The Cost Efficiency of Commercial Banks in Hong Kong

Abstract

Using the stochastic frontier approach and a panel dataset of retail banks, this paper assesses the cost efficiency of the banking sector in Hong Kong. The average cost inefficiency during the period 1992-2005 is found to be about 15% to 29% of observed total costs, which is largely in line with the experience of US and European banks. Cost efficiency is found to be correlated with macroeconomic conditions, with a significant rise in cost inefficiency triggered by the Asian financial crisis and the outbreak of SARS during the period 1998-2003, partly due to the lack of perfect flexibility by banks to adjust their factor inputs in response to falling outputs. Nevertheless, the cost efficiency has started to improve by 2004 Q1, along with the recovery of the economy, and with the adjustments and streamlining by banks beginning to bear fruit. Empirical results also indicate that cost efficiency is positively correlated with bank size, suggesting large banks are on average more efficient than smaller banks.

Keywords: Hong Kong Banking, Cost efficiency, Stochastic frontier approach

JEL Classification: G14, G21, G28, L11, L22