Working Paper

Problem Loans and Cost Efficiency in Commercial Banks

Abstract: This paper addresses a little-examined intersection between the problem-loan literature and the bank-efficiency literature. We employ Granger causality techniques to test four hypotheses regarding the relationships among loan quality, cost efficiency, and bank capital. The data suggest that problem loans precede reductions in measured cost efficiency; that measured cost efficiency precedes reductions in problem loans; and that reductions in capital at thinly capitalized banks precede increases in problem loans. Hence, cost efficiency may be an important indicator of future problem loans and problem banks. Our results are ambiguous concerning whether or not researchers should control for problem loans in efficiency estimation.

Keywords: Commercial banks; cost efficiency; loan quality; Granger causality;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Number: 1997-08

Pages: 30 pages