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Author(s): Ila M. Semenick Alam
Source: Journal of Money, Credit and Banking, Vol. 33, No. 1 (Feb., 2001), pp. 121-139
Published by: Ohio State University Press
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ILA M. SEMENICKALAM
A NonparametricApproachforAssessing
ProductivityDynamicsof LargeU.S. Banks
The 1980s markedan era of substantialchange for the U.S. com-
mercialbankingindustry.An issue of considerableinterestto bank-
ing analysts and economists alike is whether the intensified
competitivepressure,generatedby deregulationand notable finan-
cial innovations,enhancedproductivity.To investigatethe response
to these changes, the nonparametricMalmquist index is used to
evaluateproductivitydynamics. A statistically significantproduc-
tivity surge found between 1983 and 1984 is followed by produc-
tivity regress the next period; post-1985, sustained productivity
progressis observed for the remainderof the decade. Productivity
movements are primarily attributableto technological changes
ratherthanscale changes or convergenceto the productionfrontier.
The authorthanksthe following for helpful comments: Robin Sickles, Allen Berger, RobertAdams,
Joe Hughes, two anonymousreferees,andparticipantsat the GeorgiaProductivityConferenceIII,Athens,
and the 1998 SouthernEconomicAssociation Conference,Washington,D.C.
1. For an in-depthdiscussion concerningbankinginnovations(includingincreasedautomationsuch as
ATMs, and improvedinformationprocessing and credit scoring) and commercialbank deregulation(in-
cluding the removalof interestceilings on certaindeposits, creationof new types of accounts, and the re-
laxationof branchingrestrictions)in the United States, see Berger,Kashyap,and Scalise (1995).
2. Approximatelyfive thousandcommercialand savings bankswere the object of takeoversduringthe
1980s; in 1995, record volume levels were reached due to a large numberof mega-mergers(Peristiani
1997).
3. As evidenced by the survey articles of Colwell and Davis (1992), Berger, Hunter, and Timme
(1993), Bergerand Mester(1997) and Bergerand Humphrey(1997). The degree of attentionthis research
area has attractedis apparentby the dramaticincrease in the numberof articles publishedbetween 1992
and 1997, the dates of these reviews. Most recently,Adams, Alam, and Sickles (1998) and Bauer et al.
(1998) discuss the robustnessof variousmeasuresof bankingtechnicalefficiency and cost efficiency, re-
spectively.
4. An enhanceddecompositionis furtherpossible. Efficiency change (or imitation)can be separated
into two terms:change in scale and change in pureefficiency. See footnote 10 as well as Fareet al. (1994,
p.75).
5. Refer to Berger and Humphrey(1997), Table 1 for a recent comprehensivelist of DEA banking
studies;69 of the 122 paperslisted are linearprogrammingstudies, with 62 of the 69 being DEA.
ILA M. SEMENICKALAM : 123
1. RELATED
BANKING
PRODUCTIVITY
LITERATURE
Berg, F0rsund, and Jansen (1992) used the Malmquist to analyze Norwegian
banks between 1980 and 1989. They identifiedproductivityregress priorto deregu-
lation of the Norwegianbankingsystem, and rapidproductivityprogresspostdereg-
ulation with large banks exhibiting the most rapid growth. The productivitygains
were mostly attributableto gains in relative efficiency ratherthan frontiershifts; in
other words, under the increased competitive forces of deregulation, inefficient
banks convergedto the frontierin order to survive. The U.S. deregulatoryexperi-
ence, which also occurredin the 1980s and focused on the asset side of the balance
sheet, was quite differentfrom the Norwegianone. Thus, Norway's experienceis not
necessarilygeneralizableto the Americanone. Berg et al. (1993) expandedthe Nor-
wegian study to an internationalcomparison by including Finnish and Swedish
bankingindustries.The authorsemployed the Malmquistapproachin orderto make
cross-countrycomparisonsusing datafrom a single year.
ElyasianiandMehdian(1995), workingwith U.S. data,selected 1979 and 1986 as
roughproxies for the pre- and postderegulationperiods.Using DEA, they calculated
efficiency scores for samples of U.S. banks from these two years. The authorsfound
that,for large banks,technicalefficiency declined by 3 percentand, using a time-de-
pendentratio analysis,6technology regressedby 2 percentover this eight-yearspan.
methodology as outlined in Fare et al. (1994), this paper avoids choosing an arbitraryreferencepoint in
orderto measuretechnologicalshifts.
Ynl+lcf = . e .....
......
/F /;
...... (xn,l+ln / Ynl+Z)
/
provides a means of checking the sensitivity of results which rely upon an a priori
specificationof a functionalform for the productiontechnology.
2. METHODOLOGY
YA
oT,+,
Ynt= a / t (X"l,
ynl)
O Xn Xn,+w X
7. Similarly,an input efficient firm is one which cannot contractits inputs without decreasingone or
more of its outputs.
8. Alternativeassumptionsinclude nonincreasing,nondecreasing,or variablereturnsto scale; Seiford
andThrall(1990) have a detaileddiscussion. Underthe Malmquistparadigm,nonconstantreturnsto scale
raises uniqueness,internalconsistency,and measurementaccuracyissues; Grifell-Tatjeand Lovell (1995,
1998), Bjurek (1996), Ray and Desli (1997), and Fare, Grosskopf, and Norris (1997) are among those
who have contributedto this emerging literature.McAllister and McManus(1993) provide evidence that
CRS holds for large banks (>500 million in assets), which is the set of banks dealt with in this paper.
Alam (2000, 2001) examines the Malmquistproductivitydynamics,includingscale issues, for a database
includingbanks below 500 million in assets.
126 : MONEY,
CREDIT,
ANDBANKING
and xt+l, moved out between periods t and t+1 (At+lzl). The efficiency change
component can be further decomposed into pure efficiency change and scale
change.
To determinewhetheror not the index and its componentsare significantlydiffer-
ent from 1, confidenceintervalsare derivedin two ways. Asymptotic confidencein-
tervals based on the central limit theorem (CLT) are determinedfirst. In a sample
with a large number of firms (large N), the distributionof time means (averaging
over firms at a point in time) becomes asymptoticallynormal under the CLT.The
Student'st distributioncan then be used to calculate the appropriateconfidence in-
tervals.One drawbackof this approach,however,is thatin studies with a small num-
ber of firms,the ability to use the CLTis obviatedsince the asymptoticresultsdo not
hold when discussing patternsin means based on a small sample. Small sample size
is a problemoften faced by not only linearprogrammingbut also econometricanaly-
ses in this literature.Anothercomplicationarises if the researcheris specifically in-
terestedin the statisticalsignificanceof the efficiency scores themselves as opposed
to time or firmmeans. In the case of DEA scores, Charnesand Cooper (1980) show
thatan assumptionof normalityis probablyincorrect;this problemis also presentin
econometric models, which have a composed error term with inefElciencybeing
modeled as a truncatednormal,exponential,or gammadistribution.
In orderto addressthese issues, Atkinson and Wilson (1995) present a nonpara-
metric bootstrappingalgorithmas a means of calculatingconfidence intervals.As a
distribution-freealternative,bootstrappingis a methodology that can be used to ob-
tain a sampling distributionof a sample statistic which, in this application,is the
geometricmean of the Malmquistindex and its components.ll
3. BANKINGPANELDATASETI2
The data set consists of all large (>$500 million in total assets) U.S. insuredcom-
mercialbanks with complete data over the ten-yearintervalfrom 1980 to 1989. The
data are from the Reportof Conditionand Income (Call Report)and the FDIC Sum-
mary of Deposits. In orderto allow for the distinct regulatoryand, hence, competi-
tive circumstances of each state, the banks are separated by type of regulatory
environmentas advocatedby BergerandHumphrey(1991,1992), Berger(1993) and
Adams, Berger, and Sickles (1999). The resulting balanced panel consists of 112
banksin states allowing statewidebranching,43 banksin states with limited branch-
ing, and 11 banksin unit-bankingstates;as expected, more banks meet the size con-
4. RESULTS
EJjQciency Dynamics
Levels: Table2 reportsthe averagetechnical efficiencyl5 underthe DEA method-
ology for this sample of largerbanks by regulatoryenvironment.The last category
(ALL) combines all the banks and assumes thatbanks underall three regulatoryen-
vironmentshad similartechnologies which is unlikely and violates the homogeneity
requirement;this categoryis presentedmainly for comparativepurposes.
First, within each regulatoryenvironment,notice how overall decennialefficiency
(that is, averageefficiency over the decade) consistently declines as the numberof
inputs and/or outputs is reduced: Model 1 has four outputs and six inputs while
model 4, using aggregateddata, has two outputsand four inputs. STATEbanks, for
example, exhibit a drop in averageoverall efficiency of almost 10 percentfrom 0.94
to 0.85. This observationis a well-known DEA phenomenon:as the numberof vari-
ables increases, averageefficiency rises because each firmhas a greateropportunity
13. The speciElcationof deposits as inputs is a common practice. Studies include Elyasiani and
Mehdian(1990, 1992, and 1995), Humphrey(1991), English et al. (1993), Lang and Welzel (1996) and
Adams, Berger,and Sickles (1999). Adams, Berger, and Sickles (1999) presentpreliminaryresults indi-
cating that this specificationis favored based on statisticalgrounds.For completeness, models with de-
posits and purchasedfunds as outputsratherthan inputs were also run. The trendswere generally robust
with a few exceptions as noted in the results section.
14. Securitiesand equity are controlledfor in the model specificationto mitigate bias. Holding assets
constant, if some banks hold fewer securities investmentsand relatively greateramounts of loans over
time, the Malmquistproductivityindex will show that those banks have experiencedgreaterproductivity
growthwhen all that has occurredis a shift in assets from securitiesinto loans. Similarly,on the liability
side of the balance sheet, banks that use small amountsof deposits relative to equity capital will tend to
look more efficient than banks that use large amountsof deposits relativeto equity. If banks tend to rely
more on equity over time then this will show up as increased productivity(Hughes and Mester 1998
Hughes et al., 1996). The authorthanksan anonymousreferee for these observations.For completeness
the model was also run without the securities or equity variables;as expected, levels changed but trend
patternswere robustacross these two specifications.
15. Averagetechnicalefficiency is often quoted as being approximately80 percentfor the U.S. bank-
ing industry.In fact, this average performancelevel is what is usually found by stochastic frontierand
thick frontierapproachesto efficiency measurement;the linearprogrammingapproachof DEA yields es-
timates that are more variableacross studies, rangingfrom below 50 percentto over 90 percent average
efficiency for banks (Berger 1993).
ILA M. SEMENICKALAM : 129
TABLE 1
VARIABLEDEscRIPrIoNs
ANDDECENNIAL
MEANS
FORLARGE
U.S. BANKS;
MODEL
SPECIFICATIONS
Sample
Mean
Variable Definition unit Limit State
1: Securities, Yl Equity, xl
Real estateloans, Y2 Capital, x2
Commercialandindustrialloans, y3 Labor, X3
Installmentloans. y4 Purchasedfunds, X4
Demand deposits, x5
Otherdeposits. x6
2: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Purchasedfunds, X4
Demand deposits, X5
Otherdeposits. x6
3: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Purchasedfunds, X4
Core deposits. x1
4: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Loanablefunds. x8
NarEs:
Allvariables,
except
labor,
areinthousands
of 1982 dollars.
Labor
ismeasured
innumber
of full time-equivalent
employees.
130 : MONEY,CREDIT,AND BANKING
TABLE 2
AVERAGE EFFICIENCY BY REGULATORYENVIRONMENT,YEAR, AND MODEL SPECIFICATION
cant coefficient.l6The fact that STATEbanks are the least efficient on averagemay,
therefore,simply be a reflectionof the statisticalfactoridentifiedby Caves and Bar-
ton. This explanationis furtherupheldby the observationthat,when all the banksare
groupedtogether(N= 166), averageefficiency is less than that for the three individ-
ual categories; if SQRTN and technical efficiency were not correlated,one would
expect the ALL groupingto be a weighted averageof the three regulatoryenviron-
ments and fall somewhere between, ratherthan below, STATE,LIMIT,and UNIT
averageefficiency.
Thus, when interpretingefficiency levels, one must be very circumspect,as the re-
sults are sensitive to the numberof observationsas well as the numberof variables.
Trends:Efficiency trends,on the other hand, tend to be more robustacross these
dimensions.STATEis the most robustwith correlationsbetween the models averag-
ing 95 percent;correlationsbetween the models average90 percentfor ALL and 71
percentfor LIMIT.Correlationsare the weakest for UNIT, which exhibits no signif-
icant correlationbetween model 1 and the other models but averages69 percenton
the remainingpairs.
In general,when averageefficiencies fromTable2 are plotted over time, the over-
all technical efficiency trendis slightly increasing for all models across the regula-
tory categories.Again UNIT is the notableexception as would be expected based on
the above correlations:efficiency rises between 1980 and 1989 for model 1 but mod-
els 2 and 3 have a pronounceddip for 1989 while model 4 has an even more notice-
able decline over time. Furthermore,whereas UNIT is entirely above the other
categoriesfor model 1, it falls furtherand furtherbelow LIMIT,STATE,andALL as
one moves from models 2 to 4. The relative sensitivity of UNIT to model specifica-
tion is probablythe result of its small sample size; therefore,its results must be sub-
ject to greaterscrutiny.
In summary,the main distinctionsamongthe models are (i) the level of efficiency,
which falls as one moves from model 1 to 4; and (ii) the degree of variability,which
rises as one moves from model 1 to 4 (variabilityis heightened due to the smaller
numberof inputs and/oroutputs).
each other (at the 8.7 percentlevel or better)for 1985-1986. Since AScale for UNIT and LIMIT are not
differentfrom 1, while AScale for STATEis differentfrom 1, it makes sense that both UNIT and LIMIT
banks are significantlydifferentfrom STATEAScale. Second, these nonparametrictests again illustrate
the importanceof separatingbanksby regulatoryenvironment:the Malmquistand componentsare signif-
icantly differentacross regulatoryenvironmentsfor several time periods.Also, the time periods of signif-
icance can vary dependingon which pair of regulatoryenvironmentsare being compared(for example,
1982-1983 and 1988-1989 are significantly different for UNIT versus LIMIT, and for UNIT versus
STATE,but not for LIMITversus STATE).Finally,the patternof resultsis consistent.Namely, whenever
the Malmquistproductivityindex is significantlydifferentbetween bank environments,the ATechnology
componentis also significantlydifferent.This patternwas originally observed in Table 3: it is primarily
ATechnologydrivingthe productivityresults ratherthan AScale or APureEfficiency.
TABLE 3
AVERAGE ANNUAL CHANGE FOR MALMQUIST PRODUCTIVITY INDEX AND COMPONENTS (MODEL 1 )
UNIT BANKS
Year Malmquist ATechnology APureEfficiency AScale
LIMIT BANKS
Year Malmquist ATechnology APureEfficiency AScale
STATE BANKS
Year Malmquist ATechnology APureEfficiency AScale
ALL BANKS
Year Malmquist ATechnology APureEfficiency AScale
for 1984-1985; it then grows again above 1. Note that APureEfficiency and AScale
arerelativelyflat indicatingthat almost all the changes in productivitywere due, not
to diffusion of technology or scale changes, but ratherto technological advances.
Upon examinationof the /\Technology column of Table 3, it is apparentthat those
values closely mirrorthatof the Malmquistcolumn.Note also thatthe values thatare
signiIScantlydifferentfrom 1 are mostly in the MalmquistandATechnologycolumns
with APureEfficiency and AScale registering significance only occasionally. This
findingcontrastswith thatof Berg, F0rsund,and Jansen(1992) who found thatNor-
wegian banks convergedratherthaninnovatedduringthe 1980s. However,it is con-
sistent with Wheelock and Wilson's (1999) U.S. study, which found large advances
in technology between 1984 and 1993.
Considering each regulatory environment individually the following patterns
emerge. For LIMIT banks productivitywas less than 1 between 1980 and 1983;
then between 1983 and 1984, productivityrose dramatically(12.9 percent)relative
to other years before falling back down below 1 (indicatingproductivitydecline of
11.5 percentfor 1984-1985). After 198Sfthere was sustainedprogressas productiv-
ity rose above 1 for the durationof the decade. The patternfor LIMIT banks lies
somewherebetweerlUNIT and STATE.STATEbanks are very similar to, although
somewhat less volatile than, LIMIT, its 1983-1984 peak is 10.3 percent and its
1984-1985 troughis 5.5 percent. Finally UN1T banks are the most volatile of the
threeregulatoryconditions;its peaks and troughsare usually more pronouncedthan
those for LIMITand STATEbanks. For example, UNIT has a significantproductiv-
ity decline of 12.5 percent for 1982-1983 not apparentfor LIMIT or STATE;its
peak in 1983-1984 of 12.2 percent and troughin 1984-1985 of 13.4 percent are at
least as large as those for LIMITbanks. Thus, UNIT banks are reactingin a more
volatile mannerto changes in theirenvironments.lS
Figure 2 shows the cumulativeeffect of productivitygrowthfor each subperiodof
the 1980s. The Malmquistis trendingupwardbut does not get above 1 for STATE
and LIMIT banks until late in the decade.l9 Contrastthis with the DEA study of
18. Analysts in the industrybelieve the transformationapproachis (perhapsweakly) dual to the mar-
gin approach.To explore this issue, two additionalmodel specificationswere run:(i) deposits are treated
as an outputratherthan an input, and (ii) purchasedfunds, in additionto deposits, are treatedas outputs.
Comparedto each other,models (i) and (ii) yield similar graphs.Comparisonof models (i) and (ii), with
the transformationapproachfocused on in the paper, yields both distinct similarities as well as differ-
ences. For example, a main findingof this paperis thatproductivitytrendsover the decade are primarily
due to innovationratherthan imitationor scale change. This observationis mirroredwith the marginap-
proach:the graphsof l\Technology and Malmquistare very similar Also, before the 1982-83 period and
after the 1984 85 period, the trendsfor the marginand transformationapproachesare very similar;the
differences that do arise appear between 1982 and 1985. The dramaticpeak and trough apparentfor
1983-84 and 1984-85 underthe transformationview is mutedand shifted.For example, while UNIT still
has a peak for 1983-84, it is only between 2.3-4 percent(dependingon whetheryou considerModel (i)
or (ii); this is smallerthan the 12 percentunderthe transformationview); also, it is followed by a trough
that is between 3.4-4.7 percent(as comparedto 13.4 percentfor the transformationview). Although the
level of the responsemay differ,the overallpatternfor UNIT is remarkablysimilarto thatexhibitedunder
the transformationapproach.STATEand LIMIT exhibit muted levels as well as shifted patterns.Both
have peaks in 1982-83 and 1984-85 while the troughnow occurs in the 1983-84 period.
l 9. The cumulativeplots for ATechnology,APureEfficiency,and AScale exhibit the same patternes-
tablishedearlierwith the discussion for Table 3; ATechnologyclosely mirrorsthe Malmquistplot while
APureEfficiencyand AScale are relativelyflat.
ILA M. SEMENICKALAM : 135
Elyasiani and Mehdian (1995) that found technological and efficiency regress for
large banks. That analysis was limited to two years of data (1979 and 1986) which
may have maskedthe overallproductivityeffects. In addition,ratherthan separating
the data by regulatoryenvironment,the data was pooled. To make a more direct
comparison of their results with the currentstudy, a vertical line is drawn at the
1980-1986 cutoff and the ALL cumulative results are also plotted. Note that the
Malmquistis below 1 for all threeregulatoryenvironmentsas well as the ALL cate-
gory at that point in time. It is only when the analysis is carried furtherinto the
decade do values above 1 start appearingfor two of the three regulatoryenviron-
ments; the ALL grouping never makes it above 1. In addition,the currentstudy is
done annuallyover a decade which reveals a more detailed picturethan comparing
the end points of an eight-yearspan as in Elyasiani and Mehdian.Thus, as noted by
Bergerand Humphrey(1997), measurementover longer time periodsis necessaryto
discernif the deregulatoryand othershocks of the 1980s had a net positive impacton
productivity,efficiency and technology.
5. CONCLUSIONS
LITERATURECITED
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