Determining cost and profit efficiency of banks using DEA technique and identifying its determinant factors

The objective of this research is to measure cost efficiency and profit efficiency of Iranian commercial banks and to investigate relationship between the measured efficiency and some variables composed of size, capital adequacy ratio, cost to income ratio and profitability. With respect to the above-mentioned objective, this research is accomplished in two steps. First, using DEA technique, cost and profit efficiency of 10 banks over the period of 2006-2010 is calculated. Then, utilizing panel data regression, the correlation between cost and profit efficiency and pre-determined variables is investigated. At the first stage, the sample banks are classified into two groups, i.e., efficient and inefficient, with respect to cost and profit. Moreover, among other findings of this research, is to equip inefficient banks with a path in which they can approach efficiency frontier. In fact, the DEA technique discovers reference units (among efficient banks) in order to determine optimum cost and profit required for inefficient banks. The results arrived from the second phase of this research indicate that some assumed determinants of efficiency including capital adequacy ratio and profitability ratio do not affect significantly the cost efficiency. However, the variables cost to income ratio and size have a significantly negative and positive effect on cost efficiency respectively at the 5% level, indicating that the banks more willing to control costs are more cost efficient and also the larger banks are more taking advantages of economies of scale. Moreover, among other results of this research is that except for the profitability variable, none of the other investigated variables, i.e. capital adequacy ratio, cost to income ratio and size, do not bear any effect on the profit efficiency significantly.