African Journal of Economic and Management Studies

Competition and bank efficiency in emerging markets: empirical evidence from

Ghana
Abdul Latif Alhassan Kwaku Ohene-Asare
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Abdul Latif Alhassan Kwaku Ohene-Asare , (2016),"Competition and bank efficiency in emerging
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Vol. 7 Iss 2 pp. 268 - 288
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AJEMS
7,2
Competition and bank efficiency
in emerging markets: empirical
evidence from Ghana
268 Abdul Latif Alhassan
Received 24 January 2014
Graduate School of Business, University of Cape Town,
Revised 13 April 2014 Cape Town, South Africa, and
Accepted 14 April 2014
Kwaku Ohene-Asare
Department of Operations and Management Information Systems,
University of Ghana Business School, Accra, Ghana
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Abstract
Purpose The purpose of this paper is to examine the relationship between competition and
efficiency in the Ghanaian banking industry.
Design/methodology/approach Data on 26 banks from 2004 to 2011 is used to estimate technical
and cost-efficiency scores by the data envelopment analysis while the Boone indicator is employed to
proxy for competition. Controlling for bank size, lending, income diversification, tangibility, leverage
and profitability, ordinary least squares, instrumental variables and fixed effects estimations are used
to estimate the panel regression model. The authors also apply the growth convergence theory to
examine the existence of efficiency convergence.
Findings The results points to improvements in cost efficiency (CE) and competition within the
banking industry. From the empirical estimations, the findings suggest that competition exerts a
positive influence on CE. The authors also find evidence of convergence in both technical and CE.
Research limitations/implications The study recommends that efforts at improving
competitiveness of the banking industry will translate into lower interest rate spread through improved
CE. This will ultimately improve access to bank credit and impact positively on economic growth. Future
studies could also examine productivity changes and scale economies in the banking industry.
Originality/value To the authors best knowledge, this is the first study to apply the Boone (2001)
indicator in assessing the competitiveness of the Ghanaian banking industry. This is also the first
study to examine efficiency convergence within the banking industry in Ghana.
Keywords Convergence, Competition, Efficiency, DEA, Boone indicator, Ghanaian Banks
Paper type Research paper

1. Introduction
A major driver of competition in financial markets in emerging economies has been the
introduction of financial liberalization policies and strengthening price mechanism
(Hermes and Lensink, 2008). According to Berger and Humphrey (1997), these policies
sought to improve banking efficiency and at the same time limit governments
involvement for an effective market mechanism to enhance the competitiveness of
emerging banking markets and improve consumer welfare. These arguments are
theoretically grounded in the quiet life hypothesis (QLH) of Hicks (1935). According to
its proponents, firms in less competitive markets enjoy monopoly rents which serves as
a disincentive to control cost; leading to inefficiencies. The quiet life thus promotes
African Journal of Economic and
Management Studies inefficient behaviour by firms leading to deterioration in consumer welfare. However,
Vol. 7 No. 2, 2016
pp. 268-288
the promotion of competition within financial services industry has some adverse
Emerald Group Publishing Limited
2040-0705
effects. As argued by the proponents of what we term as the noise market hypothesis,
DOI 10.1108/AJEMS-01-2014-0007 competition may breed anti-competitive behaviour among firms. Efficient firms
 producing at lower cost may also be forced to abandon their pursuit of efficiency goals Bank
and engage in price wars. This practice eventually leads to adverse selection and moral efficiency in
hazard in bank loan markets, hence high probability of default affecting the stability of
the industry. Therefore, market noises (competition) could also results in declining
emerging
efficiencies (Diamond, 1984). markets
Ghanas banking system has undergone several reforms since the banking crises in
1980s with the aim to ensure a stable and competitive banking environment. These 269
reforms have sought to elevate the standards of banking regulations to globally accepted
levels. The banking laws instituted since the financial distress of state banks include the
Banking Law, 1989 (P.N.D.C.L 225), Bank of Ghana Act 2002, Act 612, the Banking Act,
2004 (Act 673) and the Banking Act 2004, Amendment 783. The Banking Law (P.N.D.C.L
225) was revised in 1989 under the Financial Sector Adjustment Programme (FINSAP I).
A revised Bank of Ghana Law (P.N.D.C.L 291) was also enacted in 1992 to give more
supervisory powers to the central bank. These two laws together provided the legal and
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regulatory framework for the banking business in Ghana. The Bank of Ghana Act 2002,
Act 612 sought to strengthen the regulatory capacity of Bank of Ghana in order to
regulate, supervise and direct the banking and credit system and ensure the smooth
operation of the financial sector and also ensure that prudential banking reforms were
adhered to by Ghanaian banks. The Act also established the Banking Supervision
Department headed by an officer of the bank to be responsible for the supervision and
examination of all banking institutions in the country. Banking Act, 2004 (Act 673)
replaced the Banking Law, 1989 (P.N.D.C.L 225) with the objectives of: promoting an
effective banking system; dealing with any unlawful or improper practices of banks; and
considering and proposing reforms of the laws relating to banking business. The
regulations covered the licensing of banks, capital requirements, liquidity, ownership and
control, restrictions on lending, supervision and control and accounts and auditing. The
minimum capital adequacy ratio was increased from 6 to 10 per cent. The Banking
Amendment Act (2007), Act 738 replaced the Banking Act (2004) to further enhance the
soundness and stability of the financial system in this country and also the establishment
of offshore banking and other offshore financial services. Most notable among these
regulations was the introduction of the universal banking licence in Ghana from 2003
which granted banks the opportunity to pursue all banking businesses unlike before
when restrictions were placed on the type of banking businesses depending on licensing
requirements. Since this introduction, banks operating in Ghana increased from 18 in
2003 to 27 as at the end of 2011 (about 50 per cent increase). The increasing number of
banks has led to competition among banks to increase their market share either through
deposit mobilization or loan advancement. With this background, this study seeks to the
answer these questions: has the new universal banking market led to general improvements
in efficiency? How has the resulting competition impacted on industry efficiency?
In answering the research questions, this paper provides empirical contributions on
the competition-efficiency nexus within the Ghanaian banking industry in three steps.
The first step involves the cross-sectional estimations of the Boone (2001, 2008) indicator
to examine the evolution of banking market competition after the introduction of the
Universal banking license. To the best of our knowledge, none of the studies on the
banking industry have applied this indicator in measuring competition. All previous
studies[1] have employed the structural indicator in the Herfindahl Index which is based
on the structure-conduct-performance (SCP) hypothesis that concentration implies less
competition. The Boone indicator (BI) proceeds on the assumption that efficiency lowers
production cost which translates into higher sales and profit.
 AJEMS Second, we estimate technical and cost efficiency (CE) of Ghanaian banks over the
7,2 study period using the data envelopment analysis (DEA). We extend the few studies on
banking efficiency in Ghana (Frimpong, 2010; Saka et al., 2012; Aboagye, 2012) by
proceeding to examine efficiency convergence within the banking industry. Any
evidence of technical efficiency (TE) convergence would reflect technology diffusion
which attest to the ability of inefficient banks to imitate banks on the production
270 frontier (Kumar, 2013). Convergence in CE is necessary for the reduction in wide
intermediation spread which characterizes the banking industry. This would indicate
improvements in industry CE[2]. Inefficient banks with high product pricing would
become cost efficient and reduce product prices. Since effective regulation seeks to
enhance general industry performance, efficiency convergence would help evaluate the
effectiveness of regulatory policies in improving general levels of efficiency in the
banking industry.
Finally, we examine the impact of competition on both cost and technical
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efficiencies. Although Saka et al. (2012) and Aboagye (2012) examined the relationship
between competition and efficiency, the limitations to their studies has been in their
application of structural measure of competition in the Herfindahl Hirschman Index
(HHI) compared to indicators which are based on the new empirical industrial
organization approach such as the BI. For the estimation technique, we favour the
ordinary least squares (OLS) estimation to the two-limit Tobit estimation which treats
the efficiency scores as censored between 0 and 1 as employed by Saka et al. (2012).
In the presence of heteroskedastic disturbance terms, the OLS has been found to
provide consistent estimates in the second stage DEA analysis compared to the Tobit
estimations. We also analyse the relationship in a dynamic framework to provide
robustness to our OLS estimates.
The rest of the study is organized into Section 2 which focuses on stylized facts about
Ghanaian banks, Section 3 reviews related studies on the competition and efficiency
nexus, Section 4 on efficiency estimation and econometric specification. Section 5
discusses the results of the empirical estimation while Section 6 concludes the study.

2. Stylized facts about Ghanaian Banks

2.1 Deposit mobilization and bank lending
The ability of banks to expand their intermediation activities depends on their deposit
mobilizations capacity. Figure 1 represents a trend of loan origination captured as the
ratio of net loans and advances to total assets and deposit mobilization captured as the

80
65 67.9
65.2 63 63.9 72.5
70

60

50
Percentage

52.3
40 50.3
45 43.8
30 40.1 37.8

20

10
Figure 1. Loans Deposits
Trend of loans and 0
2006 2007 2008 2009 2010 2011
deposits (2006-2011)
Source: Bank of Ghana (2012)
 ratio of deposits to total bank liabilities. From the figure, bank deposit mobilization Bank
exhibits an upward trend indicating the continuous reliance of Ghanaian banks on efficiency in
deposits to finance their loan assets. Total industry lending showed a fluctuating trend;
rising initially before falling after 2008. The reduced bank lending may affect business
emerging
and individuals ability to access bank financing. markets

2.2 Bank profitability 271

Banking industry profitability is captured by the spread between interest income and
expense, interest margin to total assets and gross income and returns on assets and
equity. The industrys net interest margin to gross income fell to 46.8 per cent in 2011
from 50.10 per cent in 2010 while the share of net interest income of total assets also
declined to 6.6 per cent in 2011 from 8.4 per cent in 2010. Return on assets exhibited a
marginal increase to 2.8 per cent in 2011 from 2.7 per cent in 2010 but return on equity
decreased to 27.2 per cent in 2011 from 28.6 per cent in 2010 (Table I).
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2.3 Banking industry operational efficiency

Operational efficiency of Ghanaian banks over a five period is presented in Table II. Bank
operational cost consistently accounted for over 50 per cent of bank operating income.
In 2007, the ratio was 59.1 per cent before falling to 58.6, 55.4, 57.5 and 59.5 per cent in
2008, 2009 and 2010, respectively. The ratio however rose in 2011 to 59.5 per cent.

3. Competition and bank efficiency: related studies

The objective of any competition policy is to improve efficiency of firms. However, the
vast body of empirical literature on the impact of bank market competition on
efficiency still remain inconclusive. This section gives a brief theoretical underpinning
of the competition-efficiency nexus and reviews empirical studies on competition-
efficiency relationship in emerging markets that have undergone financial reforms.
These reforms have been the main stay at improving the competitiveness of banking
markets in these emerging economies.

2006 2007 2008 2009 2010 2011

Spread 10.2 8.4 8.6 9.1 11.1 9.7

Interest margin to total assets 7.8 6.4 6.6 6.9 8.4 6.6
Interest margin to gross income 51.8 46.1 41.3 39.4 50.1 46.8
Return on equity 39.6 35.8 30.1 23.6 28.6 27.2 Table I.
Return on assets 3.3 2.6 2.5 2.1 2.7 2.8 Profitability
Source: Bank of Ghana (2012) indicators

2007 2008 2009 2010 2011

Operational cost to gross income (%) 59.1 58.6 55.4 57.5 59.5
Total cost to total assets (%) 11.7 13.8 15.8 14.3 11.6 Table II.
Operational cost to total assets (%) 8.3 9.3 9.7 9.6 8.4 Operational
Source: Bank of Ghana (2012) efficiency (2007-2011)
 AJEMS At the heart of the competition-efficiency nexus is the QLH of Hicks (1935) which posits
7,2 that monopolistic powers breeds inefficiency because of the enjoyment of monopoly
rents by managers experiencing a quiet life from competition. Berger and Hannan
(1998) found that noises in competitive banking environment improves cost
efficiencies of US banks. They argue that, a quiet life in concentrated banking
markets induces incompetent managerial practices since their market power allows
272 them to pass on cost in the form higher prices. Studies that have found empirical
evidence to support the QLH include Petersen and Rajan (1995), Williams (2004),
Schaeck and Cihak (2008) and Maghyereh and Awartani (2014).
On the other hand, competition may lead to inefficiencies in banking industry since
the drive for market share shortens lending relationships, exacerbating the information
asymmetry within the credit market (Diamond, 1984). In testing the competition-
efficiency nexus on banks, Weill (2004), Maudos and De Guevara (2007), Williams
(2012) and Ab-Rahim et al. (2012) provided evidence of an inverse competition-
efficiency relationship indicating that managers experiencing noisy life do not
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necessarily become efficient. Although Casu and Girardone (2006) find no clear
relationship between competition and bank efficiency, Casu and Girardone (2009) find a
positive causality to run from market power to efficiency in EU countries. Turk-Ariss
(2010) also found that competition leads to decreased profit efficiency even though it
improves CE in 60 developing countries using the Lerner Index as an indicator of a
banks pricing power.
In analysing efficiency and technological changes of Korean banks from 1980 to
1994, Gilbert and Wilson (1998) found that banking reforms led to productivity
improvements to contrast Hao et al. (2001) who found little evidence of the impact of
banking reforms on Korean banks efficiency from 1985 to 1995. Maudos et al. (2002)
also found evidence that competition improved CE of Spanish banks from 1985 to 1996.
In a comparative study of banks in India and Pakistan, Ataullah et al. (2004) examined
the evolution of TE during financial market liberalization from 1988 to 1998 and found
improvements in TE in the two countries during the period. Subsequently, Ataullah
and Le (2006) focused on broader set of reforms[3] to provide evidence on the positive
effect of increased competition on bank efficiency in India
Following financial market deregulation in Turkey, Denizer et al. (2000) compared
banking sector efficiency of pre and post-financial liberalization from 1970 to 1994. The
authors find evidence of decline in efficiency in post-liberalization period compared to
pre-liberalization period. While Fu and Heffernan (2007) found improved efficiency for
Chinese banks from financial sector reform, Fu and Heffernan (2009) however found that
the financial reforms had no impact on the structure and efficiency of the banking sector.
Gardener et al. (2011) employed the DEA in studying the efficiency of five South East
Asian countries[4]. Using Tobit estimation, the authors find significant decline in
efficiency after crisis induced restructuring of the banking system. On the African
continent, Hauner and Peiris (2005) concluded that efficiency has improved in the
competitive banking industry in Uganda driven by the efficiency of foreign-owned banks
and larger banks. They also found efficiency to be positively related to bank size and
portfolio diversification. Few studies have considered the link between efficiency and
competition within the Ghanaian banking industry after the seminal work of Buchs and
Mathiesen (2008). Biekpe (2011) finds evidence that the uncompetitive nature of Ghanas
banking industry hindered intermediation efficiency. High overhead costs and economies
of scale enjoyed by larger banks were found to restrict entry into the industry and inhibit
smaller banks ability to compete with larger banks. Mlambo and Ncube (2011) analysed
 examined competition and efficiency of the South African banking system using bank Bank
level data from 1999 to 2008 in a three-step analytical framework. Through the efficiency in
estimation of efficiency and competition indicators using the DEA and the Panzar-Rosse,
respectively, in the first two stages, the authors re-estimated competition controlling for
emerging
efficiency in the third stage. While the authors find general improvements in efficiency, markets
the number of efficient banks declined over the study period. Tabak et al. (2011)
examined the impact of concentration on cost and profit efficiency of 495 banks in Latin 273
America from 2001 to 2008. The authors uses the HHI as the measure of concentration
while the parametric Stochastic frontier analysis (SFA) was employed to estimate
efficiency scores. They conclude that concentration results in declining CE.
In examining the welfare losses arising out of resource misallocation in loan and
deposit market in Ghana using the Harbergers triangle, Aboagye (2012) employed the
SFA to provide evidence that concentration improves efficiency in both loans and
deposit market. By examining the impact of foreign banks entry into the Ghanaian
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banking industry on efficiency, Saka et al. (2012) find that the resultant competition had
improved the efficiency of the banking system. They employed the two-stage DEA
procedure to estimate TE scores in the first stage and Tobit estimation to examine the
drivers of efficiency within the Ghanaian banking system. These two studies employed
the structural measures of market structure in the Herfindahl Index. Kumar (2013)
examined cost and technical efficiencies of public-owned Indian banks from 1992 to
2008 which coincided with the post-deregulation of the banking sector. The author
finds general improvements in both cost and technical efficiencies while test of
convergence provided evidence for the existence of -convergence and -convergence.
Most recently, Using the Simar and Wilson (2007) DEA double bootstrapping
procedure on 70 GCC banks[5] from 2000 to 2009, Maghyereh and Awartani (2014) also
found evidence in support of the quiet life hypothesis. The authors also identified
equity, supervisory power, market discipline and risk as the other determinants of
efficiency among the sampled banks. The above literature clearly points to the lack of
consensus on the effect of competition arising out of financial reforms and deregulation
on banking efficiency. While Gilbert and Wilson (1998), Maudos et al. (2002), Ataullah
et al. (2004), Ataullah and Le (2006) and Fu and Heffernan (2007) found positive
evidence for deregulation, Hao et al. (2001), Denizer et al. (2000) and Fu and Heffernan
(2009) also found negative or no effect of reforms on efficiency. In light of this
knowledge conflict, this paper seeks to provide new empirical evidence on competition
and bank efficiency in Ghana by the employing the recently developed Boone (2001,
2008) indicator as our measure of bank market competition in Ghana.

4. Methodology
4.1 Measuring bank competition: the BI
The structural measures in concentration ratios and Herfindahl Index have
traditionally been used to measure market structure. It is premised on the SCP
paradigm that the structure of an industry reflects the conduct of firms; hence a
concentrated industry implies collusion. However, the new industrial economics
organization paradigm emerged with direct measures of competition in the Breshnan
(1982) model and the Panzar and Rosse (1978) H-statistics[6]. Boone (2001) and Boone
(2008) also developed the BI, which is premised on the efficient structure hypothesis
of Demsetz (1973) that competition drives the performance of efficient firms through
lower production cost and higher market share. Inefficient firms are either forced to
operate on the production frontier or forced out of the market, leading to concentration.
 AJEMS We follow Bikker and Leuvensteijn (2008), Leuvensteijin et al. (2011) and Park (2013)
7,2 and adopt the BI to measure competition within Ghanaian banking industry over the
study period. The equation for estimating the BI is modelled below as:
I nROAi a bI nM C i ei (1)
where ROAi is the return on assets for bank i; MCi the marginal cost for bank i; the BI; i
274 the unobserved error term. In estimating the marginal cost, we follow Schaeck and Cihk
(2010) in using the ratio of the average variable cost[7] to total income over the Translog
cost function due to its simplicity in computation. We estimate Equation 1 on a cross-
sectional basis for each of the study periods to derive the BI, for each year for the industry.
If the o0, it implies that banks with lower marginal cost enjoy higher profitability
through higher market share, hence a competitive bank market. A W0 implies a collusive
and uncompetitive market. For robustness check, we employ the HHI[8] for loans, assets
and deposits as well as the five bank concentration ratio for assets and loans as measures of
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competition. In using the BI for the regression analysis, we multiply the values by 1 for
easy interpretation of the regression coefficients. Positive values for the BIs this indicate
competition while negative values would imply less competition or concentration.

4.2 Measuring efficiency: DEA

In estimating bank efficiency, the non-parametric DEA technique was preferred over
the SFA[9]. The DEA technique measures the relative performance of firms by
comparing multiple inputs and outputs. The efficiency score is estimated as the ratio of
the weighted sum of outputs to weighted sum of inputs. Taking n decision-making
units (hence forth DMU) producing s outputs with m inputs, the efficiency of a DMU p,
is estimated by solving a linear programming (LP) model proposed by Farrell (1957)
and made popular by Charnes et al. (1978) described below:
Xs
max h0 ur yr0
r1
X s
subject to: vi xi0
i1

X
s X
s
ur y r j  vi xi j p 0; j 1; 2; . . .; n (2)
r1 i1

ur ; vi X 0 r 1; 2; . . .; s i 1; 2; . . .; m
where xij is the quantity of input i used by bank j; yrj quantity of output r produced by
bank j; ur and vi the weights chosen for output r and input i, respectively:

min h0 y
X
n
subject to: y0 xi0  lj xi j X 0
j1
X
m
lj r yr j X yr0 (3)
j1
lj 40
 The input-oriented model seeks to minimize cost in achieving a desired level of output. Bank
An efficient DMU has an efficiency score of 1 and serves as the bench mark for the efficiency in
DMUs within an industry and employs the same technology. The modelled LP
assumes constant returns to scale as per Charnes et al. (1978) which implies that each
emerging
DMU operate at their optimal scale and that any increase in inputs will result in markets
proportional increase in outputs. However, when inputs changes results in
disproportional changes in the output variables, the DMUs are said to be operating 275
at variable returns to scale, which Banker et al. (1984) describes as pure TE.
Following Ohene-Asare and Asmild (2012), Saka et al. (2012) and Elyasiani and
Wang (2012), this study employed the intermediation approach which assumes that
banks acts as financial intermediaries in accepting deposits and transferring them into
loan assets for deficit spending units ahead of the value-added and user-cost
approaches. Under either input or output orientation, a DMUs may be assumed to be
operating at an optimal scale (assuming constant returns to scale) or below their
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optimal scale (assuming variable returns to scale). A cost efficient DMU makes use of
the right combinations of various inputs which can be decomposed into TE which
reflects a DMUs ability to maximize outputs from a given set of inputs; whereas
allocative efficient DMU are able to use inputs in a cost minimizing optimal
proportions. Allocative efficiency is defined as the ratio of the CE score to TE score.
This study employed deposits, fixed assets and personnel expenses as inputs and
loans, other earning assets and fees and commission income as the output variables in
line with Ohene-Asare and Asmild (2012). The summary statistics are shown in
Table III. In estimating the CE scores, prices for the input variables used were the ratio
of staff expenses to total assets to proxy for price of labour, the ratio of interest expense
to total deposits as proxy for price of deposits and the ratio of depreciation to fixed
assets as proxy for cost of fixed assets.

4.3 Test of -convergence in efficiency

The expectation of competition policy is the improvements in general level of market
efficiency. We therefore apply the growth concept of convergence to evaluate the
effectiveness of regulatory policy in improving the general level of banking market
efficiency. We estimate the -convergence, which when applied to efficiency, refers to
the ability of inefficient banks to catch-up with efficient ones and become efficient
over time. If inefficient banks are able to improve their efficiency levels more rapidly
than banks which were initially efficient, convergence occurs. In line with studies by

Variables Mean SD Minimum Maximum

Output variables
Investment 116,610,495.48 271,067,584.39 121,927.60 2,204,136,732.00
Loans 267,990,870.85 342,086,294.80 825,957.00 2,065,056,490.00
Fees 11,314,532.30 12,367,270.36 13,355.55 61,150,098.61
Input variables
Staff expenses 13,190,327.92 17,104,955.99 11,708.32 94,760,008.11 Table III.
Fixed assets 19,083,324.96 24,166,317.56 53,892.59 166,951,823.00 Descriptive statistics
Deposits 428,288,257.83 600,134,783.53 2,270,100.00 4,284,732,561.00 of input and
Source: Authors estimation in STATA12 output variables
 AJEMS Fung (2006), Kumar (2013) and Daley et al. (2012), we model the rate of efficiency
7,2 convergence as below:
DEFF i; t a bEFF i; t1 gTREN Dt ei; t (4)
where EFFi, t is the cost and TE scores for bank i in year t; the difference operator for
estimating efficiency growth rate; the rate of convergence to the efficient frontier.
276 Higher values of implies faster rate of convergence if o 0 while W 0 indicates
divergence. Model 2 is estimated with and without the time trend, TRENDt which
captures the path of efficiency improvement for the industry as a whole.

4.4 Empirical model

The relationship between competition and banking efficiency is modelled on the works
of Ariff and Can (2008), Saka et al. (2012) and Elyasiani and Wang (2012).
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fi; t ai b1 BI t b2 SI Z E i; t b3 LOTAi; t b4 N ON i; t

b5 TAN Gi; t b6 LEV i; t b7 ROAi; t ei; t (5)

where i, t is the log forms of technical and CE scores estimated by the DEA; BIt the BI
that proxy for competition in the bank market. SIZEi, t the natural logarithm for total
assets for bank i in period t; LOTAi, t the ratio of gross loans and advances to total
assets for bank i in period t; NONi, t the ratio of fees and commission income to
total operating income for bank i in period t; TANGi, t the ratio of fixed assets to total
asset for bank i in period t; LEVi, t the ratio of total liabilities to bank asset for bank i in
period t; ROAi, t the ratio of profit after tax to total assets for bank i in period t; i the
time invariant effect; and i, t the time variant effects.

4.5 Control variables

Other empirical studies have also looked at firm-specific determinants of efficiency by
examining how firm size, leverage, ownership structure, income diversification,
profitability, capital structure among several others have impacted on the efficiency of
banking institutions. Studies have reported ambiguous relationship between bank size
and efficiency. While Ataullah et al. (2004), Hauner (2005) and Chen et al. (2005) among
several others have found a positive relationship, others (Isik and Hassan, 2003;
Girardone et al., 2004; Weill, 2004) found negative relationship. However, Ab-Rahim
et al. (2012) found varying relationships depending on the form of efficiency considered.
In examining the determinants of CE of Malaysian banks, Ab-Rahim et al. (2012) found
larger banks to be technically and pure technically efficient but scale, cost and
allocative inefficient. Increased bank lending (LOTA) implying higher bank
intermediation could either imply efficient utilization of resources in generating more
loan assets or an indication of risk taking behaviour of the banks (Ariff and Can, 2008;
Lozano-Vivas and Pasiouras, 2010). In respect of the former, a positive relationship is
expected but a negative relationship is expected for the latter. With respect to bank
income diversification (NON), Ariff and Can (2008) find that firms with diversified
income stream to be more efficient for Chinese banks. According to Elyasiani and
Wang (2012) banks with high ratio of intangible assets (TAN) to total assets
(low tangibility) are less efficient. Equity capital (LEV) have been found to exhibit
mixed relationship with efficiency, with higher bank equity (low leverage) found to
improve the efficiency of banks (less efficient; Casu and Girardone, 2006; Carvallo and
 Kasman, 2005; Chang and Chiu, 2006) and vice versa (Altunbas et al., 2007). As per the Bank
agency theory, threat of bankruptcy forces bank managers to be efficient to meet efficiency in
interest expense, hence highly levered (low capitalized) banks are expected to efficient.
On bank profitability (ROA), consistent evidence have been provided for the positive
emerging
relationship between bank profitability and efficiency (see Ataullah et al., 2004; markets
Casu and Girardone, 2006; Chang and Chiu, 2006) but Ataullah and Le (2006) found that
the non-performance of loans offset any efficiency gains in creating earning 277
assets Table IV.

4.6 Data
We employed annual bank level data from 2004 to 2011 for 26 banks out of the
27 banks in existence over the period. The bank exempted was because it had only one
observation for the study period. All the bank level data were sourced from the
Banking Supervision Department of Bank of Ghana. The data are extracted from the
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financial statements (income and balance sheet statements) of the all sampled banks.

4.7 Model estimation

The use of efficiency scores from DEA in the second stage analysis has traditionally
favoured the Tobit estimations with the assumption that the data generating process is
censored between 0 and 1 (Ariff and Can, 2008; Saka et al., 2012; Elyasiani and Wang,
2012). Saxonhouse (1976) and Arabmazer and Schmidt (1984) provided evidence of the
unreliability of the Tobit estimations in the second stage analysis by proving that
heteroskedastic disturbance terms associated with using the scores in the second stage
cannot be accounted for by the Tobit estimation. Simar and Wilson (2007) further
argues that the data generation process of the DEA scores is not censored but rather
truncated, hence second stage estimation should take into account the serial
correlations among the efficiency scores and proposed a bootstrapped truncated
regression in the second stage analysis to correct for such biases. McDonald (2009) also
refutes that the efficiency scores generating process is censored, but fractional data
making the Tobit estimation in the second stage analysis biased. Accordingly, Tobit
estimations of such data generating process becomes inconsistent. Thus, following
Banker and Natarajan (2008) and McDonald (2009) among others the second stage
model estimation was estimated by using the OLS method. With the OLS estimations of
non-spherical error term models inconsistent, this study adopted the panel corrected
standard error (PCSE) estimation of Beck and Katz (1995) to deal with
heteroskedasticity. The efficiency scores are logged for the second stage analysis to

Variables Symbols Expectation

Competition BI +/
Bank size SIZE +/
Intermediation LOTA +/
Income diversification NON +
Asset tangibility TANG +
Leverage LEV +/ Table IV.
Return on assets ROA + Expected results
 AJEMS reduce any simultaneity bias (De Bandt and Davis, 2000). The systems generalized
7,2 method of moments (S-GMM)[10] and the Fixed effects (FE) estimations were employed
as tests of robustness.

5. Empirical results
The results from the BI, estimations from the cross-sectional regressions, the
278 Herfindahl Index and concentration ratios are depicted in Table V. While competition
was intensive between 2004 and 2005 as shown by the negative values of the , the
positive values[11] for 2006 and 2007 indicates strong collusion. After 2007 however, the
intensity of competition improved within the industry with the exhibiting negative
signs necessary for efficient firms to earn higher profit. The evolution (as applied by
Weill, 2013)[12] of BI shows that the industry experienced 9 per cent improvements in
competition which is similar to declines in concentration indicators of 6, 5 and 6 per cent
for the Herfindahl Index in deposit, assets and loan markets, respectively.
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With respect to the estimated efficiency scores, technical, pure technical, scale, cost and
allocative efficiency scores are also presented in Table VI from 2004 to 2011. The CE

Boone indicator HHI

Years HHIDEP HHIA HHIL

2004 0.11 0.12 0.11 0.11

2005 2.15 0.11 0.10 0.10
2006 0.50 0.10 0.09 0.09
2007 1.57 0.09 0.08 0.09
2008 1.43 0.08 0.07 0.09
2009 0.82 0.07 0.07 0.08
2010 0.20 0.07 0.06 0.06
2011 0.20 0.06 0.06 0.05
Mean 0.354 0.088 0.080 0.084
Evolution 0.09 0.06 0.05 0.06
Notes: , Boone indicator; HHIL, Herfindahl Hirschman Index for loans; HHIA, Herfindahl Hirschman
Table V. Index for assets; HHIDEP, Herfindahl Hirschman Index for deposits. Evolution is the difference
Evolution of bank between competition/concentration values in 2011 and 2004 (i.e. 2011-2004)
competition Source: Authors estimation from BoG (2003-2011)

Years TE PTE SE CE AE No. of banks

2004 0.902 0.973 0.928 0.363 0.402 18

2005 0.902 0.968 0.932 0.477 0.529 19
2006 0.918 0.972 0.944 0.458 0.499 23
2007 0.905 0.962 0.941 0.405 0.448 23
2008 0.856 0.961 0.891 0.338 0.395 26
2009 0.846 0.928 0.911 0.582 0.688 27
2010 0.838 0.919 0.913 0.471 0.562 27
2011 0.814 0.907 0.898 0.577 0.709 27
Mean 0.873 0.949 0.920 0.459 0.529
Table VI. Evolution 0.088 0.066 0.030 0.214 0.307
Evolution of bank Notes: TE, technical efficiency; PTE, pure technical efficiency; SE, efficiency; CE, cost efficiency;
efficiency in Ghana AE, allocative efficiency; Evolution, the difference between efficiency scores in 2011 and 2004
 scores ranged between 33.8 and 58.2 per cent implying Ghanaian banks need to improve Bank
their cost efficiencies between the ranges of 66.2 and 41.8 per cent to be on the efficient efficiency in
frontier. On the average, Ghanaian banks need to be 54.1 per cent more cost efficient
(because of average CE of 45.9 per cent) to enable them operate on the efficiency frontier.
emerging
Pure TE accounts for 93.8 per cent of TE compared to scale efficiency contribution of 92.3 markets
per cent. The evolution of efficiency shows declines of 8.8, 6.6 and 3 per cent in technical,
pure technical and scale efficiencies while improvements were recorded for cost[13] and 279
allocative efficiencies at 21.4 and 30.7 per cent, respectively, over the study period.
Table VII reports the results from the test of efficiency convergence. All model
diagnostics indicates a reasonable goodness of fit. The results show that the coefficient
of the initial value (EFFi,t1) of efficiency is negative and statistically significant at
1 per cent for both technical and cost efficiencies. This implies that inefficient banks at
the beginning of the period were able to catch-up with the efficient banks at the end of
the study period. However, we find the rate of convergence to the technical efficient
frontier occurs at a faster rate compared to cost frontier. This is indicated by the
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absolute values for being higher for TE than CE. These results remain consistent
after controlling for time trend. Since the average Ghanaian banks operate closer to TE
frontier (mean of 0.873) compared to the cost efficient frontier (mean of 0.459),
inefficient banks are able to catch-up with the technically efficient banks faster
compared to cost efficient banks. The evidence of convergence is consistent with what
Kumar (2013) found for the Indian public-owned banks during a period of deregulation.
Overall the efficiency analysis reveal that; whereas Ghanaians banks quickly adopt
technology of best performing banks (for inefficient banks to catch-up with efficient
ones), their inability to effectively allocate resources (allocative inefficiency) hampers
the convergence in CE.
Table VIII presents the descriptive results of the variables in the regression model.
The average growth rate in bank assets was 19.64 per cent with the ratio of loans to
assets at 40.4 per cent. Fees and commission income formed 25.2 per cent of total bank
income with average return on assets of 2.2 per cent. Tangibility is at 3.9 per cent while
bank leverage was at 84.9 per cent.

5.1 Test for multicollinearity

The correlation matrix in Table IX was used to identify any possibility of
multicollinearity among the independent variables. Considering all the independent

CE TE
Coef. Coef. Coef. Coef.

Constant 0.662*** 181.46*** 0.164*** 45.394***

EFFi, t1 0.647*** 0.707*** 0.977*** 1.005***
Trend 0.090*** 0.023***
F(1, 115) 64.85*** 39.51*** 96.91*** 55.13***
R2 0.3606 0.4094 0.4552 0.4895
Hausman 2
23.41*** 36.31*** 17.68*** 27.53***
Banks 26 26 26 26
Observations 142 142 143 143 Table VII.
Notes: Estimations were based on the fixed effects estimations based on the Hausman test results. -convergence
***Significant at 1 per cent estimate
 AJEMS Mean SD Minimum Maximum n
7,2
SIZE 19.640 1.263 16.20 22.45 205
LOTA 0.404 0.142 0.04 0.70 205
NON 0.252 0.101 0.02 0.57 205
TANG 0.039 0.036 0.00 0.28 205
LEV 0.849 0.122 0.13 1.13 205
280 ROA 0.022 0.046 0.16 0.32 205
Notes: SIZE, the natural logarithm of total assets; LOTA, loans to total assets ratio; NON, ratio of
Table VIII. interest income to total income; TANG, ratio of fixed assets to total assets; LEV, ratio of total liabilities
Summary statistics to total assets; ROA, return on assets
of model variables Source: Authors estimation in STATA12
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BI SIZE LOTA NON TANG LEV ROA

BI 1
SIZE 0.028 1
LOTA 0.096 0.197*** 1
NON 0.120* 0.008 0.014 1
TANG 0.076 0.459*** 0.072 0.029 1
LEV 0.153** 0.113 0.165** 0.162** 0.221*** 1
ROA 0.124* 0.134* 0.022 0.110 0.036 0.115* 1
Table IX. Notes: BI, Boone indicator; SIZE, natural logarithm of total assets; LOTA, loans to total assets ratio;
Correlation matrix NON, ratio of interest income to total income; TANG, ratio of fixed assets to total assets; LEV, ratio of
for explanatory total liabilities to total assets; ROA, return on assets. *,**,***Significant at 10, 5, 1 per cent levels,
variables respectively

variables, the correlation coefficients of less than 0.05 indicates that their inclusion
will not result in any multicollinearity issues since they are less than 0.70
(Kennedy, 2008).

5.2 Efficiency and competition relationship

Table X presents the results of the empirical estimation using the BI as our measure of
competition. The model is estimated using the panel-corrected standard errors (OLS-
PCSE), FEs and system generalized method of moments (S-GMM) estimation
techniques. All estimation diagnostics points a significant fit of the regression models.
The test of overidentifying restrictions for the two-step S-GMM points to the validity of
the instruments used while theres no evidence of second order serial correlation.
Using TE as the dependent variable, we find an insignificant relationship with the
BI[14]. However, the results show a significant positive relationship between CE and
the BI across all estimations at 1 per cent significance level. This implies that
competition improves cost efficiencies within the banking system and is consistent
with Berger and Hannan (1998), Schaeck and Cihak (2008) who found similar results in
US and EU banks, respectively, whilst Turk-Ariss (2010) also found similar results for a
sample of developing countries. This supports the existence of quiet life in Ghanaian
banking industry implying bank managers have no incentive to be cost efficient in
concentrated industry. In a competitive banking market, price becomes a tool for
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Technical efficiency Cost efficiency

OLS-PCSE FE S-GMM OLS-PCSE FE S-GMM
Coef. z Coef. t Coef. z Coef. z Coef. t Coef. z

Constant 0.542* 1.81 0.225 0.52 0.629 1.6 13.183*** 12.04 9.187*** 6.36 11.525*** 13.55
L.DEP 0.07061 0.26 0.309*** 2.75
BI 0.005 0.33 0.002 0.12 0.004 0.25 0.173*** 3.18 0.182*** 3.4 0.190*** 5.28
SIZE 0.038*** 2.63 0.026 1.29 0.04** 2.2 0.554*** 10.75 0.343*** 5.02 0.460*** 10.84
LOTA 0.173 1.54 0.293** 2.13 0.161 0.89 1.638*** 4.06 2.273*** 4.78 2.036*** 3.15
NON 0.398*** 2.76 0.330* 1.83 0.186 1.59 0.536 0.92 0.797 1.33 0.819 1.08
TANG 2.283*** 3.85 1.411* 1.8 2.371** 2.41 1.8 1.00 1.561 0.6 0.406 0.13
LEV 0.007** 2.01 0.004 0.92 0.004 0.77 0.019 1.43 0.02 1.22 0.02 1.54
ROA 0.382 0.89 0.675 1.57 0.519 0.81 1.13 0.81 3.043** 2.21 2.007 1.16
Wald 2(7) 28.83*** 213.96***
F(7, 145) 2.4** 12.94***
R2 0.1387 0.103 0.5391 0.3846
AR(1): p-values 0.006 0.003
AR(2): p-values 0.958 0.147
Hansen J: p-values 0.463 0.399
Instruments 22 22
Instruments ratio 1.18 1.182
Banks 26 26 26 26 26 26
Observations 180 180 143 178 178 142
Notes: BI, Boone indicator; L.DEP, A years lag of the dependent variable; SIZE, natural logarithm of total assets; LOTA, loans to total assets ratio; NON, ratio
of interest income to total income; TANG, ratio of fixed assets to total assets; LEV, ratio of total liabilities to total assets; ROA, return on assets; OLS-PCSE,
ordinary least squares panel corrected standard errors; FE, fixed effects; S-GMM, system generalized method of moments; AR(1), first order serial correlation;
AR(2), second order serial correlation. *,**,***Significant at 10, 5, 1 per cent levels, respectively
markets
emerging

indicator
bank efficiency;
Competition and
Bank

Table X.
281

using Boone
efficiency in
 AJEMS gaining competitive advantage, hence the improvements in input-output combinations
7,2 at the minimal cost (Cetorelli, 2001). This finding is however inconsistent with Aboagye
(2012) and we attribute this to his measure of competition[15].
On the impact of control variables on banking efficiency, large banks were found to
be technically inefficient (Girardone et al., 2004; Weill, 2004) but cost efficient (Ataullah
et al., 2004; Chen et al., 2005). The CE could be attributed to economies of scale and
282 scope enjoyed by large banks which enable them produce at lower cost. This we argue
could result from the market power of large banks who have the ability to source
deposits at lower cost (Hauner, 2005). This finding is inconsistent with Ab-Rahim et al.
(2012) who find large banks to be technically efficient but cost inefficient but is in line
with the finding Biekpe of (2011) that larger Ghanaian banks are more cost efficient
compared to smaller banks.
Bank intermediation function was found to exhibit significant positive relationship
with both technical and cost efficiencies but the impact was more pronounced on CE
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compared to TE[16]. This implies that increases in loan origination helps banks to
operate closer to their optimal scale of operation as they maximize their output in
producing more loan assets. Bank income diversification activities were found to have
significant positive relationship with TE at 1 and 10 per cent in the OLS and FE
estimations but insignificant relationship with CE. By adding to their traditional
interest income, banks are able to maximize their outputs drawing them to their TE
frontier at little or no cost since most of these non-interest generating activities requires
little or no set up cost. This finding is in line with that of Ariff and Can (2008). The
structure of banks asset as captured by tangibility (TANG) was also found to have
negative relationship with bank TE at 1, 10 and 5 per cent significant levels in the OLS-
PCSE, FE and S-GMM estimations, respectively. This implies that as banks increase
their investment in fixed assets, they are not able to maximize productivity moving
them further away from their efficiency frontier. This results is inconsistent with
Elyasiani and Wang (2012) who find banks with high intangible assets (low tangibility)
are less (more) efficient. Leverage was found to negatively influence bank TE at
5 per cent in the OLS-PCSE estimation while showing no significant relationship with
cost efficiencies. This finding is also consistent with the findings of Casu and Girardone
(2006). Carvallo and Kasman (2005) and Chang and Chiu (2006) who provided evidence
of significant positive relationship between bank leverage and efficiency. While return
on assets was positively related to TE but insignificant in all the estimations, it
exhibited significant negative relationship at 5 per cent with CE in the FEs estimation.
The negative relationship between bank profitability and CE could be explained by
non-performance of bank loans[17] which offset any gains from loan origination
activities and is consistent with Ataullah and Le (2006) who found a negative
relationship with return on assets and efficiency in Indian banks after economic
reforms.

6. Conclusions and recommendations

This study sought to provide an understanding of the effect of competition on both
technical and cost efficiencies of Ghanaian banks by employing the two-stage DEA
on 26 Ghanaian banks from 2004 to 2011. The efficiency scores estimated under the
input-orientation assuming constant returns to scale were decomposed into technical
and cost efficiencies and used as the dependent variables while employing the recently
developed Boone (2008) indicator as our competition measure. We also examine the
convergence of efficiency in the banking industry.
 The average Ghanaian bank was found to operate closer to the TE frontier Bank
compared to its CE frontier and the source of the cost inefficiency was largely driven efficiency in
by allocative inefficiency. While there had been general improvements in CE,
TE declined over the study period. The convergence analysis finds evidence of
emerging
-convergence that inefficient banks were able to catch-up with efficient banks. markets
However, convergence by inefficient banks to TE was faster compared to CE.
The high levels of cost inefficiency among Ghanaian banks accounts for the slow 283
rate of CE convergence. The evolution of competition shows that improvements in
competition was experienced over the study period. In examining the effect of
competition on bank efficiency, we find robust evidence for a positive relationship
between competition and cost efficiency to indicate that CE improves in the
competitive banking market. With market power, banks are able to pass on any
increased cost to consumers in concentrated markets because of the quiet-life bank
management enjoy. On the other determinants of bank efficiency, while we find large
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banks and banks are cost efficient, smaller banks are found to be more technically
efficient. Increased bank intermediation activities were found to improve CE. Bank
non-intermediation activities was also found to improve technical improve while
having no effect on CE. Both asset tangibility and leverage lead to declines in TE
in Ghana. In summary, we conclude that competition has had a positive effect on
CE in the Ghanaian banking industry although the rate of convergence to a state of
one price has not been as quick as the convergence in technical ability.

6.1 Implications of the findings

The results of this study have policy implications for the management and regulation
of the banking industry. The results of the DEA analysis suggests that more have to be
done to improve the low level of CE by aiming at achieving the best mix of their inputs
to be able to maximize output. We recommend that efforts at enhancing the
competitiveness of the banking industry should be intensified by the regulator and
other stakeholders to improve CE and convergence. This would lead to low production
cost reduction in terms of loan pricing which is among the highest in the sub-region.
Finally, the significant determinants of efficiency should serve as indicators to bank
management who are always concerned with ways of improving performance.
Specifically, the conflicting effect of bank size on technical and CE scores implies a
trade-offs and should serve as a guide for bank management in operating with the size
that optimizes both technical and cost efficiency.
Future studies can be carried out to improve the study in several ways. One area
that could be of interest to researchers would be an assessment of the impact of foreign
banks in enhancing efficiency convergence. Our data could not permit us to classify our
sample based on the ownership type. Additionally, studies could also examine the
impact of the new regulatory regime on the productivity changes and economies of
scale analysis in the banking industry. Finally, the causal relationship between
efficiency and competition could also be added to the menu for future researchers.

Acknowledgements
This paper was prepared while the corresponding author was a Teaching Assistant at
the Department of Finance at the University of Ghana Business School. He is currently
pursuing his PhD at the Graduate School of Business, University of Cape Town,
South Africa. The authors appreciate the insightful comments of two anonymous
 AJEMS reviewers on the final draft of the paper. The authors are grateful for the comments by
7,2 participants at the Tenth African Finance Journal Conference in Durban, South Africa
in May, 2013. The authors are also acknowledge the help of Gifty Adjei-Mensah for
proofreading the final draft of the paper. All other errors are of the authors.

Notes
284 1. This refers to studies examining competition and efficiency relationship, e.g. Saka et al.
(2012) and Aboagye (2012).
2. This indicates the convergence towards the one price law (Weill, 2009).
3. Financial reforms, fiscal reforms and private investment liberalization.
4. Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.
5. Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates.
6. This measure is based on a reduced form revenue function which measures revenue
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elasticity to changes to input prices.

7. Made up of operating expenses and staff cost.
8. The HHI is measured as the sum of the squares of the market of each bank.
9. We prefer the DEA to SFA to avoid the possibility misspecification errors normally
associated econometric modelling. Cummins and Zi (1998) also provide evidence that results
from the SFA are not different from the DEA efficiency scores.
10. To deal with possible endogeneity and reverse causality biases, the systems GMM uses the
lagged differences of the explanatory variables as instruments instead of the level variables
as the instruments. We employ the xtabond2 command in STATA12 for the estimation.
See Roodman (2009) for more on xtabond2.
11. Leuvensteijin et al. (2011) and Tabak et al. (2012) also found positive values for the .
12. He examined convergence in bank competition among EU countries.
13. Isshaq and Bokpin (2012) also find evidence of improvements in cost efficiency.
14. To enable easier interpretation of the Boone coefficient, we multiply by 1 so the positive
value would imply competition and negative values would imply concentration or less
competition. This is only done for the regression estimations.
15. Aboagye (2012) employs the Herfindahl index for concentration as his proxy for competition.
16. The coefficients for LOTA was higher across all estimations in the cost efficiency model
compared to the technical efficiency model.
17. Non-performing loans of Ghanaian banks have been found to pose a threat to the stability of
the financial system in Ghana (IMF, 2011).

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Further reading
Aboagye, A.Q.Q., Akoena, S.K., Antwi-Asare, T.O. and Gockel, F.A. (2008), Explaining interest
rate spreads in Ghana, African Development Review, Vol. 20 No. 3, pp. 378-399.
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Working Paper No. 9(143), IMF, Washington, DC.
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the case of Uganda, Applied Economics, Vol. 40 No. 21, pp. 2703-2720.
King, R.E. and Levine, R. (1993b), Finance and growth: Schumpeter might be right, Quarterly
Journal of Economics, Vol. 108 No. 3, pp. 717-737.
Levine, R. (1997), Financial development and economic growth: views and agenda, Journal of
Economic Literature, Vol. XXXV No. 2, pp. 688-726.

Corresponding author
Abdul Latif Alhassan can be contacted at: lateef85@yahoo.com

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