A Nonparametric Approach for Assessing Productivity Dynamics of Large U.S.

Banks
Author(s): Ila M. Semenick Alam
Source: Journal of Money, Credit and Banking, Vol. 33, No. 1 (Feb., 2001), pp. 121-139
Published by: Ohio State University Press
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 ILA M. SEMENICKALAM

A NonparametricApproachforAssessing
ProductivityDynamicsof LargeU.S. Banks
The 1980s markedan era of substantialchange for the U.S. com-
mercialbankingindustry.An issue of considerableinterestto bank-
ing analysts and economists alike is whether the intensified
competitivepressure,generatedby deregulationand notable finan-
cial innovations,enhancedproductivity.To investigatethe response
to these changes, the nonparametricMalmquist index is used to
evaluateproductivitydynamics. A statistically significantproduc-
tivity surge found between 1983 and 1984 is followed by produc-
tivity regress the next period; post-1985, sustained productivity
progressis observed for the remainderof the decade. Productivity
movements are primarily attributableto technological changes
ratherthanscale changes or convergenceto the productionfrontier.

THE BANKINGSECTORis constantly and rapidly evolving;

the last two decades,in particular,representa substantialmetamorphosisfor banking
sectors in countries aroundthe world. For example, the Norwegian banking sector
was deregulatedin the 1980s, while U.K. banks faced increasedcompetitiondue to
the entryof othernonbanklending institutions.Meanwhile,in the United States, the
deregulationmovement,which began in the 1970s, expandedto many industriesin-
cluding banks in the 1980s. Under the loosening of regulatoryconstraints,which
continues into the l990s, U.S. banks have found greaterversatility in their opera-
tions. In addition,the industrynow has availablemanynew financialinstrumentsand
technological advances.l Finally, the restructuringand consolidation wave of the
1980s, which engulfed the industry,2has continuedinto the present with the recent
trendtowardmegamergersgeneratingempiricalevidence thatfuels the debateon na-

The authorthanksthe following for helpful comments: Robin Sickles, Allen Berger, RobertAdams,
Joe Hughes, two anonymousreferees,andparticipantsat the GeorgiaProductivityConferenceIII,Athens,
and the 1998 SouthernEconomicAssociation Conference,Washington,D.C.
1. For an in-depthdiscussion concerningbankinginnovations(includingincreasedautomationsuch as
ATMs, and improvedinformationprocessing and credit scoring) and commercialbank deregulation(in-
cluding the removalof interestceilings on certaindeposits, creationof new types of accounts, and the re-
laxationof branchingrestrictions)in the United States, see Berger,Kashyap,and Scalise (1995).
2. Approximatelyfive thousandcommercialand savings bankswere the object of takeoversduringthe
1980s; in 1995, record volume levels were reached due to a large numberof mega-mergers(Peristiani
1997).

ILA M. SEMENICK ALAM is an associateprofessorof economicsat TulaneUniversity.

E-mail:ila.alam@tulane.edu
Journalof Money,Credit,andBanking,Vol. 33, No. 1 (February2001)
Copyright2001 by The Ohio State University
122 : MONEY,CREDIT,AND BANKING

tionwidebranching.As a resultof these factors,a substantialliteraturehas developed

aroundthe issues of banking efficiency and productivity.3This literaturehas been
facilitatedby the presence of comprehensiveand reliable data sets that are a conse-
quence of the regulatoryenvironment.In addition, the analysis of relative perfor-
mance among banks is aided by a large degree of producthomogeneity.In orderto
make valid comparisonsbetween efficient and inefficientoperations,firmsmust have
the same fundamentalcharacteristicsin termsof environmentand operations.
Because it encompasses the initial deregulatorypush as well as other dramatic
fundamentalchanges, the decade of the 1980s is an especially interestingepisode in
U.S. banking sector history. It was expected that increased competitive forces,
brought about by the changing banking environment,would act as a stimulantto
those firms operatinginside the productionfrontier.Banks not allocating their re-
sources efficiently would perish unless they could become more like their efficient
competitorsby producingmore outputwith existing inputs.Alam and Sickles (2000)
find supportfor this hypothesis in the case of the U.S. airline industry;they present
evidence thatthe Airline DeregulationAct of 1978 led to more efficientresourceuti-
lization by firmsin that industryover the next decade. This result of mountingcom-
petition is separate from the notion of technological innovation although the
consequencesmay be similar.In additionto improvingefficiency performancerela-
tive to the productionfrontierin response to greatercompetition,firmsmay innovate
more as well and, hence, push out the frontier.
The presentstudy evaluatesU.S. bankingproductivityusing the Malmquistindex
approach.This index is a valuabletool since it allows for the decompositionof pro-
ductivity into the two components discussed above: innovation and imitation. The
firstcomponent,also called technologicalchange, capturesany expansionof the pro-
duction possibilities frontier.The second component captures the convergence of
firms toward the existing technology; this phenomenon is also called efficiency
change or "catchingup."4 The Malmquistis calculatedwithin the frameworkof data
envelopmentanalysis (DEA), which is a linearprogrammingmethodologythatcon-
structs a nonparametric,piecewise-linear,"best-practice"frontierfrom observable
input and outputdata. Otherauthorshave used the DEA techniqueto study the effi-
ciency of the bankingsector beginning with Shermanand Gold (1985); more recent
studies includeAly et al. (1990), Elyasiani and Mehdian(1990, 1992, 1995), Ferrier
and Lovell (1990), and Athanassopoulos(1998), inter alia.5 Most of these studies,
however, have only one or two time periods of data available and hence consider
mainly efficiency levels since they can not examine productivitychanges in detail.

3. As evidenced by the survey articles of Colwell and Davis (1992), Berger, Hunter, and Timme
(1993), Bergerand Mester(1997) and Bergerand Humphrey(1997). The degree of attentionthis research
area has attractedis apparentby the dramaticincrease in the numberof articles publishedbetween 1992
and 1997, the dates of these reviews. Most recently,Adams, Alam, and Sickles (1998) and Bauer et al.
(1998) discuss the robustnessof variousmeasuresof bankingtechnicalefficiency and cost efficiency, re-
spectively.
4. An enhanceddecompositionis furtherpossible. Efficiency change (or imitation)can be separated
into two terms:change in scale and change in pureefficiency. See footnote 10 as well as Fareet al. (1994,
p.75).
5. Refer to Berger and Humphrey(1997), Table 1 for a recent comprehensivelist of DEA banking
studies;69 of the 122 paperslisted are linearprogrammingstudies, with 62 of the 69 being DEA.
 ILA M. SEMENICKALAM : 123

The focus here is on identifyingthe degree of productivityprogress(or regress)in

the 1980s and the degree to which this productivitycan be attributedto innovation
versus imitation.These measuresof productivity,convergence,and innovationhave
wide-spread appeal since they have numerous international applications and a
heightened relevance in today's volatile operating and regulatory environments.
Many industriesin many countriesare undergoingsweeping changes and this index
can help identify how the firms in those industries are reacting. For example, as
noted by Bergerand Humphrey(1997), a primarygoal of deregulationis to improve
resourceallocation.Such a deregulatoryresponse would reduce the degree of ineffi-
cient productioncausing firmsto convergeto the productionfrontier.The Malmquist
index enables one to test this premise since it can distinguishbetween convergence
and innovation.Furthermore,confidenceintervals,generatedusing the CentralLimit
Theoremas well as a nonparametricbootstrappingtechnique,can be used to deter-
mine the statisticalsignificanceof the findings.
The paperproceeds as follows. Section 1 reviews the relatedliteraturewhile sec-
tion 2 discusses the DEA and Malmquistmethodologies, and the issue of statistical
significance.Section 3 presentsthe bankingdata and section 4 reportsthe empirical
findings.Section 5 concludes.

1. RELATED
BANKING
PRODUCTIVITY
LITERATURE

Berg, F0rsund, and Jansen (1992) used the Malmquist to analyze Norwegian
banks between 1980 and 1989. They identifiedproductivityregress priorto deregu-
lation of the Norwegianbankingsystem, and rapidproductivityprogresspostdereg-
ulation with large banks exhibiting the most rapid growth. The productivitygains
were mostly attributableto gains in relative efficiency ratherthan frontiershifts; in
other words, under the increased competitive forces of deregulation, inefficient
banks convergedto the frontierin order to survive. The U.S. deregulatoryexperi-
ence, which also occurredin the 1980s and focused on the asset side of the balance
sheet, was quite differentfrom the Norwegianone. Thus, Norway's experienceis not
necessarilygeneralizableto the Americanone. Berg et al. (1993) expandedthe Nor-
wegian study to an internationalcomparison by including Finnish and Swedish
bankingindustries.The authorsemployed the Malmquistapproachin orderto make
cross-countrycomparisonsusing datafrom a single year.
ElyasianiandMehdian(1995), workingwith U.S. data,selected 1979 and 1986 as
roughproxies for the pre- and postderegulationperiods.Using DEA, they calculated
efficiency scores for samples of U.S. banks from these two years. The authorsfound
that,for large banks,technicalefficiency declined by 3 percentand, using a time-de-
pendentratio analysis,6technology regressedby 2 percentover this eight-yearspan.

6. Efficienciesfor eachbankfromthe 1986samplewerecalculatedtwo ways:oncerelativeto the

1979frontierandoncerelativeto the 1986frontier.
Theratioof theformerefficiencyscoreoverthelatter
efficiencyscorewas definedas the rateof technological
changefor thatbank(ElyasianiandMehdian
1995).Thisapproach is dependent
on theyearchosenfor the benchmark. By followingtheMalmquist
124 : MONEY,CREDIT,AND BANKING

Unfortunately,an analysislimited to only two, widely spacedyears of datamutes the

industry'sresponsepattern.As will be shown, a large advancein one year can be off-
set by a large pullbackin anotheryear, yielding the impressionof little activity over
the entire time period understudy.Thus, there is a distinct advantageto a more de-
tailed, annualinvestigation.
Wheelock andWilson (1999) used the Malmquistdecompositionto examine U.S.
banks from 1984 to 1993. The authorsdocumenteda dropin averageproductivityas
well as technicalefficiency;however,therewas considerabletechnologicaladvance-
ment during this ten-year period. The degree and timing of the productivity,effi-
ciency, and technologicalchanges variedwith bank size.
OtherU.S. productivitystudies include Humphrey(1991) who analyzed the rela-
tionship between deregulationand productivityfor U.S. banks between 1977 and
1987. He focused on the growthaccountingapproachratherthan on econometricor
linear programmingmethodologies. The very low, to negative, productivitygrowth
(estimatesrange between-0.07 percentand 0.6 percentper annumfor the produc-
tion and cost approachesrespectively)is attributedto the deregulationof the 1980s.
Almost all of the remainingU.S. studies estimatetechnical change using profitor
cost function models. Humphrey(1993), working with banks from states that al-
lowed statewideor limited branching,pooled data between 1977 and 1988 and esti-
mated a translog cost function. He found that the very largest banks experienced
averageannualproductivitychange between-0.5 percentand-0.9 percent.This is
in contrastto Hunterand Timme (1991) who, using a similar model and data set,
found a positive annual growth rate of 1 percent between 1980 and 1986. Mean-
while, Berger and Humphrey(1992), using a thick-frontiercost function approach,
evaluatedtechnical change and productivityand found little change in these mea-
sures duringthe 1980s. Bauer,Berger,and Humphrey(1993), employing data from
1977 to 1988, used the stochasticeconometricand thick frontierapproachesto esti-
mate total factorproductivitywith a cost functionmodel. They found productivityto
be between-3.55 percentand 0.16 percentgrowthper annum.Humphreyand Pul-
ley (1997) looked at the technological and efficiency response to deregulationin
termsof profitfunctions.They averagedthe databetween 1977 and 1988 by consec-
utive four-yearintervals(1977-80, 1981-84, and 1985-88) and found productivity
regress in the 1980s (-7 percentbetween the 1981-84 period and the 1985-88 pe-
riod for the largerbanksin theirsample).Finally,Bergerand Mester(1999) included
datathrough1997 and found that,in the 1990s, cost productivitydeterioratedwhile
profitproductivityrose considerably,especially for banksinvolved in mergers.
The present paper complements and extends the literaturediscussed above. By
utilizing the flexible, nonparametricMalmquistindex methodology, the robustness
of the findings across countries as well as across methodologies can be assessed.
This study is an especially good counter-pointto the econometric studies since it

methodology as outlined in Fare et al. (1994), this paper avoids choosing an arbitraryreferencepoint in
orderto measuretechnologicalshifts.
 Ynl+lcf = . e .....
......
/F /;
...... (xn,l+ln / Ynl+Z)
/

ILA M. SEMENICKALAM : 125

provides a means of checking the sensitivity of results which rely upon an a priori
specificationof a functionalform for the productiontechnology.

2. METHODOLOGY

An output-efficientfirm is one which cannot increase its outputunless it also in-

creases one or more of its inputs;7such a firm has an efficiency score of 1. Con-
versely, an output-inefficientfirm has an efficiency score less than 1. Figure 1 is
illustrativeof a single-input,single-outputproductionscenario.The bold rays from
the origin, labeled Ttand Tt+1, representthe boundariesof technology at time t and
t+ 1, respectively,under the assumptionof constantreturnsto scale.8 Since Tt+l is

YA
oT,+,

Ynt= a / t (X"l,
ynl)
O Xn Xn,+w X

FIGE1.Single-Input, Single-OutputProductionTechnology IllustratingDeterminationof Efficiency

Scores and MalmquistIndex of TotalFactorProductivityunderConstantReturnsto Scale

7. Similarly,an input efficient firm is one which cannot contractits inputs without decreasingone or
more of its outputs.
8. Alternativeassumptionsinclude nonincreasing,nondecreasing,or variablereturnsto scale; Seiford
andThrall(1990) have a detaileddiscussion. Underthe Malmquistparadigm,nonconstantreturnsto scale
raises uniqueness,internalconsistency,and measurementaccuracyissues; Grifell-Tatjeand Lovell (1995,
1998), Bjurek (1996), Ray and Desli (1997), and Fare, Grosskopf, and Norris (1997) are among those
who have contributedto this emerging literature.McAllister and McManus(1993) provide evidence that
CRS holds for large banks (>500 million in assets), which is the set of banks dealt with in this paper.
Alam (2000, 2001) examines the Malmquistproductivitydynamics,includingscale issues, for a database
includingbanks below 500 million in assets.
126 : MONEY,
CREDIT,
ANDBANKING

above Tt,technologicalprogresshas occurredbetween t and t+ 1. Considerthe case

of firmn in period t representedas (xtlt,Ytlt).Since it is interiorto Tt,this firm is not
efficient and its output inefficiency is measured as the ratio Oa/Ob.Similarly, the
same firmin t+ 1, denoted (xtlt+1,Ytlt+l), is inefficientwith respect to the Tt+l fron-
tier and its inefficiency score is given by Oe/O%.
DEA is used to define the boundaryof the technology and obtain the efficiency
score for each bank in each time period. It does so by creating an envelope of ob-
served productionpoints (Charnes,Cooper, and Rhodes 1978). DEA provides for
flexible piecewise-linear approximationsto model the best-practicereference tech-
nology. One advantageof programmingmethods over econometric models is that
they do not requirean assumptionof cost minimizationor profit maximization.In
addition,linear programmingmethods are nonparametricand thus do not requirea
priori specificationof a productionfunction. Finally, these methods do not smooth
effects and, therefore,they allow for greaterflexibilityin thatsubstantialannualvari-
ations in efficiency can occur if they exist in the data.9
To identify productivitydynamics, the Malmquistindex procedureis used. It is
able to accountfor changes in both technicalefficiency (catchingup) and changes in
frontiertechnology (innovation).In a study of industrializedcountries, Fare et al.
(1994) note that this decomposition allows for a more comprehensivemeasure of
productivitygrowth convergence since earlier endeavors failed to distinguish be-
tween these two components.The decompositioncan be illustratedby referringback
to Figure 1. For firmn the decompositionis

MalmquistIndex = (OQ/) (ORY ) FO/d?) j

( Of )( Oa) |( Oc )( Ob) | = Et+, * At+, * (1)

This index capturesthe dynamicsof productivitychange by incorporatingdatafrom

two adjacentperiods:Et+1reflects changes in relative efficiency while At+1reflects
changes in technology between t and t+ 1. For the index and its components,values
below 1 indicateproductivitydecline (regress)while values above 1 indicate growth
(progress).For the firmn in the example, both componentsexceed 1. In termsof rel-
ative technical efficiency, the firm moved closer to the relevant contemporaneous
frontier indicating that production for this firm is converging to the frontier
(Et+1>l). In terms of technology shifts, the frontier,as measuredat input levels xt

9. Econometricalternatives stochastic frontier,thick frontier,and distributionfree analyses exist

for measuringtemporalproductivity;upon implementationof these methodologies, however, the author
has found thatthey, unlike the linearprogrammingapproach,do not tend to reveal the rich dynamicsem-
bedded in the data.
 ILA M. SEMENICKALAM : 127

and xt+l, moved out between periods t and t+1 (At+lzl). The efficiency change
component can be further decomposed into pure efficiency change and scale
change.
To determinewhetheror not the index and its componentsare significantlydiffer-
ent from 1, confidenceintervalsare derivedin two ways. Asymptotic confidencein-
tervals based on the central limit theorem (CLT) are determinedfirst. In a sample
with a large number of firms (large N), the distributionof time means (averaging
over firms at a point in time) becomes asymptoticallynormal under the CLT.The
Student'st distributioncan then be used to calculate the appropriateconfidence in-
tervals.One drawbackof this approach,however,is thatin studies with a small num-
ber of firms,the ability to use the CLTis obviatedsince the asymptoticresultsdo not
hold when discussing patternsin means based on a small sample. Small sample size
is a problemoften faced by not only linearprogrammingbut also econometricanaly-
ses in this literature.Anothercomplicationarises if the researcheris specifically in-
terestedin the statisticalsignificanceof the efficiency scores themselves as opposed
to time or firmmeans. In the case of DEA scores, Charnesand Cooper (1980) show
thatan assumptionof normalityis probablyincorrect;this problemis also presentin
econometric models, which have a composed error term with inefElciencybeing
modeled as a truncatednormal,exponential,or gammadistribution.
In orderto addressthese issues, Atkinson and Wilson (1995) present a nonpara-
metric bootstrappingalgorithmas a means of calculatingconfidence intervals.As a
distribution-freealternative,bootstrappingis a methodology that can be used to ob-
tain a sampling distributionof a sample statistic which, in this application,is the
geometricmean of the Malmquistindex and its components.ll

3. BANKINGPANELDATASETI2

The data set consists of all large (>$500 million in total assets) U.S. insuredcom-
mercialbanks with complete data over the ten-yearintervalfrom 1980 to 1989. The
data are from the Reportof Conditionand Income (Call Report)and the FDIC Sum-
mary of Deposits. In orderto allow for the distinct regulatoryand, hence, competi-
tive circumstances of each state, the banks are separated by type of regulatory
environmentas advocatedby BergerandHumphrey(1991,1992), Berger(1993) and
Adams, Berger, and Sickles (1999). The resulting balanced panel consists of 112
banksin states allowing statewidebranching,43 banksin states with limited branch-
ing, and 11 banksin unit-bankingstates;as expected, more banks meet the size con-

10. hEfficiency= APureEfficiencyx AScale.ThehEfficiencycomponent is calculatedunderCRS

whilethePureEfficiencycomponent is efficiencychangeundervariablereturnsto scale,VRS.A scale
changevalueexceeding1 indicatesa movement towardCRSwhilea valuebelow1 indicatesa movement
awayfromCRS.
11. Or,equivalently,
thearithmetic meanof thelog of thesevariables.
12. Thedatadescriptionfollowsthatof Berger(1993).
128 : MONEY,CREDIT,AND BANKING

dition understatewide(STATE)branchingthanundereither limited (LIMIT)or unit

(UNIT) branching.
Table 1 presents the variables used in the DEA productionfunction linear pro-
gramsandreportsthe means by regulatoryenvironment.Outputs(the yks,k= 1,. . .,4)
consist of securities and three disaggregatedloan categories real estate, commer-
cial, and industrial,and installment;inputs (the xjs,j= 1,...,6) consist of two disag-
gregated deposit categoriesl3 demand, and other deposits that contain time and
savings deposits-in additionto purchasedfunds, capital, labor,and equity.l4Means
for several aggregatedvariablesare also reported:total loans 05), core deposits (X7)
and loanable funds (x8). These aggregatedvariablesallow for various specifications
in the input-outputcombinations for the productiontechnology. lSourmodels are
specified and listed at the bottom of Table 1.

4. RESULTS

EJjQciency Dynamics
Levels: Table2 reportsthe averagetechnical efficiencyl5 underthe DEA method-
ology for this sample of largerbanks by regulatoryenvironment.The last category
(ALL) combines all the banks and assumes thatbanks underall three regulatoryen-
vironmentshad similartechnologies which is unlikely and violates the homogeneity
requirement;this categoryis presentedmainly for comparativepurposes.
First, within each regulatoryenvironment,notice how overall decennialefficiency
(that is, averageefficiency over the decade) consistently declines as the numberof
inputs and/or outputs is reduced: Model 1 has four outputs and six inputs while
model 4, using aggregateddata, has two outputsand four inputs. STATEbanks, for
example, exhibit a drop in averageoverall efficiency of almost 10 percentfrom 0.94
to 0.85. This observationis a well-known DEA phenomenon:as the numberof vari-
ables increases, averageefficiency rises because each firmhas a greateropportunity

13. The speciElcationof deposits as inputs is a common practice. Studies include Elyasiani and
Mehdian(1990, 1992, and 1995), Humphrey(1991), English et al. (1993), Lang and Welzel (1996) and
Adams, Berger,and Sickles (1999). Adams, Berger, and Sickles (1999) presentpreliminaryresults indi-
cating that this specificationis favored based on statisticalgrounds.For completeness, models with de-
posits and purchasedfunds as outputsratherthan inputs were also run. The trendswere generally robust
with a few exceptions as noted in the results section.
14. Securitiesand equity are controlledfor in the model specificationto mitigate bias. Holding assets
constant, if some banks hold fewer securities investmentsand relatively greateramounts of loans over
time, the Malmquistproductivityindex will show that those banks have experiencedgreaterproductivity
growthwhen all that has occurredis a shift in assets from securitiesinto loans. Similarly,on the liability
side of the balance sheet, banks that use small amountsof deposits relative to equity capital will tend to
look more efficient than banks that use large amountsof deposits relativeto equity. If banks tend to rely
more on equity over time then this will show up as increased productivity(Hughes and Mester 1998
Hughes et al., 1996). The authorthanksan anonymousreferee for these observations.For completeness
the model was also run without the securities or equity variables;as expected, levels changed but trend
patternswere robustacross these two specifications.
15. Averagetechnicalefficiency is often quoted as being approximately80 percentfor the U.S. bank-
ing industry.In fact, this average performancelevel is what is usually found by stochastic frontierand
thick frontierapproachesto efficiency measurement;the linearprogrammingapproachof DEA yields es-
timates that are more variableacross studies, rangingfrom below 50 percentto over 90 percent average
efficiency for banks (Berger 1993).
 ILA M. SEMENICKALAM : 129

to be efficientin some dimensionof production.Thus, when comparingaverageeffi-

ciency across studies, attentionmust be paid to the numberof variables.
Second, within each model, notice that STATEbanks are consistently the least ef-
ficientof the threebankingenvironments.UNIT bankshave the highest decennialef-
ficiency undermodels 1-3 but falls to second place behind LIMITbanks for model
4. Berger (1993) similarly found that UNIT banks tend to be the most efficient and
STATEthe least. This performanceranking may at first appear counter-intuitive
since it is contrary to the expectation that the greater competition in statewide

TABLE 1
VARIABLEDEscRIPrIoNs
ANDDECENNIAL
MEANS
FORLARGE
U.S. BANKS;
MODEL
SPECIFICATIONS

Sample
Mean
Variable Definition unit Limit State

Yl Dollar amountof securities: 746991.30 493249.03 912908.35

Y2 Dollar amountof real estate loans: 615220.75 338379.40 1105255.23
y3 Dollar amountof commercialand industrialloans: 2677530.10 603571.63 1964542.00
y4 Dollar amountof installmentloans: 397734.36 259609.72 632140.24
y5 Dollar amountof total loans (Y2+Y3+Y4): 3690485.21 1201559.75 3701937.47
xl Dollar amountof bankequity capital: 475809.72 172135.20 465461.57
x2 Dollar value of physical capital: 79156.67 34294.80 101490.11
X3 Labor: 3840.09 1722.40 4433.32
X4 Dollar amountof purchasedfunds: 5545728.47 1063539.70 4164013.63
x5 Dollar amountof demanddeposits: 1156512.63 479294.70 1224962.40
x6 Dollar amountof other (retailand time) deposits: 1003056.42 898456.27 1863388.33
X7 Dollar amountof core deposits (x5+x6): 2159569.05 1377750.96 3088350.73
x8 Dollar amountof total loanablefunds (X4+X7): 7705297.52 2441290.66 7252364.36
Model
No. Outputs Variables Inputs Variables

1: Securities, Yl Equity, xl
Real estateloans, Y2 Capital, x2
Commercialandindustrialloans, y3 Labor, X3
Installmentloans. y4 Purchasedfunds, X4
Demand deposits, x5
Otherdeposits. x6
2: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Purchasedfunds, X4
Demand deposits, X5
Otherdeposits. x6
3: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Purchasedfunds, X4
Core deposits. x1
4: Securities, Yl Equity, xl
Totalloans. y5 Capital, x2
Labor, X3
Loanablefunds. x8
NarEs:
Allvariables,
except
labor,
areinthousands
of 1982 dollars.
Labor
ismeasured
innumber
of full time-equivalent
employees.
130 : MONEY,CREDIT,AND BANKING

TABLE 2
AVERAGE EFFICIENCY BY REGULATORYENVIRONMENT,YEAR, AND MODEL SPECIFICATION

UNIT BANKS LIMITBANKS

Model Model
Year 1 2 3 4 1 2 3 4

1980 0.9933 0.9766 0.9566 0.9301 0.9746 0.9327 0.8822 0.8597

1981 0.9952 0.9738 0.9614 0.9092 0.9722 0.9412 0.9030 0.8640
1982 0.9797 0.9407 0.9261 0.8728 0.9680 0.9386 0.9223 0.8750
1983 0.9985 0.9656 0.9363 0.8578 0.9608 0.9256 0.9135 0.8744
1984 0.9791 0.9732 0.9243 0.8966 0.9599 0.9271 0.8998 0.8434
1985 0.9847 0.9717 0.9513 0.9140 0.9671 0.9396 0.9187 0.8901
1986 0.9831 0.9551 0.9254 0.8833 0.9698 0.9427 0.9170 0.8993
1987 0.9888 0.9480 0.9182 0.8530 0.9803 0.9603 0.9375 0.9223
1988 0.9892 0.9705 0.9358 0.7975 0.9745 0.9550 0.9420 0.9261
1989 0.9964 0.9387 0.8864 0.7882 0.9720 0.9437 0.9302 0.9151
Overall 0.9888 0.9614 0.9322 0.8703 0.9699 0.9406 0.9166 0.8869

STATEBANKS ALL BANKS

Model Model
Year 1 2 3 4 1 2 3 4

1980 0.9240 0.8941 0.8574 0.8354 0.8970 0.8706 0.8384 0.8220

1981 0.9300 0.8913 0.8546 0.8394 0.8994 0.8691 0.8399 0.8230
1982 0.9268 0.8865 0.8494 0.8312 0.8938 0.8550 0.8259 0.8064
1983 0.9306 0.8850 0.8499 0.8291 0.8999 0.8552 0.8260 0.8028
1984 0.9361 0.8931 0.8621 0.8372 0.9026 0.8593 0.8321 0.8027
1985 0.9441 0.9102 0.8815 0.8520 0.9202 0.8829 0.8555 0.8243
1986 0.9606 0.9302 0.9068 0.8739 0.9413 0.9066 0.8854 0.8496
1987 0.9614 0.9363 0.9055 0.8583 0.9464 0.9149 0.8856 0.8379
1988 0.9551 0.9378 0.9096 0.8588 0.9380 0.9153 0.8937 0.8402
1989 0.9534 0.9330 0.9086 0.8695 0.9292 0.8989 0.8698 0.8122

Overall 0.9422 0.9097 0.8785 0.8485 0.9168 0.8828 0.8552 0.8221

NarEs: N = 11 for UNIT Banks; 43 for LIMIT Banks; 112 for STATEBanks; 166 for ALL Banks. Model specifications are defined in
Table 1.

branchingstates shouldresultin greaterefficiency.A possible explanationis thatit is

purelya statisticalphenomenonreliantupon the numberof firmsused to estimatethe
technical efficiency scores (Caves and Barton 1990). As the numberof observations
drawnfrom a distributionincreases, so too will the numberof extreme values (both
high and low). Caves and Barton(1990) maintainthat the relationshipbetween esti-
mated technical efficiency and the numberof observationsmay be similarly linked.
The more draws taken from a distribution,the more likely the researcheris to en-
counter a highly efficient firm, which makes all other firms in the sample less effi-
cient in comparison.Using an orderstatisticargumentthey contendthatthe rangeof
values increases at a rate approximatelyequivalentto the squareroot of the number
of observations.To test this, UNIT (N=11), LIMIT (N=43), and STATE(N=112)
technical efficiency scores were combined and regressed on the square root of the
numberof observations(SQRTN).As expected, SQRTN has a negative and signifi-
 ILAM. SEMENICKALAM : 131

cant coefficient.l6The fact that STATEbanks are the least efficient on averagemay,
therefore,simply be a reflectionof the statisticalfactoridentifiedby Caves and Bar-
ton. This explanationis furtherupheldby the observationthat,when all the banksare
groupedtogether(N= 166), averageefficiency is less than that for the three individ-
ual categories; if SQRTN and technical efficiency were not correlated,one would
expect the ALL groupingto be a weighted averageof the three regulatoryenviron-
ments and fall somewhere between, ratherthan below, STATE,LIMIT,and UNIT
averageefficiency.
Thus, when interpretingefficiency levels, one must be very circumspect,as the re-
sults are sensitive to the numberof observationsas well as the numberof variables.
Trends:Efficiency trends,on the other hand, tend to be more robustacross these
dimensions.STATEis the most robustwith correlationsbetween the models averag-
ing 95 percent;correlationsbetween the models average90 percentfor ALL and 71
percentfor LIMIT.Correlationsare the weakest for UNIT, which exhibits no signif-
icant correlationbetween model 1 and the other models but averages69 percenton
the remainingpairs.
In general,when averageefficiencies fromTable2 are plotted over time, the over-
all technical efficiency trendis slightly increasing for all models across the regula-
tory categories.Again UNIT is the notableexception as would be expected based on
the above correlations:efficiency rises between 1980 and 1989 for model 1 but mod-
els 2 and 3 have a pronounceddip for 1989 while model 4 has an even more notice-
able decline over time. Furthermore,whereas UNIT is entirely above the other
categoriesfor model 1, it falls furtherand furtherbelow LIMIT,STATE,andALL as
one moves from models 2 to 4. The relative sensitivity of UNIT to model specifica-
tion is probablythe result of its small sample size; therefore,its results must be sub-
ject to greaterscrutiny.
In summary,the main distinctionsamongthe models are (i) the level of efficiency,
which falls as one moves from model 1 to 4; and (ii) the degree of variability,which
rises as one moves from model 1 to 4 (variabilityis heightened due to the smaller
numberof inputs and/oroutputs).

Productivityand Its Components:

Levels: Turningnow to the Malmquistindex and its components,refer to Table 3
which presentsthese resultsby regulatoryenvironmentfor model 1. Significancere-
sults, based on both asymptotic and bootstrappedconfidence intervals, are also re-
ported in Table 3.17Recall that values significantly greaterthan 1 are indicative of

16. Model 1, for example,has a coefficienton SQRTNof-0.00664 (t-ratio= 8.71) indicatingthatin-

creasingN by 100 would decreaseaverageefficiency by 6.64 percent.
17. In addition, other nonparametrictests (Wilcoxon, median, van der Waerden,Savage, and Kol-
mogorov-Smirnov)were performedto determineif differences between STATEand LIMIT,STATEand
UNIT, and UNIT and LIMITare statisticallysignificant.The results supportedthose patternsestablished
with the bootstrappingand CLTapproachesin several aspects. First, considerTable 3. AScale, for exam-
ple, for STATE1985-1986, is significantat the 1 percentlevel (AScale = 1.0126) but it is insignificantly
differentfrom 1 for UNIT (AScale = 0.9981) and LIMIT (AScale = 1.0026). The above nonparametric
tests picked this resultup: UNIT versus STATE,and LIMITversus STATEare significantlydifferentfrom
132 : MONEY,CREDIT,AND BANKING

progress in relative performance,values significantly less than 1 are indicative of

regress or deterioration,and values not differentfrom 1 are indicativeof no change
in relative performance.Differences between the bootstrappedand asymptotic ap-
proachesaremost apparentfor UNIT which has a sample size of only 11. In one case
(Malmquist,1985-1986), a value significantat the 5 percentlevel becomes insignif-
icant under the asymptotic approach;in three other cases (Malmquist, 1983-1984
and 1988-1989; I\Technology, 1988-1989), significance drops from 1 percentto 5
percent. The remaining categories have a total of four disagreementsbetween the
two sets of confidence intervals;the lower numberof discrepanciesis the result of
the largersample sizes (N=43, 112, and 166 for LIMIT,STATE,and ALL, respec-
tively). Thus, even for moderatelylarge samples, differencesmight still arise.Atkin-
son and Wilson (1995), working with a sample of forty-two firms, found enough
differencesbetween confidence intervalsgeneratedby the bootstrapmethod and the
asymptoticprocedureto suggest that the researchermay not wish to rely solely on
the latter.
Totalcumulatedgrowthfor the entire decade is largestfor LIMITbanks (4.3 per-
cent) due to technologicalinnovation(4.6 percent)which offset a slight decline in ef-
ficiency (-0.2 percent; firms, on average, were moving farther away from the
efficientfrontieras the leaderspulled furtherahead).This would indicatethatLIMIT
banks were especially successful at incorporatingnew technological advances into
their operation.The level of productivitygrowth for STATEbanks was comparable
(3.2 percent) but was due to convergence to the frontier (3.5 percent) ratherthan
technologicalchange (-0.3 percent).Finally,UNIT banksactuallyexhibiteda small
decline in productivity(-0.3 percent) due to technological regress (-0.7 percent)
which offset convergence (0.3 percent).This patternof cumulativegrowth is intu-
itively appealing: those banks operating under less restrictiveregulatoryenviron-
ments (namely,LIMITand STATE)exhibited enhancedproductivitywhile banking
productivityin a more restrictivemilieu (namely,UNIT) suffered.
Finally, consideringthe ALL category,total productivityactually falls more than
UNIT (-0.9 percent) and is attributedto a large degree of technological regress
(-4.6 percent) which outweighs convergence (3.9 percent). Note how pooling the
data conceals the distinctly differentcumulativeresults for banks in the individual
regulatoryenvironments.
Trends:If the resultsfrom Table3 areplotted over time, one would notice thatthe
Malmquisthas a pronouncedpeak for 1983-1984 followed by a significanttrough

each other (at the 8.7 percentlevel or better)for 1985-1986. Since AScale for UNIT and LIMIT are not
differentfrom 1, while AScale for STATEis differentfrom 1, it makes sense that both UNIT and LIMIT
banks are significantlydifferentfrom STATEAScale. Second, these nonparametrictests again illustrate
the importanceof separatingbanksby regulatoryenvironment:the Malmquistand componentsare signif-
icantly differentacross regulatoryenvironmentsfor several time periods.Also, the time periods of signif-
icance can vary dependingon which pair of regulatoryenvironmentsare being compared(for example,
1982-1983 and 1988-1989 are significantly different for UNIT versus LIMIT, and for UNIT versus
STATE,but not for LIMITversus STATE).Finally,the patternof resultsis consistent.Namely, whenever
the Malmquistproductivityindex is significantlydifferentbetween bank environments,the ATechnology
componentis also significantlydifferent.This patternwas originally observed in Table 3: it is primarily
ATechnologydrivingthe productivityresults ratherthan AScale or APureEfficiency.
TABLE 3
AVERAGE ANNUAL CHANGE FOR MALMQUIST PRODUCTIVITY INDEX AND COMPONENTS (MODEL 1 )

UNIT BANKS
Year Malmquist ATechnology APureEfficiency AScale

1980-1981 0.9696 0.9676 1.0050 0.9971

1981-1982 0.9475 0.9631 0.9916 0.9922
1982-1983 0.8751 ** 0.8581 ** 1.0094 1.0103
1983-1984 1.1223**t 1.1467** 1.0000 0.9787
1984-1985 0.8660** 0.8606** 1.0000 1.0063
1985-1986 1.0559*-- 1.0579 1.0000 0.9981
1986-1987 1.0329 1.0256 1.0000 1.0071
1987-1988 1.0398* 1.0398 1.0000 1.0000
1988-1989 1.0918**t 1.0832**t 1.0000 1.0079

LIMIT BANKS
Year Malmquist ATechnology APureEfficiency AScale

1980-1981 0.9334** 0.9358** 0.9993 0.9981

1981-1982 0.9534** 0.9588** 0.9947 0.9997
1982-1983 0.9854 0.9920 0.9952 0.9981
1983-1984 1.1287** 1.1303** 0.9948 1.0039
1984-1985 0.8846** 0.8774** 1.0113 0.9971
1985-1986 1.0311* 1.0277**, 1.0008 1.0026
1986-1987 1.0392** 1.0270* 1.0052 1.0066*-
1987-1988 1.0326** 1.0391** 0.9992 0.9945*
1988-1989 1.0153 1.0185 0.9944 1.0024

STATE BANKS
Year Malmquist ATechnology APureEfficiency AScale

1980-1981 0.9474** 0.9409** 0.9973 1.0096

1981-1982 0.9784*,- 0.9824 0.9974 0.9986
1982-1983 0.9831 0.9784* 1.0017 1.0031
1983-1984 1.1025** 1.0953** 1.0076 0.9990
1984-1985 0.9451** 0.9368** 1.0007 1.0082*
1985-1986 0.9835* 0.9654** 1.0060 1.01264
1986-1987 1.0396** 1.0383** 1.0015 0.9997
1987-1988 1.0282** 1.0357** 0.9994 0.9934*
1988-1989 1.0021 1.0038 0.9983 1.0000

ALL BANKS
Year Malmquist ATechnology APureEfficiency AScale

1980-1981 0.9479** 0.9448** 0.9983 1.0049

1981-1982 0.9676** 0.9749** 0.9929 0.9997
1982-1983 0.9749** 0.9672** 1.0002 1.0078*$t
1983-1984 1.1066** 1.1035** 0.9995 1.0033
1984-1985 0.9270** 0.9080** 1.0101** 1.0107**
1985-1986 0.9914 0.9677** 1.0122** 1.0122**
1986-1987 1.0392** 1.0327** 1.0061 1.0002
1987-1988 1.0287** 1.0385** 0.9973 0.99334
1988-1989 1.0094 1.0195** 0.9955 0.9946*
NarEs:The symbols (*) and (**) indicatesignificanceat 5 percentand 1 percentlevels, respectively,underboth asymptoticand bootstlapped
approaches.If the asymptoticconfidence intervalresults in a differentconclusion regardingsignificancethis is indicatedby either a (-), in-
dicating insignificanceunderthe asymptoticapproach,or a (0, indicating significance at the 5 percent significance level. Regulatoryenvi-
ronmentis presentedfrom most restrictive(UNIT) to least restrictive(STATE).
134 : MONEY,CREDIT,AND BANKING

for 1984-1985; it then grows again above 1. Note that APureEfficiency and AScale
arerelativelyflat indicatingthat almost all the changes in productivitywere due, not
to diffusion of technology or scale changes, but ratherto technological advances.
Upon examinationof the /\Technology column of Table 3, it is apparentthat those
values closely mirrorthatof the Malmquistcolumn.Note also thatthe values thatare
signiIScantlydifferentfrom 1 are mostly in the MalmquistandATechnologycolumns
with APureEfficiency and AScale registering significance only occasionally. This
findingcontrastswith thatof Berg, F0rsund,and Jansen(1992) who found thatNor-
wegian banks convergedratherthaninnovatedduringthe 1980s. However,it is con-
sistent with Wheelock and Wilson's (1999) U.S. study, which found large advances
in technology between 1984 and 1993.
Considering each regulatory environment individually the following patterns
emerge. For LIMIT banks productivitywas less than 1 between 1980 and 1983;
then between 1983 and 1984, productivityrose dramatically(12.9 percent)relative
to other years before falling back down below 1 (indicatingproductivitydecline of
11.5 percentfor 1984-1985). After 198Sfthere was sustainedprogressas productiv-
ity rose above 1 for the durationof the decade. The patternfor LIMIT banks lies
somewherebetweerlUNIT and STATE.STATEbanks are very similar to, although
somewhat less volatile than, LIMIT, its 1983-1984 peak is 10.3 percent and its
1984-1985 troughis 5.5 percent. Finally UN1T banks are the most volatile of the
threeregulatoryconditions;its peaks and troughsare usually more pronouncedthan
those for LIMITand STATEbanks. For example, UNIT has a significantproductiv-
ity decline of 12.5 percent for 1982-1983 not apparentfor LIMIT or STATE;its
peak in 1983-1984 of 12.2 percent and troughin 1984-1985 of 13.4 percent are at
least as large as those for LIMITbanks. Thus, UNIT banks are reactingin a more
volatile mannerto changes in theirenvironments.lS
Figure 2 shows the cumulativeeffect of productivitygrowthfor each subperiodof
the 1980s. The Malmquistis trendingupwardbut does not get above 1 for STATE
and LIMIT banks until late in the decade.l9 Contrastthis with the DEA study of

18. Analysts in the industrybelieve the transformationapproachis (perhapsweakly) dual to the mar-
gin approach.To explore this issue, two additionalmodel specificationswere run:(i) deposits are treated
as an outputratherthan an input, and (ii) purchasedfunds, in additionto deposits, are treatedas outputs.
Comparedto each other,models (i) and (ii) yield similar graphs.Comparisonof models (i) and (ii), with
the transformationapproachfocused on in the paper, yields both distinct similarities as well as differ-
ences. For example, a main findingof this paperis thatproductivitytrendsover the decade are primarily
due to innovationratherthan imitationor scale change. This observationis mirroredwith the marginap-
proach:the graphsof l\Technology and Malmquistare very similar Also, before the 1982-83 period and
after the 1984 85 period, the trendsfor the marginand transformationapproachesare very similar;the
differences that do arise appear between 1982 and 1985. The dramaticpeak and trough apparentfor
1983-84 and 1984-85 underthe transformationview is mutedand shifted.For example, while UNIT still
has a peak for 1983-84, it is only between 2.3-4 percent(dependingon whetheryou considerModel (i)
or (ii); this is smallerthan the 12 percentunderthe transformationview); also, it is followed by a trough
that is between 3.4-4.7 percent(as comparedto 13.4 percentfor the transformationview). Although the
level of the responsemay differ,the overallpatternfor UNIT is remarkablysimilarto thatexhibitedunder
the transformationapproach.STATEand LIMIT exhibit muted levels as well as shifted patterns.Both
have peaks in 1982-83 and 1984-85 while the troughnow occurs in the 1983-84 period.
l 9. The cumulativeplots for ATechnology,APureEfficiency,and AScale exhibit the same patternes-
tablishedearlierwith the discussion for Table 3; ATechnologyclosely mirrorsthe Malmquistplot while
APureEfficiencyand AScale are relativelyflat.
 ILA M. SEMENICKALAM : 135

1980-1981 1980-1982 1980-1983 1980-1984 19861985 1980-1986 1980-1987 1980-1988 1980-1989

FIG. 2. CumulatedGrowthfor MalmquistIndex by RegulatoryEnvironment(Model 1)

Elyasiani and Mehdian (1995) that found technological and efficiency regress for
large banks. That analysis was limited to two years of data (1979 and 1986) which
may have maskedthe overallproductivityeffects. In addition,ratherthan separating
the data by regulatoryenvironment,the data was pooled. To make a more direct
comparison of their results with the currentstudy, a vertical line is drawn at the
1980-1986 cutoff and the ALL cumulative results are also plotted. Note that the
Malmquistis below 1 for all threeregulatoryenvironmentsas well as the ALL cate-
gory at that point in time. It is only when the analysis is carried furtherinto the
decade do values above 1 start appearingfor two of the three regulatoryenviron-
ments; the ALL grouping never makes it above 1. In addition,the currentstudy is
done annuallyover a decade which reveals a more detailed picturethan comparing
the end points of an eight-yearspan as in Elyasiani and Mehdian.Thus, as noted by
Bergerand Humphrey(1997), measurementover longer time periodsis necessaryto
discernif the deregulatoryand othershocks of the 1980s had a net positive impacton
productivity,efficiency and technology.

5. CONCLUSIONS

This paper quantifiesthe productivity,efficiency, and technological changes for

large U.S. commercial banks during the 1980s using the Malmquist productivity
index. One advantageof this index is the ability to separateout diffusion of technol-
ogy (movement toward the productionfrontier) from shifts in technology (move-
ment out of the frontier) and scale changes (movements toward or away from
constant-returns-to-scaleoperation).Another advantageis that, unlike econometric
approaches,it does not smooth effects; the flexibility inherentin this nonparametric
methodology allows for substantialannualvariationsto be detected if they exist in
136 : MONEY,CREDIT,AND BANKING

the data.This paperalso utilizes recentbootstrappingliteratureto identify significant

changes in productivity,imitationand innovation.
Results suggest thatbanks underthree differentregulatoryenvironments UNIT,
LIMIT,and STATE acted similarlyin terms of trend,althoughby varyingdegrees
(levels were different),to the deregulatory,financial,and technological innovations
which were rapidly occurringduringthis decade. All bank types made tremendous
gains in productivityand technologicaladvancesbetween 1983 and 1984. This exer-
tion led to a recovery period of one or two years during which productivity re-
gressed. Finally, afterthe wave of shocks, which roiled the industryin the early part
of the decade, the banks adjustedand settled down into a patternof slower, steadier
growthand innovation.
Consideringthe entire body of evidence presentedin this paper,there appearsto
be a several-year lag time between when the deregulatorybills were passed and
when the industry finished reacting and returned to relatively stable levels of
growth.20The presenceof an adjustmentperiodhas been observedby Humphreyand
Pulley (1997). These authorsaveragedtheirdataover threeconsecutivefour-yearin-
tervalsand found that large banks experiencedsizable adjustmentcosts between the
1977-80 and 1981-84 intervalsin responseto deregulation.They concludedthatthe
adjustmentto deregulationwas essentially complete after four years. The present
study fine-tunesthe analysis and is able to pinpointthe end of the adjustmentperiod
to 1985, a year later,because it is a year-by-yearbreakdownthatdoes not smooththe
annualchanges.
The average bank did not move closer to the frontier;the measuredchanges in
productivityare due almostentirelyto shifts in technology ratherthanchanges in ef-
ficiency. The lack of dramaticincreases in terms of efficiency may be explained by
the fact that,by the 1980s, banks alreadyfaced significantcompetitionfrom otherfi-
nancial institutions.For example, startingin the late 1970s, money marketmutual
funds expanded,eroding some of the competitiveadvantageof the bankingindustry
by the beginningof the 1980s (Berger,Kashyap,and Scalise 1995). It is importantto
realize that APure Efficiency held near one throughoutthe decade indicating that,
even though the production frontier was being pushed out by technological ad-
vances, firms on average were not falling furtherbehind. Thus, even though there
were no great gains in efficiency, neither were there any great losses: banks were
keeping up despite the fact they were being measured relative to more advanced
technology.
The results presentedhere are in agreementwith those studies finding slight pro-
ductivity progress during the 1980s. It is apparent,however, that by grouping the
regulatoryenvironmentstogether the productivityeffects become muted: the ALL
grouping indicates productivityregress of approximately1 percent for the decade

20. The Depository InstitutionsDeregulationand MonetaryControlAct (DIDMCA) was passed by

Congressin late 1980. This was followed two years laterby the Garn-St.GermainDepositoryInstitutions
Act (DIA).
 ILA M. SEMENICKALAM : 137

but UNIT banksindicateonly a 0.3 percentdropwhile LIMITand STATEbanks ac-

tually grew between 3 and 4 percent.Whatis also apparentis the ability of the linear
programmingapproachto detect notable annualmovements.

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