0.090 ;113 0.05 1
a2 - 0.260 x34 -0.032 YL4 0.002
3L3 0.554 %4 0.150 YZI - 0.026
J4 0.494 PI 1 0.352 Y22 0.002
;: - 0.640
2.145 1:: - 0.043
0.009 723
Y24 0.014
0.011

;: - 0.464
1.953 ,4 -0.170
-O.OQl Y32
;131 0.023
311 0.191 ;:: 0.042 j133 - 0.030
a12 - 0.022 ;:z 0.00 1 734 -0.015
El3 ~ 0.052 -0.200 Y41 0.004
%I4 -0.117 ;:: 0.128 I’42 - 0.004
%!2 0.029 0.002 YL3 0.00 1
x23 -0.006 i’l I - 0.066 744 -0.001

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