How to measure banks’ efficiency? Application of data envelopment approach and frontier efficiency analysis: An overview

Abstract

The aim of this paper is to review why and how banks' performance could be measured by observing the findings of different scholars from national and international journal articles. It has been observed that the rationale of measuring bank performance is not questionable because the main reason for the establishment of banks is to mobilize the scarce resources of a given economy from surpluses to deficit areas to maintain the smooth, efficient and effective accomplishment of economic activities. Thus, different tools are being applied by different scholars to measure the banks' efficiency which includes; the traditional financial accounting ratio analysis and frontier efficiency analysis. Studies on the area suggest that financial accounting measures are very primitive and are being obsolete as it lacks to incorporate the risk factor, industry and macroeconomic factors which severely affect the performance of banks. Virtually these deficiencies are currently resolved by the application of frontier analysis, especially data envelopment and stochastic frontier analysis with their own merits and demerits. It is also recommended that scholars can use either of these approaches with their own logical preference and circumstances as well.