Bank efficiency derived from the profit function

Abstract

Both input and output inefficiencies are derived from a profit function for US banks. These inefficiencies are decomposed into allocative and technical components in a new way using shadow prices. About half of all potential variable prolits are estimated to be lost to inefliciency. Most inefficiencies are from deficient output revenues, rather than excessive input costs. Larger banks are found to be more efficient than smaller banks, which may offset scale diseconomies found elsewhere. Tests of a new concept, ‘optimal scope economies’, suggest that joint production is optimal for most banks, but that specialization is optimal for others.