ABSTRACT
Increased competition, ongoing consolidation, continuing pressure for the reduction of existing excess capacity and shrinking profitability in the European banking industry have put efficiency high on the agenda of most banks as they monitor their performance over time and against competitors. The research literature provides little consensus on the efficiency topic as no broad pattern can be detected for scale-, scope-and X-efficiency. However, it is generally documented that X-inefficiencies tend to be much larger than scale-and scope-inefficiencies. The rationale of looking at the cost to income ratio and its dispersion is the growing use of it as a proxy for bank (in)efficiency. Possible dispersion is often interpreted as an indication of (in)efficiency. This paper gives a brief overview of the cost to income ratio within the European banking industry as the recent consolidation wave is reflected in only an overall small reduction of the ratio. Linear benchmarking of the cost to income ratio may be misleading as the interpretation is often not unambiguous. Based on a regression model for a sample of European banks, the residual-analysis could be used as a simple indication of possible (in)efficiency. The results reveal that both for commercial banks and savings banks the ratio is initially quite high and robust. Changing the composition of the bank income (all other elements remaining equal) through increasing the share of interest income and trading income should result in a lower ratio, while shifting towards fee business has an upward pressure on the ratio. As expected, lowering the share of personnel costs in the total overhead tends to move the cost to income ratio downwards. The regression model tends to signal that changing the composition of the bank income and overhead has on average a small impact. The findings therefore seem to confirm that changing scale and scope has a limited impact on the cost to income ratio. By using the available inputs efficiently in order to generate a given (or higher) output level the direct impact on the ratio itself is much larger.
