Technical efficiency in banks: a review of methods, recent innovations and future research agenda

Abstract

Technical efficiency in banking is a critical aspect of the financial industry and has been widely studied using various measurement techniques. This systematic literature review offers a comprehensive examination of 305 studies on the application of technical efficiency measurement techniques in both Islamic and conventional banking sectors from 1989 to 2019. Our comprehensive analysis not only provides a broad view of the efficiency measurement literature but also outlines a future research agenda. Despite the extensive research in this field, several issues remain unresolved, including input–output selection, a comparison of efficiency between Islamic and conventional banks, limited cross-country studies, and a lack of exploration into the impact of regulation and Shariah principles. To address these gaps, this review highlights the most commonly used methods, variables, and findings and provides three key recommendations for future research. Three key themes emerge from our examination. First, there is a need to better understand and the application of new frontier techniques other than the traditional methods, which currently dominate the existing literature. Second, the intermediation approach is the most frequently used in variable selection, thus more studies with comparative findings with applications of production and value-added approaches are suggested. Third, the most frequently used input variables are ‘labor’, ‘deposits’ and ‘capital’, whilst ‘loans’ and ‘other earning assets’ are the most popular output variables. We recommend three vital directions for future research: (i) non-interest expenses to be included amongst the inputs, while non-interest income should be added to the list of outputs, especially when estimating efficiency scores of Islamic banks. (ii) The impact of environmental variables such as, inter alia, Shariah principles, country-specific factors, and management quality is suggested to be considered simultaneously in models measuring and comparing the efficiency of Islamic and conventional banks. (iii) The selection of performance metrics employed should be expanded to include both the standard efficiency scores and the Malmquist Total Factor Productivity Index (TFP). The paper concludes with research needs and suggests directions for future research.