engleski

Financial Institutions Efficiency: Theory, Methods and Empirical Evidence

Financial institutions have an important role in economic growth of a country. Among financial institutions, a crucial role falls on banks whose activities as financial intermediaries are unavoidable in modern economics. Another, perhaps less significant but nonetheless important role falls upon insurance companies whose activities at its core deal with risk pooling and risk diversification. To ensure stability of financial systems and further economic development, it is necessary that financial institutions operate efficiently. This paper deals with the theoretical background, methods and empirical evidence on financial institutions efficiency. Traditionally, financial indicators (ratios of accounting information from financial statements) are used as measures of performance – efficiency. Financial indicators are simple and easy to use methods for measuring efficiency such as: return on assets (ROA), return on equity (ROE) and efficiency ratio (ER) to name a few. However, financial indicators are limited in information that they provide by producing an absolute number on efficiency. Their main drawback is that they do not indicate sources of inefficiency. There are several concepts of efficiency found in literature, as well as different approaches in measuring efficiency. The goal of applying complex methods in measuring efficiency is to eliminate the drawbacks of traditional efficiency estimation and provide more information to end users (academics, government institutions (regulatory and supervisory) and firms’ management). These modern approaches use complex methods, such as stochastic models and linear programming in measuring efficiency, while mostly used are parametric and non-parametric methods. The most popular parametric model is Stochastic Frontier Approach (SFA) while the most popular non- parametric model is Data Envelopment Analysis (DEA). In this paper, we study the theory, concepts, frameworks and methods on efficiency estimation of financial institutions. Additionally, we research current empirical evidence on banking and insurance efficiency while analyzing differences in approaches between different types of financial institutions. The research focuses on DEA as a linear programming method that is widely used in measuring efficiency in banks and insurance companies. Several papers study DEA in measuring efficiency, evaluating its drawbacks and advantages as a sophisticated method against traditional ratio method (financial indicators). Literature review of empirical evidence indicates that more complex, sophisticated measures of efficiency provide more insight in the sources of inefficiencies in financial institutions. Modern approaches that involve activities characteristic to specific financial institutions, such as risk management in insurance companies and banks, propose themselves as a promising approach in a more precise measurement of efficiency.

Banking efficiency, Data Envelope Analysis, efficiency analysis, financial intermediation, insurance efficiency

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