International Review of Economics and Finance 8 1999 165–182
DEA efficiency profiles of U.S. banks operating internationally
John A. Haslem
a,
, Carl A. Scheraga
b
, James P. Bedingfield
c
a
Department of Finance, College of Business and Management, University of Maryland, College Park, MD 20742, USA
b
School of Business, Fairfield University, Fairfield, CT 06430, USA
c
Department of Accounting, College of Business and Management, University of Maryland, College Park, MD 20742, USA
Received 28 January 1997; accepted 30 December 1997
Abstract
Data envelopment analysis DEA was used to analyze the 1987 and 1992 inputoutput efficiency of U.S. banks operating internationally. In 1987, banks belatedly began to acknowl-
edge with huge writeoffs the crisis in lending to less-developed countries LDCs. Some 20 of the banks were identified as inefficient in each year, and approximately 50-60 of the total
inputsoutputs of inefficient banks were excessivedeficient, with inputs proportionately more so than outputs. In 1987, the herd instinct that had led to the LDC loan crisis caused DEA’s
empirical “best practice” production frontier to identify as efficient banks that were financial “bad practice” banks. However, by 1992, normalcy had returned and DEA best practice banks
were also financial good practice banks. Overall, it was found that management should focus on overall efficiency, but with particular attention to inputs, especially cash and real capital,
and to foreign loans among the outputs.
1999 Elsevier Science Inc. All rights reserved.
Keywords: DEA; U.S. banks; Efficiency; International; Inputoutput
1. Introduction
This study investigates the inputoutput efficiency of large U.S. banks that engaged in both domestic and foreign operations during a particularly dynamic and difficult
period. Since 1980, banks have been subjected to various forces that have significantly changed the nature of the industry and its competitive environment. These include
legislative and regulatory changes, institutional changes, increased globalization and macrolocalregional economic events.
1
Corresponding author. Tel.: 301-405-2236; fax: 301-405-0359. E-mail address
: jhaslemmbs.umd.edu J.A. Haslem 1059-056099 – see front matter
1999 Elsevier Science Inc. All rights reserved.
PII: S1059-05609900013-1
166 J.A. Haslem et al. International Review of Economics and Finance 8 1999 165–182
In addition to these exogenous factors, management behaviors were also extremely important. For example, Park 1994 found that some managers contributed to in-
creased bank risk by adopting high variance strategies.
2
These actions, especially in banks with inadequate cost controls and poor investment choices, had adverse results
that contributed to bank inefficiency. Graham and Horner 1988 also detailed the importance of management to bank
performance. They found that internal factors greatly influenced the degree to which adverse external conditions harmed banks, with management and the board of direc-
tors the ultimate determinants of bank success or failure.
3
The Economist 1990
surveyed the world of international banking and noted that the 1980s “did not add up to the best of times for America’s commercial banks.” Further, “efficiency and
profitability, not size, became the holy grail; but for many banks it remained elusive.”
4
In particular, 1987 was terrible year for large U.S. banks. This was due to the increasingly severe problems with LDC loans, especially in Latin America, that banks
belatedly began to acknowledge in a significant way on their financial statements. The year was characterized by huge increases in loan-loss provisions, which, of course,
greatly impacted reported financial performance.
5
The elusiveness of bank efficiency during the 1980s and its implications for profitabil- ity performance provided the motivation for this study.
6
Specifically, the objective was to analyze the 1987 and 1992 efficiency of large U.S. banks for purposes of: 1
identifying inefficient banks; 2 determining and profiling the inputoutput variables associated with inefficiency; and 3 profiling and summarizing the financial perfor-
mance of efficient and inefficient banks.
As reviewed in Evanoff and Israilevich 1991, earlier production theory recognized two basic types of bank inefficiency: output inefficiency, which represents suboptimal
andor deficient output production; and input inefficiency, which represents excess inputs andor suboptimal input mixes for a given levels of output.
7
The story that emerged from the study was that efficiency was a major problem. First, some 20 of the sample of large U.S. banks were identified as inefficient in
1987 and in 1992. Second, some 50–60 of the total inputsoutputs of inefficient banks were excessivedeficient, with inputs proportionately more inefficient than outputs.
Third, management should focus on overall efficiency, but with particular attention to inputs, especially excess cash and real capital, and foreign loans among the outputs.
Fourth, in 1987, the herd instinct that had led to the LDC loan crisis caused the methodology to find foreign loans as positive contributors to efficiency and incorrectly
identified efficient and inefficient banks, when measured by financial performance. Fifth, by 1992, banking had normalized and foreign activities were again profitable, and
inefficient banks were deficient in foreign loans. Sixth, in 1992, efficient banks were more profitable than inefficient banks across all measures—overall, foreign and domestic.
2. Methodology and model
