The comparative bank efficiency across countries and its relation to economic growth: An empirical study of ASEAN countries

Bank efficiency becomes critically important in an environment of increasingly contestable international markets. As such, information regarding the efficiency of banks in a particular country as compared to their counterparts in other countries is a matter of great importance, enabling policy makers to make better decisions. The issue of banking efficiency, however, is secondary if greater efficiency in the banking sector does not help generate faster economic growth. Despite overwhelming empirical evidence on the importance of well functioning financial system to a country's economic growth, there is no empirical study being done on the importance of banking efficiency as an indicator of financial development to economic growth.; Hence, this study has two main objectives. First, by using a stochastic cost frontier approach, this study investigates whether there are significant differences in banking efficiency across countries in the ASEAN region. Second, the average efficiency scores from the stochastic cost frontier estimation are used to determine whether countries with more efficient banking sectors have higher economic growth by using panel data econometrics analysis.; The results indicate that there are significant difference in bank efficiency across countries in ASEAN. The results also show that, on average, ASEAN banks enjoy increasing return to scale. Although scale economies for ASEAN banks decrease with asset sizes, larger banks tend to have higher cost efficiency than smaller banks. Results for panel data regression indicate that bank inefficiency has a negative effect on GDP growth in the short-run while only persistent increases/decreases in bank inefficiency affect long run GDP growth. The results also show that while non competitive banking market can have positive effect on short run GDP growth, it has a detrimental effect in the long run if concentration persists over time.; These results support the policy of consolidating the banking sector in the ASEAN countries. However, consolidating the banking sector in itself will not promote long run economic growth if competition among banks is not encouraged.