Technical and Allocative Efficiency in European Banking

This paper specifies an empirical framework for estimating both technical and allocative efficiency, which is applied to a large panel of European banks over the years 1996 to 2003. Our methodology allows for self-consistent measurement of technical and allocative inefficiency, in an effort to address the issue known in the literature as the Greene problem. The results suggest that, on average, European banks exhibit constant returns to scale, that technical and allocative efficiency are close to 80% and 75% respectively, and that overall economic efficiency shows a clearly improving trend. We also show through the comparison of various estimators that models incorporating only technical efficiency tend to overestimate it.