by Robert Tannenwald
May/June 1995

Economists devoted little attention to differences across banks in operational efficiency until about 15 years ago, when banks began to fail with increasing frequency. Some economists attributed the rising failure rate in part to intensified competitive pressures generated by deregulation and technological innovation. If this hypothesis is correct, and a significant number of banks are still inefficiently managed, then further deregulation and technological change could "shake up and shake out" the banking industry. Using data from 1985 through 1993, this study evaluates the extent to which banks' operational efficiency—efficiency in the use of inputs, or "X efficiency"—varies within the First Federal Reserve District. The study finds substantial dispersion in X efficiency among First District banks, with differences between the most and least efficiently managed banks widening over time, while differences between the most efficiently managed banks and banks exhibiting an average degree of efficiency narrowed. However, the author points out several anomalies in his empirical results that lead him to conclude that measures of bank efficiency need further development before one can rely on them with confidence.

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