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Chapter-2Literature ReviewOnlyfew related works have been reviewed in order to understand or elicit the efficiencydifferences among private, public and foreign banksin Bangladesh.

Yasmeen (2006), conducted a study to find out the technicalefficiency and productivity growth of various banks in Bangladesh. She examinedfour ratios: two for input and two for output by taking the datafrom 2003-2007 of 35 banks. The findings also providedsome indication on the likelihood of dynamic convergence of these banks’performance as well as the challenges that these banks faced amidrising competition.  Anotherwork had been carried out byKhanam & Nghiem (2004), on the efficiency of commercial banks in Bangladeshand the data consist of only one year on 48 banks.

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Theyconsidered seven ratios of which five were inputs and two wereoutputs. They also found that the technical efficiency score of banks in thesample is 84 percent(income based model)1 and 80percent (user-cost model)2, which is consistent with results from a parametricapproach called parametric linear programming. However, the proof onrelationship between foreign ownership on bank efficiency is not importantfor the income-based model.  Uddinand Suzuki (2011) had undertaken a study to investigate the performance ofcommercial banks in Bangladesh after theimplementation of a significant financial reform. They considered datafrom2001-2008 of 38 banks including state owned, private owned, Islamic and foreignbanks and they had considered three inputs and two outputs tomeasure the efficiency. Their findings indicated that incomeefficiency and cost efficiency of sample banks have increased by 37.84 percentand 15.28 percent in 2008 and 2001 respectively.

On the contrary,private proprietorship has positive influence on efficiency of income, returnon assets, and non-performing loans, whereas unfavorable influence on efficiencyof cost.  Akhtaret al. (2011), used data envelopment analysis to estimate the relevantefficiency of 12 commercial banks of Pakistan.The results of their study offered some very constructive managerialinsightsinto evaluation and advancing of banking operations. The estimated result showsthat 6 banks are relatively efficient when their efficiency ismeasured in terms of ‘constant returns to scale’2 and 8 banks are relativelyefficient when their efficiency is measured in terms of ‘variable return toscale’. However,they suggested that by improving the handling of operating expenses, advances,capital and by boosting banking investment operations, the lessefficient banks can successfully endorse resource utilizationefficiency. Several models based on Data Envelopment Analysis(DEA)-have been developed in order to Operationalize the framework, andtheir use has been illustrated using data for the branches of a commercialBank. Specially, the service-profit chain has been casted as a source ofefficiency measurementmodels.

Exploratory outcome shows that superior insights can be gained by analyzingat onetime operations, service quality and profitability than the informationobtained from benchmarking studies of these three dimensionsseparately (Soteriou 1997).  Fiordelisiet al. (2010), assess the inter-temporal relationships among bank efficiency,capital and risk for the Europeancommercial banking industry.

They build on previous work using Grangercausality methods 3 (Berger and De Young 1997) in a panel data framework. The outcomeshow that restrainedbank efficiency (cost or revenue) Granger causes risk supporting the “badmanagement” and the “efficiency version of the moral hazard”hypotheses. They found only limited evidence of relationshipsbetween capital and risk in line with the moral hazard hypothesis. The findingsshowed lowerefficiency scores (either cost or revenue) suggest greater future risks andefficiency improvementstend to shore up banks’ capital positions. Their findings also emphasize theimportance ofattaining long-term efficiency gains to support financial stability objectives.

 Subsequentlythe profitability test focused by Spong Et Al. (1995), the core distinctions betweenthe most and least efficient banks seem to be highly related to the personnel expenses.In thecontext of important technological improvements in banks’ productive processes,the study suggestedan urgent need for greater labor market flexibility and the consequentsubstitution of labor for capital. In addition,inefficient banks always come up with lower levels of equity/assets and higherlevelsof nonperforming loans.

Their finding also suggested that efficient banks areassigning more attention and resources to loan origination,monitoring and other credit judgment activities. Finally, the analysisalso shows that there is no clear relationship between the size of assets andbank efficiency. Yiweiet al. (2011), found that the average profit efficiency of Eastern Europe isclose to the Central Eastern Europe region,but average cost efficiency leaves considerable room for improvement.Theyalso found that foreign owned banks are somewhat less cost efficient thandomestic private banks. It is also evident that progress in theimplementation of major economic reforms such as enterpriserestructuring and privatization are positively associated with bankingefficiency. Moreover, banking efficiency affects the development of the capitalmarket.

This focuses that the relationship betweenbanks and the capital market is both competitive and supplementary. Whenbanks are very inefficient, an increase in banking efficiency actually resultsin more borrowers migrating to the capital market. Beyond a certainpoint, an increase in the efficiency of banks attracts moreborrowers to banks.

Thus, the quality cut-off that determines which borrowersgo to the market and which go to the banks is non-monotonic with respectto bank efficiency. It may not be possible to develop agood capital market in an economy if it does not have good banks. In this way, theinitial focus in a developing financial system should be on improving the efficiencyof banks.

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