#08-25
Efficiency in Banking: Theory, Practice, and Evidence
Joseph P. Hughes and Loretta J. Mester, January 2008
Abstract: Great strides have been made in the theory of bank technology in terms of explaining
banks’ comparative advantage in producing informationally intensive assets and financial
services and in diversifying or offsetting a variety of risks. Great strides have also been made in
explaining sub-par managerial performance in terms of agency theory and in applying these
theories to analyze the particular environment of banking. In recent years, the empirical
modeling of bank technology and the measurement of bank performance have begun to
incorporate these theoretical developments and yield interesting insights that reflect the unique
nature and role of banking in modern economies. This chapter gives an overview of two general
empirical approaches to measuring bank performance and discusses some of the applications of
these approaches found in the literature.
Keywords: Bank, efficiency, risk, cost, profit, agency costs, X-inefficiency
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