X-Efficiency Analysis of Pakistani Commercial Banks

Article excerpt

[Abstract] This paper contributes to literature by extending the analysis on efficiency assessment of commercial banks across Pakistan for the years from 2001 to 2006 by using Data Envelopment Analysis (DEA). The average efficiency scores of banks across Pakistan appear to be low. Foreign banks tend to perform better than those of the local banks in Pakistan, both private and public. However, private local banks perform better than those of their counterparts in the public sector. Furthermore, findings of the research support the global advantage hypothesis where foreign banks appear to be overcoming the cross-border disadvantages. This might be surfacing out of their superior investment strategies, advanced management techniques, and better-quality services to their clients. On the contrary, Pakistani commercial banks fail to support the home field advantage hypothesis, where local banks are expected to perform more efficiently than those from abroad. This might be due to concentrating on servicing the retail markets only, existence of competition in the banking industry, rising interest rates, higher levels of non-interest and administrative expenses, pursuing less sophisticated investment strategies, and providing less competitive managerial services to their clients. The study bears some useful managerial implications for banking sectors of developing countries across the globe.

[Keywords] X-efficiency analysis; commercial bank; Pakistan; data envelopment analysis

Introduction

The ever-increasing phenomenon of globalization has made the concept of efficiency more vital both for the non-financial and financial institutions, banks being part of them. Banks are largely driven by a competitive marketing strategy that determines the extent of their success and growth. The modalities of the banking business have changed a lot in the new millennium compared to the way they used to be in the years bygone. A number of factors seem to be at work in this regard. These include mainly the trends towards mergers and acquisitions, privatization, deregulation of financial markets, a faster pace of innovations, competition among banks (both local and foreign) and the development of ebanking services. These factors have caused changes in the productivity and performance of banks around the globe, Pakistan being no exception. With the changes taking place in the new environment, empirical research on performance of banking sector becomes inevitable. This paper is an attempt to fill a gap in the literature on bank efficiency across developing countries.

The banking system across Pakistan is diverse in its composition and scope of activities. The ownership of these banks is divided across public, private, and foreign banks. The public banks serve as a legacy of the government-regulated market for financial services, gradually converting into private banks overtime. This, magnified with the induction of new banks, resulted in an enlargement of the private banking sector. At the same time, foreign banking in Pakistan is not a new phenomenon; rather it is the continuity and result of the heritage of colonialism and international business expansion respectively. The entry of foreign banks at the colonial times was largely guided by follow the customer hypothesis (Akhtar, 2001) that prevails in some of the cases even today. However, modern expansion is more a reflection of the international business expansion and emerging trends towards Islamic banking system, both locally and globally. Thus, the study of the banking system across Pakistan would be unique in two ways: first, with the entry of an increasing number of banks in the market, the banking sector has turned into a more competitive and challenging one as far as the Xefficiency issues are concerned. Second, given the structure of Pakistani banking, it would be interesting to compare the performance of local vis-à-vis foreign banks in the country.

The rest of the discussion proceeds as follows. …