Bank efficiency in New Zealand: a stochastic frontier approach

ABSTRACT

A parametric stochastic frontier analysis approach is employed to examine the cost and profit efficiency of banks in New Zealand over the study period of 2002–2011. Our result shows that foreign banks exhibit higher average cost and profit efficiency than domestic banks. We further document that Australian-owned banks operate more efficiently than foreign banks from other nations, supporting the limited global advantage hypothesis. Other distinguishing determinants of banks’ cost and profit efficiencies are bank size, equity ratio, asset quality, market concentration, interest rate, inflation and unemployment level. Lincoln University (LU).

KEYWORDS:

• Bank efficiency
• cost efficiency
• profit efficiency
• stochastic frontier analysis

JEL CLASSIFICATIONS:

• E44
• E50
• G21

Acknowledgement

We are especially indebted to anonymous referees for help and many valuable suggestions.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. The standard linear homogeneity restriction mandates that a cost (profit) function is homogeneous of degree one in all input prices, that is, a proportional increase in all input prices increases the cost (profit) by the same proportion, holding other exogenous factors constant.

2. Standard approaches to deal with negative profit in a translog specification are truncation, that is, eliminating observations with negative profits, and rescaling, that is, adding the sample minimum plus one to the negative value of profits. These approaches are problematic in SFA with respect to a loss of observations and a disturbance to the error term structure (Bos & Koetter, 2011).

3. We obtain negative signs for the coefficients on NPI of the stochastic profit frontier, which is as expected. The results are displayed in Table A3.

4. Our descriptive statistics tabulated in Table A1 vividly reveal the differences in inputs, outputs and bank-specific characteristics between groups.

5. Foreign branch banks are usually small and operate in the host country under the defensive expansion hypothesis with different output mixes and specialised services (William, 2002).