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Abstract:
Note: The following is a description of the paper and not the actual abstract.

The results of applying frontier efficiency analysis to financial institutions are surveyed. While most of the 130 studies have been applied to U.S. financial institutions, 21 countries are covered overall. We find that the various nonparametric and parametric frontier methodologies generally differ both in terms of reported average efficiency as well as in rankings of financial firms by their efficiency level. The results of these studies for government policy, methodological issues, and managerial performance are also summarized and topics where further analysis would prove useful are identified.

Abstract:
This paper surveys 130 studies that apply frontier efficiency analysis to financial institutions in 21 countries. The primary goals are to summarize and critically review empirical estimates of financial institution efficiency and to attempt to arrive at a consensus view. We find that the various efficiency methods do not necessarily yield consistent results and suggest some ways that these methods might be improved to bring about findings that are more consistent, accurate and useful. Secondary goals are to address the implications of efficiency results for financial institutions in the areas of government policy, research and managerial performance. Areas needing additional research are also outlined.

Abstract:
This paper examines the efficiency and price effects of mergers by applying a frontier profit function to data on bank "megamergers." We find that merged banks experience a statistically significant 16 percentage point average increase in profit efficiency rank relative to other large banks. Most of the improvement is from increasing revenues, including a shift in outputs from securities to loans, a higher-valued product. Improvements were greatest for the banks with the lowest efficiencies prior to merging, who therefore had the greatest capacity for improvement. By comparison, the effects on profits from merger-related changes in prices were found to be very small.

Abstract:
This paper examines the efficiency and price effects of mergers by applying a frontier profit function to data on bank `megamergers'. We find that merged banks experience a statistically significant 16 percentage point average increase in profit efficiency rank relative to other large banks. Most of the improvement is from increasing revenues, including a shift in outputs from securities to loans, a higher-valued product. Improvements were greatest for the banks with the lowest efficiencies prior to merging, who therefore had the greatest capacity for improvement. By comparison, the effects on profits from merger-related changes in prices were found to be very small.

Abstract:
We propose a set of consistency conditions that frontier efficiency measures should meet to be most useful for regulatory analysis or other purposes. The efficiency estimates should be consistent in their efficiency levels, rankings, and identification of best and worst firms, consistent over time and with competitive conditions in the market, and consistent with standard nonfrontier measures of performance. We provide evidence on these conditions by evaluating and comparing efficiency estimates on U.S. bank efficiency from variants of all four of the major approaches -- DEA, SFA, TFA, and DFA -- and find mixed
results.

Abstract:
NOTE: Below is a description of the paper and not the actual abstract.

We define six consistency conditions that frontier efficiency approaches to measuring the performance of financial institutions should meet to be useful for regulatory purposes. The first three conditions--that the efficiencies generated by these approaches be consistent with each other in terms of their efficiency levels, rankings, and identification of best and worst firms--help determine the degree to which the different approaches are consistent with each other. The latter three conditions--that the efficiencies are consistent over time, consistent with competitive conditions in the market, and consistent with standard non-frontier measures of performance--help determine the degree to which the efficiencies generated by the different approaches are consistent with reality and are believable, which is necessary for the efficiency estimates to be useful. We evaluate all four of the main approaches to estimating frontier efficiency or X-efficiency by employing multiple techniques within each of the four approaches, for a total of nine efficiency techniques evaluated. To be sure that the applications are comparable, all nine techniques estimated use the same efficiency concept (cost efficiency), the same sample of banks, same time interval, same specifications of inputs and outputs, and (for the parametric methods) the same functional form.

Our data set consists of a panel of 683 large U.S. banks that were in operation over the entire period from 1977-88 and operated in states that allowed branch banking. This was a period of many changes in regulations and market conditions, making it an almost ideal period to determine how the different frontier approaches identify and measure bank efficiency over a variety of extreme conditions.

Our findings yield some mixed evidence regarding the consistency of the four approaches. For the first three consistency conditions, these data suggest that the parametric methods are generally consistent with one another, and the non-parametric methods are generally consistent with one another, but the parametric and non-parametric methods are not generally mutually consistent.

Possible ?tie-breakers"--or conditions which help to choose whether the non-parametric versus parametric methods might be ?better?--are whether the efficiencies drawn from the different approaches are consistent with reality and are believable. All of the methods are found to be consistent over time (condition iv), but the parametric methods appear to be more consistent with what are generally believed to be the competitive conditions in banking markets (condition v), and also more consistent with non-frontier measures of bank performance such as return on assets or various cost ratios that are often used by regulators, managers, and consultants (condition vi). Furthermore, the parametric measures are generally highly positively correlated with the standard non-frontier performance measures, whereas DEA measures are much less strongly related to these other indicators of firm performance.

When performing regulatory analysis (or any other analysis that depends on frontier efficiency measurement), the use of multiple techniques and specifications should be helpful. If the six consistency conditions are met for two or more approaches, then one can be more confident in the conclusions drawn.

Abstract:
Lessons from the evolution of payment systems in Europe, Japan, and the United States provide a useful guide for emerging market economies in improving their own payment arrangements to foster economic growth. Some payment arrangements are more efficient than others in promoting economic growth in a market-based economy. The payment experience of industrial countries is diverse enough to identify those payment arrangements that provide the infrastructure for sustained growth and the emergence of market-based enterprise.

Based on the historical experiences of Europe, Japan, and the United States, a number of country attributes have led to the intensive use of different payment instruments and, in some cases, a different mix of private and public ownership and participation in the payment system. Such attributes include country size, population density, banking structure, legal framework, safety, and payment instrument pricing. These attributes explain why Japan relies heavily on cash at the point of sale but uses electronic payments for bill payments and business transactions. They also are the reason Europe relies on credit-transfer giro payments for all types of transactions and the United States instead relies on checks. Finally, the fact that consumer payment needs were not met within the banking system led to the establishment of postal giros in Europe, while untimely business payments led to central bank involvement in payment processing in the United States.

Unmet user needs, inefficient payment arrangements, differences in payment instrument costs, and improper pricing of payment services will determine the future structure of payment systems in emerging market economies just as they have determined the evolution of payment systems in industrial countries. The authors discuss these issues and apply the lessons learned to payment arrangements in emerging market economies. Although the evolution of payments has taken decades in industrial countries, emerging market economies hope to complete the process in just a few years, and so will benefit by having a better roadmap for transforming their payment systems.

This paper - a product of the Financial Sector Development Department - is part of a larger effort in the department to promote the development of financial sector infrastructure to support banking and capital market activities.

Abstract:
The substitution of noncash (check, giro, and credit and debit card) payments for cash transactions is difficult to gauge because there are no data series on the actual value or volume of cash transactions in any country. However, determining the degree of cash substitution is important because it will negatively affect the central banks' and governments' seigniorage revenue. We utilise a novel method for approximating the volume of cash transactions using public information on currency stocks and noncash payments. Applying this method, we estimate how cash has been substituted by other payment instruments in 10 European countries. We also provide a forecast of future cash use by country. We find that the trend in cash substitution across countries is quite similar. However, the countries themselves are at significantly different stages of this substitution process. The spread of debit and credit card payments has been the key factor behind the substitution away from cash as use of e-cash innovation is still in its infancy. Country-specific differences in the substitution process are largely explained by differences in the level of implementation of each country's card payment technology.

Cash substitution, learning curves, seigniorage

Abstract:
The cost of providing payment services is substantial - 3 percent of GDP. Cost reduction requires the appropriate pricing of those services.

A modern payment system is essential for promoting domestic and international trade and exchange as well as developing financial markets.

Payment users will be directed toward the most efficient payment methods when the costs of producing those services are reflected in the prices paid.

Resources are being wasted in the United States because consumers see no important difference in transaction prices or bank costs between using a check or using electronic direct debit in paying a bill, even though the social costs of these two instruments are different. Electronic payments cost only a third to half as much as paper-based payments. An estimated $100 billion (or 1.5 percent of GDP) is being lost by the continued use of paper-based checks.

When payment instruments are not appropriately priced, the costs must be covered elsewhere. One common solution is to let loan revenues cover part of payment expenses (keeping loan rates higher to compensate). When prices reflect the full cost of producing the service, users demand the services that use the fewest real resources.

Humphrey, Keppler, and Montes-Negret give examples of payment prices and price schedules and show how underlying cost data are used to build up to a price. They outline how payment services may best be structured to:

- Appropriately reflect economies of scale or scope in the production of payment services.
- Adjust cost recovery percentages to accommodate how much demand conditions associated with start-up differ from those associated with mature operation. (During a new system`s early years of operation, the transaction volume may be low and some form of underrecovery of costs may be required to encourage use of the system. But any such underrecovery must be built into future pricing arrangements once the systems are established and traffic volumes are at a level where full cost recovery is practical. To ensure fairness, the pricing structure must also guarantee that latecomers to the system do not get more favorable treatment than the initial user group.)
- Induce efficient use of scarce resources.
They note the economic principles that recommend certain pricing methods over others and apply equally to payment services provided by the private sector or through a government agency. They show why costs should be recovered through user transaction fees.

This paper - product of the Financial Sector Development Department - part of a larger effort in the department to promote the development of financial sector infrastructure to support banking and capital market activities.

Abstract:
Electronic payments are considerably cheaper than their paper-based alternatives. Similarly, ATMs are a more cost-efficient way to deliver certain depositor services than are branch offices. As the share of electronic payments in 12 European countries rose from 0.43 in 1987 to 0.79 in 1999 and ATMs expanded while the number of branch offices was constant, bank operating costs are estimated to be $32 billion lower than they otherwise might have been, saving 0.38% of the 12 nations' GDP. The authors' results are robust to the form of cost function estimated - composite, Fourier, or translog.

Payments, ATM, bank costs, Europe

Abstract:
This paper discusses various theoretic concepts which play a role in assessing the public benefits of Target, the large value RTGS payment network operated by the Eurosystem. These concepts touch upon natural monopoly, network externalities, competition and contestability, as well as economies of scale and scope. The existence of a natural monopoly provides a rationale for a temporary partial or full subsidy in order for Target to achieve the 'most efficient scale' or apply the most efficient technology to lower unit costs. Such a subsidy could be implemented through temporary 'penetration' pricing. Based on empirical results for the Federal Reserve's payment system (Fedwire), it is further argued that if Target decided to standardize its operating platforms and consolidate its processing sites into one or a few centers, it too could realize strong scale economy benefits and lower unit costs.

public good, natural monopoly, most efficient scale, partial subsidy

Abstract:
The goal of SEPA (Single Euro Payments Area) is to facilitate the emergence of a competitive, intra-European market by making cross-border payments as easy as domestic transactions. With crossborder inter-operability for electronic payments, card transactions will increasingly replace cash and checks for all types of payments. Using different methods, the authors estimate card and other payment network scale economies for Europe. These indicate substantial cost efficiency gains if processing is consolidated across borders rather than "piggybacked" onto existing national operations. Cost reductions likely to induce greater replacement of small value cash transactions are also illustrated.

Debit cards, scale economies, SEPA, cash replacement

Abstract:
Pricing should speed up the substitution of low cost electronic payments for expensive paper-based transactions and cash. But by how much? Norway has explicitly priced individual payment transactions and rapidly shifted to electronic payments while the Netherlands has experienced the same shift without direct pricing. Controlling for differences between countries, the authors estimate the incremental effect of pricing on the shift to electronic payments. If users strongly value the improved convenience or security of electronic payments, pricing - viewed negatively by most consumers - may not be necessary to ensure rapid adoption of electronic payments.

Electronic payments, Transaction pricing, Demand elasticity, Social benefits

Abstract:
Target is a real time gross settlement (RTGS) large value payment network operated by European central banks that eliminates systemic risk. Euro1 is a privately operated delayed net settlement (DNS) network that reduces substantially systemic risk but does not eliminate it. This difference makes RTGS networks more expensive to users even if both networks had the same unit operating costs. This provides an incentive for users to shift payments to the more risky network in normal times and back to Target in times of financial market disruption. The estimated extra cost to a DNS network from posting collateral sufficient to cover all exposures (and eliminate systemic risk) is from 15 to 42 cents per transaction. If full cost recovery on an RTGS system were reduced by this amount, user collateral costs but not risks would be equalized between networks. Full collateralization on DNS networks equalizes both user costs and risks.

payments, settlement, public good

Abstract:
The substitution of noncash (check, giro, credit and debit card) payments for cash transactions is of interest for monetary policy and for determining central banks' future seigniorage revenue. We develop a novel method for approximating the share of cash transactions using public information on currency stocks, noncash payments, and card payment technology for 10 European countries. We also provide a forecast of future cash use by country. The trend in cash substitution across countries is quite similar, but the countries themselves are at significantly different stages in this process. The spread of debit and credit card payments has been the key factor behind the substitution away from cash as the use of electronic cash is still in its infancy.

Cash, debit card, payments, tax evasion

Abstract:
This paper summarizes research on U.S. bank cost and profit functions, and their policy implications. The purpose is to provide a backdrop for the likely implications of European financial integration. Scale and scope economies in banking are not found to be important, except for the smallest banks. X-efficiency, or managerial ability to control costs, is of much greater magnitude -- at least 20% of banking costs. Mergers have no significant predictable effect on efficiency -- some mergers raise efficiency but others lower it. Market concentration results in slightly less favorable prices for customers, but has little effect on profitability.

Abstract:
The social cost of a payment system comprises between 1% to 1.5% of GDP. This cost can be reduced if non-cash payments shift from paper to electronics since the cost of an electronic payment is estimated to be from one-third to one-half that of a paper-based transaction.We examine the use of cash and five non-cash payment instruments in 14 developed countries over 1987-1993. Our purpose is (1) to outline the current use of check, paper giro, electronic giro, credit card, and debit card payments and (2) to determine why some payment instruments are used more intensively than others, especially electronic versus paper-based payments.Standard demand theory influences (own price and income), institutional factors, and simple availability measures across countries are examined, as is the effect of habit formation. Payment substitution relationships are also estimated and indicate that checks will decline with further growth of electronic payments while the instruments that make up electronic payments will tend to expand together rather than replace one another.

Abstract:
Synergies in providing financial services can reduce costs due to joint production (cost economies of scope) or raise revenues due to joint consumption (revenue economies of scope). Cost economies of scope between bank deposits and loans were found to be small elsewhere. Revenue economies of scope are investigated here for the first time and found to be non-existent over 1978-1990 for both small and large banks and for those on or off the revenue-efficient frontier. The lack of synergies between deposits and loans--where benefits are most likely to occur--suggests few synergies from an expansion of banking powers.

Abstract:
The deregulation of interest rates in the early 1980s raised bank funding costs and lowered profits. In response, banks raised fees for deposit services, reduced branch operating costs, and shifted to higher earning assets. Rates of return did not regain their pre-deregulation levels until the early 1990s.Our goal is to decompose the change in bank profits following deregulation into (i) internal, bank-initiated adjustments to the new regulatory structure and (ii) external, contemporaneous changes in banks' business environment. This decomposition will depend, in part, on the assumed competitive structure of the banking industry. With perfect competition, output and input prices are part of the external environment and banks' responses are limited to changes in output and input quantities. An alternative approach assumes imperfect competition where banks have some control over output prices (deposit fees, minimum balance requirements, and interest rates on certain loans) and output quantities and input prices comprise the external environment.The alternative model is supported by the data. Using this model, large banks - but not smaller banks - are found to have relied primarily on changing output prices and input use to mitigate and reverse the negative effects of deregulation on profits. The adjustment to deregulation was essentially complete after four years. Following this, additional changes in bank profitability (during the late 1980s) were primarily due to changes in banks' business environment.