Assessing relative efficiency of commercial banks in Bangladesh using the intermediation, production and profitability approaches

Abstract

The economy of Bangladesh has shown an upward trend in the past decade, indicating improved performance overall. Accordingly, banking efficiency is essential for financial stability as well as an economy’s development. It is obvious to have a positive linkage between bank efficiency and economic growth due to the equivalent and effective circulation of money in the market that supports businesses or investments. An efficient banking sector offers sound financial activities with quality loan provisions and, thus, better performance. However, extensive evidence indicates that the banking system in Bangladesh experiences considerable inefficiencies, despite decades of reforms and regulatory scrutiny. Multiple sources have reported that the Bangladeshi banking sector is facing a significant liquidity crisis and record-high levels of non-performing loans. This large amount of non-performing loans (NPLs) indicates inadequate credit evaluation, insufficient oversight, and political meddling in the loan approval procedures. As a result, the efficiency of the banking sector is questionable, suggesting a high level of inefficiency. Therefore, measuring the efficiency level of Bangladeshi commercial banks is crucial. Besides, Islamic banks have been demonstrated to be more efficient than conventional banks. Prior studies further suggested structural deficiencies and inefficiencies in the Bangladeshi banking industry, underscoring the necessity for changes aimed at governance, credit risk management, and resource optimisation. Banks operate their business in several ways in the age of technology and due to the financial crises experienced in recent decades. This research is set to evaluate the relative efficiency of commercial banks and compare the efficiency level between state-owned and private-owned commercial banks, as well as between Islamic and conventional banks in Bangladesh. To achieve these objectives, a total of 38 commercial banks, including 27 private conventional banks, 7 Islamic banks, and 4 state-owned banks, were selected for data collection. Secondary data was collected from the annual reports of each bank, and the Data Envelopment Analysis (DEA) technique was used to measure both the Constant returns to scale (CRS) and Variable returns to scale (VRS) efficiency scores. The results demonstrated a gradual improvement in banking efficiency level, except in the recent period (pandemic period) under the intermediation and production approach. The production approach showed that banks had the highest average efficiency score during the study period compared to other approaches. The findings also showed that private commercial banks were more efficient than state-owned banks in the intermediation and profitability approach. In contrast, publicly owned banks outperformed privately owned banks in the production approach. Henceforth, Islamic banks outperformed conventional banks in terms of efficiency levels under the production and intermediation approaches while underperforming under the profitability approach. The findings of this research contribute in three ways. Firstly, they enhance the literature by aiding empirical evaluation of the efficiency of the banking sector via three banking operations perspectives. Secondly, the results can assist banks in developing inclusive financial products, such as low-income savings accounts or community microfinance instruments, that bolster national initiatives in poverty alleviation and equitable development. Finally, efficient banking practices foster sustainable economic stability and resilience by minimising systemic inefficiency and encouraging financial innovation.