Banking efficiency in the European Union: 1989-1995

As the European Union enters its third stage of integration, with all member countries adopting a common currency, the EU financial services directives aim to increase competition among the national banking systems by creating a fair level of play for all banks in the region. This study examines the effects of harmonization of financial legislation across all EU member countries on the national banking cost structures. If the EU directives are successful in their goal to increase competition among all banks in the single market, the national banking cost structures should be converging over time.;A stochastic frontier model is used for the empirical analysis, estimating a multiproduct translog cost function. The final model specification estimates a separate cost function for each of the seven years in the sample, while country dummy variables are included in the cost function to capture the cost performance of the national banking systems. The empirical evidence of this study indicates that the intermediation approach (deposits as an input) for defining bank output is more appropriate for modeling production of bank output. The findings suggest that the cost differences of producing bank output between the EU countries are diminishing over time, and thus the EU policy to promote competition through harmonization of banking legislation in the region appears to be successful. Although banking cost differences are diminishing between the 15 EU countries, they have not been eliminated. Germany, Denmark, Belgium, and Austria appear to be the less costly bank output producing nations consistently throughout the sample period. On the other hand, countries like Portugal, Spain, and Greece appear to be consistently the most costly producers of bank output.;The study proceeds to rank the EU national banking systems according to the cost level of producing bank output for each year in the sample. This ranking shows no country moving significantly upwards or downwards through the sample period. This means that even though increased competition among banks for all EU countries has decreased the distance between best performers and worst performers, the latter cannot yet reach the best performers because all countries motivated by competition keep improving their banking cost structure.