Methodological Approach to the Study of X-Efficiencies and Scale Economies in Banking : Are Smaller Banks More Efficient than Larger Banks?

This paper surveys the parametric and non-parametric approaches adopted in estimating x-efficiencies and scale economies in banking. Specifically, the traditional stochastic cost frontier and Data Envelopment Analysis (DEA) methodologies, including recent refinements incorporating the profit efficiency frontier and a profitability test are also extensively reviewed. Recent empirical studies covering the late 1990s and early 2000s, and countries other than the U.S. are also reviewed and compared with the findings of earlier studies (1980s and early 1990s). The results are still mixed, suggesting more questions than answers. To a large extent the empirical evidence seems to support the view that smaller banks are more efficient than larger banks in most countries. The exceptional cases of cost efficiencies reaped by larger banks may be simply due to sheer size and market power. The pursuit of consolidation and deregulation of the banking system should therefore be implemented with caution, particularly in developing banking systems