Abstract. Great strides have been made in the theory of bank technology in terms of explaining banks’ comparative advantage in producing informationally intensive assets and financial services and in diversifying or offsetting a variety of risks. Great strides have also been made in explaining sub-par managerial performance in terms of agency theory and in applying these theories to analyze the particular environment of banking. In recent years, the empirical modeling of bank technology and the measurement of bank performance have begun to incorporate these theoretical developments and yield interesting insights that reflect the unique nature and role of banking in modern economies. This chapter gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature.
Keywords: Bank, efficiency, risk, cost, profit, agency costs, X-inefficiency
Correspondence to:
Mester at Research Department, Federal Reserve Bank of Philadelphia, Ten Independence Mall,
Philadelphia, PA 19106-1574; phone: 215-574-3807; fax: 215-574-4303; email:
Loretta.Mester@phil.frb.org.
Hughes at Department of Economics, Rutgers University, New Brunswick, NJ 08901-1248; phone: 732- 932-7517; fax: 732-932-7416; email: jphughes@rci.rutgers.edu.
The views expressed here are those of the authors and do not necessarily reflect those of the
Federal Reserve Bank of Philadelphia or of the Federal Reserve System. This paper is available free of charge at www.philadelphiafed.org/econ/wps/. Introduction
What do commercial banks do? What are the key components of banking technology?
What determines whether banks operate efficiently? The literature on financial intermediation suggests that commercial banks, by screening and monitoring borrowers, can solve potential
moral