Efficiency and Profitability of European Banks – How Important Is Operational Efficiency?

Most previous research on efficiency in banking takes a regulatory perspective. In contrast,this paper investigates the empirical relation between efficiency and profitability in five largeeconomies of the European Union during the period 1998-2005 and discusses the results fromthe perspective of corporate bank strategy. Methodologically the existing literature is expandedby the use of DEA super-efficiency values to regress profitability, the incorporation ofrisk by calculative costs of capital, and a model specification built on the modern understandingof banks as centers of value creation. The results of the conducted static and dynamic regressionanalyses show that profitable banks operate with higher technical efficiency thantheir competitors. Furthermore, the strategic environment and in this regard the structure andconcentration of the national financial sector have a considerable impact on a bank’s financialperformance. Both issues proved to be statistically and economically significant. Thus, theresults support the appropriateness of the generic strategy of cost leadership for the Europeanbanking market. Banks following this strategic position were able to achieve higher excessreturns during the analyzed period.