Efficiency Analysis of Financial Institutions in Pakistan

Abstract

The study applied parametric Stochastic Frontier Approach (SFA) and non-parametric Data Envelopment Analysis (DEA) to estimate the efficiency of financial institutions in Pakistan over the period 2005 to 2010. The financial institutions include; commercial banks, insurance companies, mutual funds, leasing companies, modarabas and investment banks which are operating in Pakistan. Present study followed the value added approach for the selection of input and output variables. The study computed technical efficiency, cost efficiency and profit efficiency with the SFA technique whereas, DEA was used to compute the technical efficiency, pure technical efficiency, scale efficiency, allocative efficiency and cost efficiency of the financial institutions in Pakistan. The highest level of efficiency is reported by the mutual funds whereas, lowest level of efficiency is found in the investment banks of Pakistan. Moreover, current study also investigated the scale economies in different financial institutions of Pakistan. The results suggested that the number of financial institutions with Decreasing Return to Scale (DRS) are increased whereas, the number of financial institutions with Increasing Return to Scale (IRS) are dropped over the study period. Furthermore, present study also undertook the Tobit analysis to find the association of various firm characteristics, financial reforms and financial uncertainty with various efficiencies computed with the SFA and DEA techniques. Firstly, the overall results indicated that the firm characteristics have mixed relationship with various efficiencies for each type of financial institution which is due to the fact that these financial institutions are dissimilar from each other. Secondly, financial reforms are found positively related with various types of efficiencies which suggest that the financial reforms have proven fruitful for the financial institutions of Pakistan. Finally, the financial uncertainty is found negatively related with the efficiency of financial institutions which implies that the financial uncertainty has adversely affected the overall performance of financial institutions in Pakistan.