Journal of Accounting & Organizational Change

Predicting change in bank efficiency in Jordan: a data envelopment analysis

Jamal I. Bdour Abeer F. Al-khoury
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Jamal I. Bdour Abeer F. Al-khoury, (2008),"Predicting change in bank efficiency in Jordan: a data
envelopment analysis", Journal of Accounting & Organizational Change, Vol. 4 Iss 2 pp. 162 - 181
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JAOC
4,2 Predicting change in bank
efficiency in Jordan: a data
envelopment analysis
162
Jamal I. Bdour and Abeer F. Al-khoury
Department of Accounting, Faculty of Economics and Administrative Sciences,
Yarmouk University, Irbid, Jordan

Abstract
Purpose This study aims to investigate the relative efficiency pattern of Jordanian banks during
the period between 1998 and 2004.
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Design/methodology/approach The deterministic data envelopment analysis (DEA) as a

quantitative approach was used to obtain the efficiency of individual commercial banks in Jordan.
Findings The results of the DEA Charnes, Cooper and Rhodes model show an increase in bank
efficiency in the entire period except in 2003 and 2004 where a decrease in bank efficiency was shown
for few banks in the sample. The total efficiency scores suggest that the liberalisation programme has
provided the anticipated efficiency gains. Most efficiency scores showed consistent increases after the
introduction of the policy with the exception of few banks which have responded differently and
shown decreased in efficiency. This may be taken to imply that the banks have responded differently
to the new system. The analysis further shows that both assets utilisation and the labour factor had an
adverse effect on bank efficiency, especially in terms of number of employees.
Research limitations/implications The effect of the Jordanian Government liberalisation
programme may not be readily discerned in such a relatively short period of time, which may require
that a longer time period elapses before this effect becomes noticeable.
Originality/value The paper analyses the performance of Jordanian banks with regard to their
efficiency.
Keywords Quantitative methods, Banks, Process efficiency, Jordan
Paper type Research paper

Journal of Accounting &
Organizational Change
Vol. 4 No. 2, 2008
pp. 162-181
q Emerald Group Publishing Limited
1832-5912
DOI 10.1108/18325910810878955
Introduction
The changes in regulatory frameworks, advancements in technology and market
enlargements impose increasing pressures and, therefore, aggravate concerns for
competition and efficiency within a deregulatory industry. The deregulation and
liberalisation of financial market has transformed the banking systems of a large
number of countries over the last two decades. The reforms are sure to have a profound
effect on the development of the banking sector in these countries and their overall
macroeconomic performance. In recent years, the Jordanian commercial banking
industry has undergone numerous changes in laws and regulations for the purpose of
bringing the banking sector operations in line with international standards. After 1993,
largely de-regulated interest rates and the allocation of credit, liberalized entry into the
sector, and introduced modern prudential regulation and supervision.
Considerable research has emerged to assess relative efficiency estimates within
and across countries (Berger and Humphrey, 1997; Allen and Rai, 1996; Haslem et al.,
1999; Dietsch and Lozano-Vivas, 2000; Drake, 2001), to predict failure (Barr et al., 1994).
 Research also suggests for regulatory and government policy (Bauer et al., 1998) and Bank efficiency
evaluates mergers and acquisitions (Kohers et al., 2000). in Jordan
Perhaps, the most intriguing use of frontier efficiency methods in improving
managerial practices comes from the analysis of an individual financial institution
(e.g. banks). Findings about best and worst practices may be used to rewrite
policies and procedures for banks. In addition, upper management may use frontier
efficiency rankings to determine the banks which need of reform, local management 163
replacement, or closure.
Efficiency studies of banking network mostly use the mathematical programming
techniques of data envelopment analysis (DEA) (Berger and Humphrey, 1997). Most of the
research has been conducted using DEA (Drake, 2001). Such research has mostly been
conducted in developed countries. The shortage of systematic studies in developing and
Middle Eastern countries, where cultural differences and environmental practices may be
of particular importance, adds to the significance of the present research.
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The purpose of this study is to examine the efficiency pattern for the years
1998-2004. However, the study does not investigate the effect of government measures
to liberalize the banking system on the performance of the Jordanian banks performance
between 1998 and 2004, which may be tackled in future research. The present
researchers use the deterministic DEA to obtain the efficiency of Jordanian banking
system. More specifically, the study investigates the following research question:
RQ1. What is the relative efficiency of a Jordanian banking system between 1998
and 2004?
The paper proceeds as follows. The second section covers the background of Jordanian
banks. The third section presents the literature review, while the fourth section
presents the DEA methodology. The data and specification of the relevant variables
are discussed in fifth section. The sixth section is devoted for the results discussion and
the final section closes with the conclusions of the analysis and some recommendations
for further research.

Background of Jordanian banks

The Jordanian banks include the central bank, commercial banks, and investment and
development banks. The development banks can be grouped as state- and
privately-owned banks. Commercial and investment banks operate as universal banks.
In other words, they engage in financial activities such as providing traditional depository
and lending services, financing foreign trade activities and maintaining capital market
transactions as well as investment banking activities. In 2005, there were 27 banks. Of
these, 13 were commercial banks, eight branches of foreign banks, two Islamic banks, and
four development and investment banks (Central Bank of Jordan, 2005).
Until the 1980s, the Jordanian banking system was highly regulated and the
Jordanian economic policies were inward looking and highly protected against foreign
competition. Because there were strict barriers to entry, the commercial banks were
operating in an oligopolistic environment and, thus, interest rates on both credits and
deposits were determined in a monopolistic manner. Following the collapse of the dinar
during the 1988-1991 currency crises and capital account liberalisation, interest rates
were rising rather than declining (Harrigan et al., 2006) at a time when higher interest
rates were needed to encourage Jordanian deposits in dinar.
 JAOC The International Monetary Fund (IMF) became more concerned with the stability
of the Jordanian Dinar (JD) after it was attached to the US dollar in 1995. The main
4,2 difference between the interest rates set for deposits and credits provided high profits
for the banking sector and, thus gave overconfidence to the commercial banks, which,
in turn, discouraged both borrowing and investment and led to economic recession
(Wazani, 1996). Fanek (2004) stated that:
164 [. . .] even when the IMF, acknowledging the contractionary effects of its policies, called for
lower interest rates after 1999, local banks reduced interest rates payable on deposits and
saving accounts much faster than reducing interest rates on credit facilities which has led to
the low private sector credit and failed to stimulate the economy (Harrigan et al., 2006).
The IMF (2004, p. 52) has noted that lower interest rates have not yet had the expected
impact on private sector credit due to structural issues.
To increase efficiency and create competition in its banking system, the Jordanian
Government announced and undertook a series of steps to liberalize the banking
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system in 1993 and 1997. The main objective of this programme was to establish a
western-type free market economy and competition. Key among the governments
measures were: removing restrictions on interest rates, reducing government direct
lending, expanding product deregulation, and reducing of restrictions on foreign
exchange transactions. With the announcement of the economic stabilization and
structural adjustment programme in 1980, 1993 and 1997, the macroeconomic situation
in Jordan changed dramatically. The programme aimed to introduce the spirit of a free
market economy and competition. It adopted policies giving priority to economic
growth based on export promotion and to structural reforms including deregulation
and liberalisation of financial markets. The financial reforms in the 1980s and part of
1990s in Jordan were mainly designed to decrease the role of the state and increase the
role of market forces in the operation of the Jordanian banks. The reforms included the
elimination of interest rate ceilings and the reductions in both the reserve and liquidity
requirements and financial taxes. In addition, together with the newly established
Jordanian banks, foreign banks were allowed to operate in Jordan and foreign
exchange trading and capital movements were significantly relaxed (Central Bank of
Jordan, 2005).
However, high-inflation rates were still a major problem in the economy. Following a
decline in the early 1980s came an upward trend which threatened the economic stability
and, in turn, had a negative impact on the growth of financial markets. Chronic inflation,
coupled with political instabilities, made financial reforms incomplete and caused public
sector borrowing to increase. In addition, macroeconomic instabilities accelerated
currency substitution, which decreased the demand for the JD[1], increased interest
rates, and shortened the maturity structure.
Over the past two decades, Jordan has compensated for its poor natural resource
endowments by exporting its surplus labour to the oil exporting countries in the
region. However, the recent worldwide recession and the Gulf War have adversely
affected Jordans economy causing a major decline in income, high inflation, and an
increase in unemployment and poverty. While real GDP is projected to grow at
an annual rate of about 6 per cent for the next several years, Jordans per capita income
in 1994 was only about two-thirds of its 1987 level. Long-term debt in 1999 was a
troublingly high 115 per cent of the GDP. Additional reforms were implemented in
1997 to further liberalize the banking system. Among those were interest rates were
 further deregulated, greater autonomy was given to bank managements, increased Bank efficiency
capital adequate requirements, promoted bank mergers and acquisitions induced the in Jordan
inter-bank market, and further liberalisation of foreign exchange transactions and
foreign investment.
A major negative impact on investment, growth, and employment creation occurred
as a result of the strong push by the World Bank for trade liberalisation and the IMF
measures which included high-interest rates that made capital more expensive. 165
Furthermore, the rapid trade liberalisation associated with high-interest rates has
caused an adverse effect on productive efficiency and, thus, Jordan could not satisfy the
high-quality requirements of international markets (Harrigan et al., 2006).
In 1999, rehabilitation of the banking sector was given priority and parliament
approved a long awaited new banking law. The changes in the banking law designated
supervision and operation of the banking sector in line with international standards,
which brought about minimal policy constraints on domestic and financial market
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intermediation as Jordanian financial authorities have allowed foreign banks to operate

in the domestic market with the expectation of capital inflows, both increasing
competition and efficiency and gaining international and domestic banking experience.
Salhieh and Abu-Doleh (2004) attributed the measures taken by Jordanian banks to
improve their performance to global and rapid changes in the international financial
market, especially after Jordan signed the World Trade Agreement in 2000. Thus,
Jordanian banks have become more conscious about potentially incoming foreign
competition, for fear that less efficient banks be singled out in a rather limited market.
The implementation of Basel II may also have driven Jordanian banks to start
changing the environment in which they conducted their business.
Furthermore, these rehabilitative and reform measures have made Jordan an
excellent investment environment which attracted a lot of local and foreign investments.
This study attempts to provide a relative technical efficiency performance measurement
of the Jordanian banks for the periods 1998-2004 and to identify the magnitude of
inefficiency as given by the magnitude of excess resources used and/or deficient outputs
produced by inefficient banks. Technical efficiency allows for the slacks to be calculated
and reflect the degree of slacks in the utilisation of the physical, financial and human
resourses (Salhieh and Abu-Doleh, 2004). Utilizing a DEA as a suitable framework,
Salhieh and Abu-Doleh (2004) have empirical analyse and describe a framework to
measure the relative efficiency of Jordanian bank and rank those banks over the period
from 1994 to 2000.

Literature review
An increasing number of empirical studies have attempted to examine the determinants
of efficiency of bank networking, using either a parametric or a non-parametric
approach. There seems to be a substantial body of research documenting the Turkish
experience (Yildirim, 1999; Denizer et al., 2000; Jackson et al., 1998; Jackson and Fethi,
2000), which the researchers are citing due to proximity and potential similarities in
economic, social, and political structure between Turkey and Jordan.
Other Turkish studies used DEA to measure banking performance efficiency. For
example, Yildirim (1999) analysed policy and performance in the Turkish commercial
banks in response to the financial liberalisation and the macroeconomic instability
between 1988 and 1996. Using four inputs (viz. demand deposits, time deposits, interest
 JAOC expenses, and non-interest expenses) and three outputs (viz. loans, interest income, and
4,2 non-interest income), he found no sustained efficiency gains in the liberalized era with
continuing scale inefficiency. The findings also revealed that the less profitable
state-owned banks were more efficient than others. Along the same lines, Denizer et al.
(2000) examined the banking efficiency in pre- and post-liberalisation environments
and the scale effects on efficiency for different Turkish ownership groups between
166 1970 and 1994 using the production and intermediation approaches. Three inputs (viz.
total own resources of the bank, total personnel expenses, and the interests and fees
paid by the bank) and two outputs (viz. total deposits, and income from charges and
commissions collected) were selected for the production stage and used as inputs
(along with non-labour operating expenditure) for the intermediation stage while total
loans and banking related income were used as outputs. The results suggested a
decrease in efficiency and a serious scale problem in Turkish banking in the
post-liberalisation era.
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Using the DEA-based Malmquist Index, Jackson et al. (1998) investigated the
efficiency and productivity changes of a number of Turkish banks between 1992 and
1996 using the value-added method. They used two inputs (viz. the number of
employees and total non-labour operating expenses) and three outputs (viz. total loans,
total demand deposits, and total time deposits). The findings suggested that except
during the financial crisis period (viz. 1993/1994), foreign and private banks were more
efficient than their state counterparts owing to the developments in competition and
technological advancements. Jackson and Fethi (2000) conducted a similar study using
the Tobit model for 1998 to explain the variation in calculated efficiencies by a set of
explanatory variables (i.e. bank size, number of branches, profitability, ownership, and
capital adequacy ratio). The results showed that larger and more profitable banks were
more likely to operate at higher levels of technical efficiency, and that the capital
adequacy ratio had a statistically significant adverse impact on the performance of
banks, which may reflect a risk-return tradeoff in the sector.
Cingi and Tarim (2000) examined the efficiency and productivity change in Turkish
commercial banking using the DEA and DEA-Malmquist total factor productivity
index between 1989 and 1996. Two inputs (viz. total assets and total expenses) and four
outputs (viz. total income, total loans, total deposits, and total non-performing
loans/total loans) were used. The findings revealed that while the four state-owned
banks in the sample were not efficient, the three private holding banks maintained
high-efficiency scores over the study period.
An additional body of research addresses bank performance efficiency in the
European Union market using DEA. For example, Lozano-Vivas et al. (2001) analysed
bank performance using either banking variables alone or together with environmental
factors to standardise the country-specific environmental conditions. Three output
variables (viz. loans, deposits, and other earnings assets) and two input variables (viz.
personnel expenses, and non-interest expenses) were used. Furthermore, environmental
factors (viz. income per capita, salary per capita, population density, and density of
demand) were used to reflect the main economic conditions in which banks carry out
their activities. Not only do the results reveal that advantageous/adverse environmental
conditions are a positive/negative factor for the home banking industry but also that
being technically efficient appears to be a significant deterrence to foreign competition.
Similarly, Halkos and Salamouris (2004) studied the performance of the Greek banking
 sector using a sample of 15, 17, and 18 banks for the years 1999, 1998, and 1997, Bank efficiency
respectively. The findings revealed that the larger the size of total assets the higher the in Jordan
efficiency.
Similarly, de Pinho (2001) used accounting data to provide estimates of productive
efficiency in Portuguese banking using a production model in which deposits are
handled as an output. The results suggest evidence for the existence of economies of
scale for the smaller banks and economies of scope between deposits and loans for all 167
but the largest banks. Determinants of individual inefficiency scores were also
presented, as being affected by factors such as size, type of ownership, and age.
The literature has also examined banking performance in other countries. For
example, Drake (2001) examined British banks to investigate relative efficiencies
within the sector and to analyse productivity change in British banking between 1984
and 1995. The results provide important insights into the size-efficiency relationship in
UK banking and offer a perspective on the evolving structure and competitive
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environment within which banks are currently operating.

Similarly, Kao and Liu (2004) used DEA to make advanced predictions of the
performance of 24 Taiwanese commercial banks using these banks financial forecasts.
The finding revealed that all efficiency scores calculated from the data contained in the
financial statements published afterwards fall within the corresponding predicted
ranges of the efficiency scores calculated from the financial forecasts.
Only one study has been conducted in Jordan. Salhieh and Abu-Doleh (2004)
described a framework to measure the relative efficiency of Jordanian banks covering
the period between 1994 and 2000. The finding revealed that an over all improvement
is evident in banking industry in Jordan from 84.10 per cent in 1994 to 94.52 per cent in
2000. The also claimed that the improvement in efficiency was due to consciousness of
the banking industry toward the challenges that are facing them in the near future.
The above review has attempted to cover research from various countries, with
special emphasis on Turkey for regional and economic considerations. The literature
presents similarities in the findings of the research although it was carried out in
different localities and used different models of analysis.

Research methodology and DEA model

The inputs and outputs used in frontier assessments in banking depend on whether
one wants to estimate the units production efficiency or its intermediation efficiency.
Efficiency is generally defined as the allocation of scarce resources that Maximises the
achievement of aims (Hollingsworth and Parkin, 1998). Efficiency and productivity
are the core concepts of economics. The recent history of microeconomic efficiency
measurement begins with Farrell (1957) whose major contribution has been to offer a
decomposition into technical efficiency, allocative efficiency (price efficiency), and
overall efficiency at the micro level of a firm (or production unit). Input minimisation
(cost DEA) with constant returns to scale (CRS) is used in this study to calculate
relative technical efficiency for each bank during the time period under study.
Returns to scale refers to performance due to the size of operations and expresses
the response of outputs to a proportional change of inputs. If a change in outputs is
equally proportional, then returns to scale are constant. Otherwise, they are variable.
In variable returns to scale, when outputs change with a greater proportion than
inputs, one faces increasing returns to scale or else, decreasing returns to scale.
 JAOC Most banking network applications employ and analyse only one year or less of
4,2 data. Nevertheless, comparison of annual changes in the relative efficiency of banks
can help the upper bank management identify the general trends of the network,
evaluate past strategies, and spot the branches which exhibit differential
performance.
DEA is based on the relative efficiency concepts originally proposed by Farrell (1957).
168 Charnes et al. (1978) have reproduced Farrells technical efficiency notions into a linear
programming format which provides a non-parametric piece-wise surface (or frontier)
over the data of all DMUs that produce similar outputs using common inputs. Efficiency
measures are then calculated relative to this frontier. Charnes and Cooper (1986) claim
that this methodological framework facilitates the measurement of efficiency in
organisations characterised by multiple outputs and multiple inputs, especially where
information about factor or product prices is lacking. In other words, DEA is believed to
be especially effective for evaluating the efficiency of organisations where the
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production function (viz. efficient input-output relation) is not known (Sherman and
Gold, 1985).
In this study, DEA methodology, with an intermediation approach and input
minimisation (cost DEA) with CRS, is used as a means to evaluate performance and the
measurement of relative efficiency in the Jordanian banking system.
Measuring the efficiency of any organisation (e.g. a bank, a university, or a
hospital), which uses multiple inputs and generates multiple outputs, is complex and
difficult to compare. DEA calculates the efficiency of a given organisation in a group
relative to the best performing organisation in that group.
It is worth noting that DEA bypasses such difficulties as multiple non-homogeneous
inputs and outputs situations, non-linear or dependent output-input relationships, and
the unavailability of controlled experiments with manipulated input (Charnes et al.,
1994). It does not require a prior specification of the production function. A fundamental
assumption of DEA methodology is that all DMUs in the evaluated field should be
homogenous, otherwise the efficiency scores may reflect some differences due to
environmental rather than inefficiencies reasons (Hass and Murphy, 2003). There are
two way to overcome the homogeniety problem, either by dividing DMUs into
homogenous groups but this requires a large number of DMUs to be included or by
making an adjustment for non-homogeniety (Hass and Murphy, 2003). However, Hass
and Murphy (2003) stated that none of the adjustment mechanisms are clearly superior
to the unadjusted Charnes, Cooper and Rhodes (CCR) model. In addition, not only does
DEA produce efficiency scores but also use data on inputs and outputs from a sample of
units to produce a number of useful sets of information about comparative efficiency
(Hollingsworth and Parkin, 1998).
In this study, the researchers attempted to apply the CCR model with CRS approach
to the Jordanian banking sector.

DEA model and extension

The non-linear DEA models used in this study are based on the primal-dual
mathematical programming model originally developed by Charnes and Cooper (1986).
The extension of the CRS (CCR) model which provides an efficiency measure for the
banks is also adopted. Before going into describing these models, the following points
are worth consideration.
 First, the procedures for identifying relevant outputs and inputs for a DEA Bank efficiency
efficiency measurement are critical to the validity of the results. When relevant outputs in Jordan
and inputs are excluded because they were overlooked, too difficult to measure, or
immeasurable, the DEA results can be biased or misleading. This issue is extremely
important, particularly in any regulatory application of the model. When an external
evaluation is to take place, DMUs should be expected to argue for inclusion of those
variables which permit them to appear as efficient as possible. At the extreme, DMUs 169
would prefer the largest variable set imaginable, for, as it will be shown later, the larger
the set of variables, the greater the likelihood the DMU will be rated efficient.
Second, as an initial step, it is advisable to explore some of the key interrelations to
select the candidate set of inputs through regression analysis.
The efficiency measure of a DMU is obtained as the maximum of a ratio of weighted
outputs to weighted inputs subject to the condition that similar ratios for every DMU in
the sample be less than or equal to unity. Technical efficiency of DMUs is found by
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solving a linear programming problem for each DMU j.

X
n
uij yij
i1
Max hj 1
X
m
vr xrj
r1
subject to:
X
n
ui yij
i1
#1 j 1; . . . ; k banks; i 1; . . . ; n; ui ; vr $ 0; r 1; . . . ; m
Xm
vr xrj
r1

where hj, efficiency score for jth DMU; yij . 0, measurement of ith value of output n for
bank j; xrj . 0, Measurement of rth value of input m for bank j; ui, vr $ 0, the input and
output weights, j, denotes the DMU being evaluated.
The efficiency score of DMU j is determined by the P ratio of Pthe sum of weighted
outputs to the sum of corresponding weighted inputs: ni1 ui yij = m r1 vr xrj . The linear
programming problem finds the vectors of weights ui, vr that maximise the efficiency
score of the DMU i, subject to the constraint that no unit has an efficiency score greater
than one. Each of the jth DMUs utilises similar inputs to produce similar outputs in
different amounts, which is a characteristic of belonging to the same industry and
using similar technology.
When inefficient units are analysed, efficiency adjustment need be introduced. In
other words, it must be determined what the outputs and inputs of a DMU would be
if that unit were to become efficient. To do so, all the outputs and inputs must be
adjusted rather than considered one at a time. The observed outputs and inputs
are adjusted by subtracting the slack value from the observed outputs and inputs.
Slacks are the amount of additional output that would be expected if the DMU were
efficient as well as how much less of the input an efficient unit would need for the
adjusted output.
 JAOC The CCR models
4,2 The primal (envelopment) DEA ratio model can be briefly stated for each bank o
o 1; . . . ; k in the data set as follows:
Minul u;
such that:
170
X
k
u xro 2 xrj lj s2
i ; s2
r $ 0 r 1; . . . ; n;
j1
2
X
k
yij lj yio s
i ; s
i $ 0 i 1; . . . ; m u unconstrained; lj $ 0;
j1
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where the xrj are the r 1, . . . , m inputs and the yij are the i 1, . . . , n outputs for the
j 1, . . . , k banks; u and lj ( j 1, . . . , k) are real scalar-valued mathematical

variables and s2 r and si are input and output primal slack variables, respectively. This
formulation computes radial efficiency measures of input-output productivity from a
ratio (CRS) CCR model (Charnes et al., 1978). The optimal value u o of 0 is called the
radial efficiency of bank o. Radial efficient banks have u o 1 and radial inefficient
hospitals have u o , 1. A bank is DEA-efficient if u o 1 and if no optimal solution has
positive primal slacks.
The corresponding dual (multiplier) model can be stated as:
X
n
Maxu;v hj uij yij ;
i1

such that:
X
m X
n X
m
ui ; vr $ 0; r 1; . . . ; m; vr xrj 1; 2 vr xij ui yrj wj 0; wj $ 0; 3
r1 i1 r1

where vr and ui are the input and output dual multiplier variables and wj ( j 1, . . . , k)
are the dual slacks. Slack analysis will be used in this study to locate the source(s) of
inefficiency and estimate the amounts of efficiency.
The data set consists of major Jordanian banks, which is examined through the
years 1998-2004. The name of the financial institution is not disclosed to insure
confidentiality.

Sample and variables selection

At the end of 2005, the Jordanian banking sector in consisted of 27 banks of which 13
were commercial, eight foreign, two Islamic and four development and investment
banks. The sample of the research was drawn from the local commercial banks since
they are subject to similar regulatory requirements. Owing to considerations of data
unavailability or recent establishment of some of these banks, only 17 were actually
included in the analysis which covered data from the banks or their annual reports for
the period between 1998 and 2004.
 The primary objective of a bank is to penetrate its local market by selling products Bank efficiency
to new and old customers. Market efficiency is defined as the extent to which in Jordan
individual banks use their resources effectively to maximise service provision. Market
efficiency has an output maximization orientation, and the final estimates of efficiency
can be used to evaluate the local managers performance, on one hand, and to control
the bank size and product mix decisions made by central headquarters, on the other
(Athanassopoulos and Thanassoulis, 1995; Athanassopoulos, 1998). 171
As noted earlier, the kind of inputs and outputs, or their measurement units, were
determined by the chosen approach of the application. For the present analysis, the six
criteria of banking sector were divided into three inputs (viz. total operating expenses,
total assets and number of employees) and three outputs (viz. total deposits, net direct
credits and net operating income) and considered in an effort to embrace the whole
spectrum of operations in a branch. These factors have been chosen because they
reflect the way the results of each unit appear in the brief upper management reports
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through which managers monitor the banks market efficiency.

The input variables consisted of net operating expenses which include premises
rents and other operating costs excluding labour expenses and total assets which
include the cost of all assets owned by the bank, as reported in the literature (Cingi and
Tarim (cited in Demir et al., 2005); Paradi and Schaffnit, 2004; Halkos and Salamouris,
2004; Jemric and Vujcic, 2002). Number of employees was also used as an input
variable as proxy for labour input which was constructed by taking the number of full
time employees working in each bank excluding these staff costs which are included in
the net operating expenses variable (Jackson et al., 1998; Jemric and Vujcic, 2002). No
part time employees were found in any of the banks under study. The study performs
an aggregate rather than a psychometric analysis, which is why no aggregation of the
employees hierarchies is given (since all are treated as a single construct).
The output variables consist of net operating income which includes interest, and
commissions regarding all bank operations and other intermediation tasks completed.
Demand deposits which encompass all kinds of deposits and investment banking
products; and net direct credits which include all kinds of direct credits excluding bad
debts granted to stakeholder, as shown in Table I.
It is worth noting that while the three outputs are desirable services (i.e. bank
management prefers more to less), the three inputs are undesirable (i.e. less is preferred
to more). Thus, although the input/output variables have been carefully chosen, these
variables are not an end in themselves but rather a means to accomplish the objectives
of this study.

Descriptive statistics of bank inputs and outputs

The descriptive statistics of intermediate outputs and inputs used in the DEA models
are given in Table II. A close inspection of this information regarding the Jordanian
banking system indicates a significant improvement of performance of most the
Jordanian banks between 1998 and 2004. The results in Table II indicate that outputs
show constant increases in average with higher margin in two of the outputs used (viz.
net operating income and demand deposits), while a slight increase occurred in the
third output (viz. direct credits) over the years covered by this study. It is noticeable
that the average net operating income has increased by 23 per cent during the period
considered. This might suggest that banks have been earning more interest on loans as
 JAOC
Bank inputs and outputs Variable name Definition
4,2
Input variables Number of employees Total number of full time employees
working in each bank
Total assets Includes the cost of all assets owned
by the bank in JD ($ 0.71 JD)a
172 Net operating expenses Includes personnel wages, premises
rents, and other operating costs
Output variables Net operating income Includes interest, and commissions
regarding all bank operations and
other intermediation tasks completed
Demand deposits All kinds of deposits and investment
banking products are considered
Net direct credits Includes all types of direct credits
Table I. excluding bad debts granted to stakeholders
Input/output variables
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and their definitions Note: aAverage exchange rate in year 2006

a result of more demand on loans with lower interest rate. In addition, demand deposits
have increased by 24 per cent as a result of the recent rise in money supplies in Jordan
due to salary increases. Thus, citizens have become aware of the value of depositing
their excess money in banks as a safer procedure than keeping it at home. Furthermore,
direct credits have witnessed a slight increase by 5 per cent, probably as a result of
excess cash available in Jordanian banks which increased the ability of these banks to
provide more direct credits to the public at a lower interest rate.
Two inputs show a trend toward a considerable increase over the period under study.
Total assets and net operating expenses have increased by 29 and 23 per cent,
respectively. This increase may have led to equal increase in bank outputs as well. It is
noticeable that a large decrease by 28 per cent in number of employees occurred between
1999 and 2002 followed by an increase during 2003 and 2004. This increase may be due
to the expanding operation in bank activities which led to hire more employees to cope
with the large expansion of operations. Total assets, considered here as an input, was
inflated by the increased amount of capital spending by large banks, which was, in turn,
reflected in poor efficiency performance. This result might be due to performance of
some banks has improved which reflected in poor efficiency performance of other banks.
It is still to be seen if the fall in the years 1999-2002 in the number of employees can be
interpreted as an indication of higher efficiency performance in the bank network.
The general pattern of the inputs and outputs is one of increasing production and
more use of resources. In terms of efficiency, this pattern is hardly considered an
increase because more use of resources has taken place, which may also indicate a fall
in efficiency. All banks had used more resources to produce more outputs and, thus, the
cost of producing these outputs has risen in the last three years of the period under
investigation. The total assets and net operating expenses have risen over time.
At the same time, output indicators have also risen during the same period.
The above observations give an overall picture of the changes in inputs and outputs in
the Jordanian banking sector, but at this stage one cannot be certain whether this
sector has managed to increase or decrease its efficiency over this seven-year period
under study.
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1998 1999 2000 2001 2002 2003 2004

Outputs
Direct credit Mean 442,988,049 440,848,351 450,423,664 476,061,610 465,637,752 574,544,052 679,505,668.2
SD 3,429,159,643 3,562,537,051 3,574,505,492 3,633,595,404 3,594,432,027 1,565,237,938 1,791,741,923
Net operational income Mean 33,032,079 32,980,269 37,634,887 41,374,602 40,650,263 51,273,441 59,311,478.67
SD 257,419,810 243,713,317 271,494,400 286,592,972 284,167,311 124,326,043 146,928,347.5
Demand deposits Mean 851,713,224 918,931,223 978,398,472 1,044,227,807 1,052,799,357 967,637,993 1,696,464,171
SD 7,295,617,153 7,839,992,061 8,075,293,757 8,523,888,294 8,421,435,770 2,363,918,234 3,629,985,375
Inputs
Number of employees Mean 926 698 647 656 664 907 986
Total assets Mean 1,010,566,199 1,086,110,131 1,205,168,090 1,286,568,825 1,302,627,220 1,438,818,702 1,660,951,644
SD 8,206,791,763 8,816,297,519 9,650,641,610 10,108,507,616 10,181,922,091 3,850,242,593 4,282,564,460
Net operating expenses Mean 23,242,617 23,881,192 26,137,720 28,606,623 28,684,436 34,522,142 36,332,945
SD 155,308,661 145,877,031 160,638,527 176,898,278 177,399,699 76,042,630 79,864,020.51
Note: All numbers are in JDs (1JD: $0.71) except for number of employees
in Jordan
Bank efficiency

outputs and inputs used

Descriptive statistics for
173

in DEA
Table II.
 JAOC Results and discussion
4,2 This section presents the results and discussion of the analysis using the DEA model.
The performance of Jordanian banks is evaluated using DEA as a non-parametric
technique first proposed by Charnes et al. (1978, p. 86) to measure efficiency
performance for banks under the assumption of CRS. Input minimisation with CRS is
used to calculate relative efficiency for each bank during the time period under study.
174 The Frontier Analyst Programme (FAP) was used to allow for making distinctions
between two types of input and output factors. The first type, controllable inputs and
outputs, refers to those under direct management control, whereas the second type
refers to those inputs and outputs which cannot be placed under direct management
control. The first type is considered more important since it is possible for the
management of relatively inefficient DMUs to attempt to achieve the identified targets
which enable them to become efficient. However, the second type (e.g. direct credits)
may be indirectly affected by management in the long run. Furthermore, FAP offers
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information about the banks which serve as frontier units (i.e. those which have
contributed to their own and other banks reference technology). Tambour (1997)
considered this as equivalent to an intensity variable greater than zero in DEA models.
Table III shows annual efficiency scores assuming CRS during the period 1999-2004
using the CCR model. The assumptions being made here are that all DMUs must
minimise the inputs they use to produce the most possible outputs. The increased
competition within the bank system places pressure on these banks to utilise their
resources more efficiently to produce banking services.
Table III draws a picture of relative efficiency for the banks under study during the
time period 1998-2004. It shows that in the CCR model there is an increase in bank
efficiency in all years except 2003 and 2004 where a decrease in bank efficiency was
evident for several banks in the sample (viz. 1, 2, 3, 4, 6, 10, and 17). In 1998, there were

No. Typea 1998 1999 2000 2001 2002 2003 2004

1 PR 100 100 100 100 100 100 95.44

2 PR 44.18 100 98.47 92.86 94.61 86.27 88.42
3 PR 38.72 93.85 97.97 99.83 100 71.82 56.32
4 PR 37.26 100 100 100 100 71.26 66.28
5 PR 25.43 71.32 100 100 100 100 100
6 PR 50.28 100 100 97.97 100 70.64 78.96
7 P 90.95 100 100 100 100 100 100
8 P 76.85 100 100 100 100 89.76 100
9 PR 73.70 83.34 100 100 100 100 100
10 PR 27.32 100 100 100 100 59.28 60.40
11 PR 100 100 100 100 100 100 73.86
12 PR 40.57 98.21 100 100 100 100 94.76
13 PR 39.74 100 96.58 97.10 100 100 100
14 PR 39.16 99.80 95.76 90.61 89.59 82.06 100
15 PR 35.47 99.87 100 100 100 100 24.03
16 PR 48.16 100 95.20 94.58 99.31 89.12 78.73
Table III. 17 PR 34.77 91.81 95.18 99.61 100 100 100
Technical efficiency Average efficiency 53.09 96.36 98.77 98.38 99.03 89.42 83.36
scores for a Jordanian Number of efficient banks 2 10 11 10 14 9 7
bank network, 1998-2004
(in per cent) Notes: aP public sector banks; PR private sector banks
 only two banks which appeared to be efficient at least once. However, the number has Bank efficiency
risen between 1999 and 2002 from 10 to 15 efficient banks only to drop to nine and in Jordan
seven efficient ones in 2003 and 2004, respectively. This may be due to the recent
worldwide recession and the Gulf War, which adversely affected Jordans economy
causing a major decline in income, high inflation, and an increase in unemployment
and poverty. In addition, some of the crises around Jordan are felt immediately,
especially recurring incidents in Iraq with whom Jordan has a close relationship, not to 175
mention that Jordan is considered the only outlet for the Iraqi economy. Thus, the last
Gulf War in 2003 has adversely affected the Jordanian economy, which reflected
negatively on Jordanian bank performance.
Under the CRS assumption the Jordanian banking system was characterised with a
large asymmetry between banks in terms of their technical efficiency in 1998. Only two
(out of 17) banks were efficient that year, and the average bank efficiency was only
53.09 per cent; this means that the average bank, if producing its outputs on the
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efficiency frontier instead of at its current location, would have needed only 53.09 per cent
of the inputs currently being used. However, as shown in Table III, the situation changed
in subsequent years. The number of efficient banks rose rapidly leading to an expedient
catch-up with the normal level of efficiency, resulting in a much higher average
efficiency of 96.36, 98.77, 98.38 and 99.03 per cent in 1999, 2000, 2001 and 2002,
respectively.
In year 2004, Bank 15 has the smallest efficiency score of 24.03 per cent, which may
attributed to documented theft and embezzlement by the managerial staff of this bank.
Two banks (viz. 7 and 8) performed better than their counterparts, which may be
attributed to the fact that these banks are not only funded by the government but also
grant loans on a wider scale than other banks.
In terms of particular inputs, the DEA analysis shows that the most significant
causes of inefficiency among the sample banks are the number of employees and total
assets (Table II). Over the period under study many of the inefficient banks had excess
labour and excessive cost of fixed assets.
These findings may suggest that, in spite of the process of equalisation in the
Jordanian banking industry, there still exist a number of banks with a relatively high
proportion of non-performing loans and low level of efficiency for which it might
become difficult to withstand challenges in an increasingly competitive environment.
This conclusion is readily supported by the fact that some efficient banks between
1999 and 2002 became inefficient with a noticeable low score in 2003 and 2004.

Slack analysis of inefficient banks

DEA not only rates efficiency but also locates the source(s) of inefficiency and
estimates the amounts of efficiency. The magnitude of inefficiency is given by the
magnitude of excess resources used and/or deficient outputs produced by inefficient
banks. Excess inputs/deficient outputs are calculated by subtracting the actual
inputs/outputs values of a given bank from the ideal values of the composite bank.
Excess resource utilisation and/or deficient output production must be eliminated
before a given bank is said to be efficient relative to its composite reference set of
banks.
To illustrate the calculations of the input-output vector for the composite banks and
the magnitude of inefficiency, Table IV provides detailed calculations of the input
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4,2

176
JAOC

Table IV.

of input variables
for inefficient banks,
Slacks/excess analysis

1998-2004 (in per cent)

Year 1998 1999 2000 2001 2002 2003 2004
Bank
No. Eff Exp Emp Eff Exp Emp Eff Exp Emp Eff Exp Emp Eff Exp Emp Eff Exp Emp Eff Exp Emp

1 100 0 0 100 0 0 100 0 0 100 0 0 100 0 0 100 0 0 95.44 2 4.56 24.56

2 44.18 255.8 255.8 100 2 56.1 234.5 98.47 234.5 2 56.1 92.86 240.8 240.8 94.61 240.4 240.4 86.27 213.73 240.05 88.42 211.58 225.36
3 38.72 261.3 261.3 93.85 2 54.1 216.5 97.97 216.5 2 54.1 99.83 228.6 228.6 100 224 224 71.82 225.20 215.32 56.32 243.68 243.68
4 37.26 262.7 262.7 100 2 60.9 236.1 100 236.1 2 60.9 100 243.2 243.2 100 222.2 222.2 71.26 228.74 233.6 66.28 233.72 238.37
5 25.43 274.6 274.6 71.32 2 82.2 245.4 100 245.4 2 82.2 100 268.1 268.1 100 255.1 255.1 100 0 0 100 0 0
6 50.28 249.7 249.7 100 2 36.8 249.4 100 249.4 2 36.8 97.97 239 239 100 251 251 70.64 229.36 232.26 78.96 221.04 258.11
7 90.95 29 29 100 0 0 100 0 0 100 0 0 100 0 0 100 0 0 100 0 0
8 76.85 223.1 223.1 100 2 29.5 0 100 0 0 100 264.5 269.4 100 227.4 227.4 89.76 210.24 227.21 100 0 0
9 73.70 226.3 226.3 83.34 2 47.7 0 100 0 0 100 0 0 100 0 0 100 0 0 100 0 0
10 27.32 272.7 272.7 100 270 272.6 100 272.6 270 100 235.7 233.9 100 241.1 241.1 59.28 273.34 240.72 60.40 266.17 243.23
11 100 0 0 100 0 218.4 100 218.4 0 100 0 0 100 212.5 212.5 100 0 0 73.86 226.14 226.14
12 40.57 259.4 259.4 98.21 2 70.1 235.3 100 254.7 2 70.1 100 266.3 228.7 100 251.7 232.9 100 0 0 94.76 2 5.24 230.47
13 39.74 260.3 260.3 100 2 51.4 213.8 96.58 213.8 2 51.4 97.10 228.2 228.2 100 217.9 217.9 100 0 0 100 0 0
14 39.16 260.8 260.8 99.80 2 69.4 248 95.76 2 48 2 69.4 90.61 248.7 248.7 89.59 249.9 249.9 82.06 217.94 217.94 100 0 0
15 35.47 264.5 264.5 99.87 2 49.3 251.7 100 251.7 2 49.3 100 216.5 216.5 100 254.3 255.9 100 0 00 24.03 297.47 275.97
16 48.16 251.8 251.8 100 2 50.4 224.2 95.20 224.2 2 50.4 94.58 239.5 239.5 99.31 229.1 229.1 89.12 10.88 210.88 78.73 221.27 221.27
17 34.77 265.2 265.2 91.81 2 55.7 222.5 95.18 222.5 2 55.7 99.61 236.9 222.2 100 221.7 221.7 100 0 0 100 0 0
Notes: Eff eficiency score; exp expenses; emp number of employees
 slacks/excess for all inefficient banks in the sample for the time periods 1998-2004. Bank efficiency
Table IV shows that all inefficient banks with efficiency scores less than 100 per cent in Jordan
should reduce their input variable by certain amounts composite of efficiency reference
set of banks in all years. For example, Banks 1, 5, and 7 are the reference set for Bank 3
in 2003. Bank 3s comparative efficiency rating of 71.82 per cent indicates the extent to
which it lacks efficiency in comparison to the efficiency of its reference subset banks.
Bank 3 is 71.82 per cent as efficient as its reference subset of banks (viz. 1, 5, and 7). 177
These efficiency reference subset banks represent the basis vectors of the linear
programme solution for Bank 3. In other word, a convex combination of the actual
outputs and inputs of the reference subset of banks results in a composite bank that
produces as much as/or more outputs as Bank 3, but uses as much as/or fewer inputs
than Bank 3. It is noticeable that all inefficient banks had an excess use of all three
inputs (viz. assets, operating expenses, and number of employees) compared to their
reference sets. In 2003, if Bank 3 was as efficient as its reference set banks, it could have
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reduced its cost of assets by 28.18 per cent, operating expenses by 25.20 per cent, and
number of employees by 15.
Table IV suggests that if the behaviour of inefficient banks is individually
compared, one can notice that some of the banks have responded to the new system
where the Jordanian Government took measures to liberalize the banking system in
1993 and 1997. These measures aimed at establishing a western-type free market
economy and competition. Despite the fact that several banks had responded between
1999 and 2002 to the government initiative, this response had been transient and
short-lived, which resulted in dwindling efficiency in 2003 and 2004.
The DEA also produces the output slacks (deficient/surplus) for the relatively
inefficient banks. Table V presents the potential increase in the production of outputs
for the relative inefficient banks during 1998 and 2004. The results pertain to a
reduction in the use of both capital and labour inputs or the potential increase in the
production of bank outputs. This evident of the consciousness of the banking industry
toward the challenges that are facing them in the near future. The bank management
should continue making decisions about reallocating the resources within their banks
to increase the performance efficiency and in order to sustain long-term growth and
profitability.
To illustrate, consider Bank 3 used in the earlier example. In 2003, if Bank 3 was
efficient as its reference set banks, it could have increased its direct credit by
60.44 per cent. The efficiency score for this bank rose from 38.72 per cent in 1998 to
93.85, 97.97, 99.83 and 100 per cent in 1999, 2000, 2001, and 2002, respectively, after
which it dropped to 71.82 and 56.32 in 2003 and 2004, respectively. It is evident that
Bank 3 should produce more of the outputs as its reference set with regards to direct
credit and operating income.

Conclusion
To summarise, banks have responded differently to the new measures taken by the
Jordanian Government. Some banks, for instance, have reduced some of their input
usage to produce more output. However, it is difficult at this early stage to reach firm
conclusions about the effect of the reform measures on bank efficiency, because these
measures have not been enforced for a long time. Furthermore, it is evident that not
only assets utilisation but also the labour factor was the problem that affected banks
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4,2

178
JAOC

Table V.

inefficient banks,
output variables for

1998-2004 (in per cent)

Slacks/excess analysis of
1998 1999 2000 2001 2002 2003 2004
Bank No. DC DD OI DC DD OI DC DD OI DC DD OI DC DD OI DC DD OI DC DD OI

1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
2 9 35 0 14 0 0 0 8 0 7 0 0 21 0 0 25.83 0 0 11.49 0 11.49
3 33 3 0 45 0 0 14 0 0 85 0 0 0 0 0 60.44 0 0 0 0 0
4 48 89 0 45 41 0 9 9 0 57 55 0 25 0 0 22.18 0 0 0 0 0
5 109 23.8 0 74 12.9 0 14.97 157 0 25.05 32.3 0 37.18 20.9 0 0 0 0 0 0 0
6 35 33 0 51 22 0 43 0 0 34 0 0 32 0 0 51.80 0 0 3.75 0 3.75
7 31 210 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
8 0 66.78 24 0 12.15 8 5 63.65 0 0 55.78 61 0 0 0 0 2476 0 0 0 0
9 0 12.1 11.1 23.7 30 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
10 0 65 11 0 70 1 0 19.7 9 0 9.7 18 0 9 0 0 162 13.6 0 73.25 0
11 0 0 0 0 0 0 0 0 0 22 0 43 26 0 31 0 0 0 66.80 0 66.80
12 0 8.1 11.14 0 39 54 0 52 0 24 0 40 11 0 0 0 0 0 0 0 0
13 30 65 0 48 45 0 6 0 0 20 21 0 19 0 0 0 0 0 0 0 0
14 1 80 0 0 60 0 0 18 0 3 0 0 6 0 0 4.82 0 0 0 0 0
15 0 57 14 0 75 20 0 117 42 0 35 0 5 32 0 0 0 0 0 0 0
16 49 119 0 59 36 0 18 0 0 36 0 0 39 0 0 57.66 0 0 6.26 0 6.26
17 6 19 0 37 18 0 0 69 21 0 21 17 0 0 0 0 0 0 0 0 0
Notes: DC direct credit; DD demand deposit; OI operating income
 efficiency performance and had an adverse effect on bank efficiency, especially in Bank efficiency
regards to the number of employees. in Jordan
The slack analysis of the inputs/outputs was explored. It was noticed that some
banks with excess capital inputs appeared as inefficient compared with their reference
set. If the behaviour of inefficient banks is compared individually, one can notice that
some of the banks have decreased their capital and labour inputs while others have
increased them. This may be taken to imply that the banks have responded differently 179
to the new system and that the government initiative of reforming the banking sector
has not yet had the expected impact on Jordanian bank efficiency. Furthermore, it is
evident that both assets utilisation and the labour factor had an adverse effect on bank
efficiency, especially in regards to the number of employees. The unique slacks for the
inefficient banks provide management with marginal values relative an efficient
frontier that can assist management in locating resources over the usual verity of
income banks activities.
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Future research could be done measuring the relative efficiency for all Jordanian bank
branches. In addition, efficiency and productivity changes over the periods covering the
periods before and after government reform of the banking sector to identify the impact
of this reform on bank efficiency performance. The fact that the government reform
implementation process is not yet complete may have cast a further limitation.
A longitudinal study covering a longer span as well as a wider scope of implementation
to build solid grounds for understanding the effect and the consequences of the
government initiative is certainly worth conducting.

Note
1. The average currency exchange rate of the JD against US dollars was 0.71 in 2006.

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Further reading
Central Bank of Jordan (2002), Annual Report, Ministry of Finance, Amman.
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Corresponding author
Jamal I. Bdour can be contacted at: jbdour@yu.edu.jo

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