Differences Across First District Banks In Operational Efficiency (Using Best Practices Methodology)

In this article, Robert Tannenwald uses Best Practices Methodology to find which banks are most efficient in the First Federal Reserve District. He also analyzed the trends in efficiency of the banks in that New England district over the course of several years. For the purpose of this article, the author defines Best Practice as an ideal or a business' "maximum attainable performance". This is impossible to calculate precisely, but scholars can approximate it by seeing which businesses operate most efficiently. To this end, the author employs two complex statistical methods to quantify best practices which are models unique to the banking industry --the Stochastic Economic Frontier Approach (SEFA) and the Thick Frontier Approach (TFA).

Strength of the Model:

• Quantifies the impact of superior practices

Weakness of the Model:

• It is hard to identify what criterion to measure for efficiency
• Statistically complex

Methodology:

The author uses SEFA, where regression techniques yield a model in which total cost = a function of variables including input prices and the mix of outputs. The resulting function represents best practice and can be used as a benchmark for evaluating the efficiency of individual banks. The study also uses TFA, which assumes that banks with relatively low average cost (total costs/ total assets) set the standard of efficiency with which experts can compare all other banks of a comparable size.

Results:

Assuming that the methodologies were sound, the banks in New England improved their practices to become more efficient between 1985-89 and 1990-93.

Critique:

These methods of using Best Practices have allure due to the hard numbers they yield. However, the results are only valid if the researcher chooses the right variable to measure in the first place. Also, the statistical complexity of this form of Best Practice task is daunting which makes it an impractical choice for low-stakes analytic exercises.

Source:

This article came from a proprietary database Business Source Elite.