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I would like to thank Liliana Schumacher and Calvin McDonald for proposing this research topic and for their support. Lilana Schumacher has provided detailed comments on several drafts of the paper and offered important insights into the topic. The paper also benefited from comments received before and during an African Department seminar, and comments from the Offices of Executive Directors of Mr. Itam and Mr. Rutayisire.
According to World Bank classification, there are 13 middle-income countries (2006 per capita GNI between US$906 and US$11,115, calculated by World Bank Atlas method) in SSA: Angola, Botswana, Cameroon, Cape Verde, Republic of Congo, Equatorial Guinea, Gabon, Lesotho, Mauritius, Namibia, Seychelles, South Africa, and Swaziland. We exclude Republic of Congo, Equatorial Guinea, and Gabon due to lack of data, and their relatively lower level of financial development compared to other countries in the same group.
Two other efficiency concepts used in the literature are scale efficiency and scope efficiency, which are found to be small in explaining the differences in performance.
There are five common techniques for estimating efficiency frontiers: data envelopment analysis (DEA), free disposable hull analysis (FDH), stochastic frontier analysis (SFA), thick frontier approach (TFA), and distribution free approach (DFA). The first two are nonparametric, and the latter three are parametric techniques in that assumptions are needed for a specific functional form of the unobservable inefficiency process.
Alternatively, the cost efficiency can be defined by the ratio between the cost needed to produce the same output mix as the best-practice bank in sample divided by the actual cost. The frontier value is usually unobservable and for most studies the relative efficiency is more important than absolute efficiency.
Another approach is the production approach, where a bank uses labor and physical capital to produce services. This approach ignores the intermediation function of the bank and does not consider deposit as input for the bank’s production process.
We approximate the price of labor in terms of total assets as data on number of employees for each bank year is not available.
The total expenditure on fixed assets is approximated by total non-personnel operating expenses.
Six indicators are available from the WGI: voice and accountability, political stability and violence, government effectiveness, regulatory quality, rule of law, and control of corruption.
Political stability and violence measures the likelihood that the government in power will be destabilized or overthrown by possibly unconstitutional and/or violent means, including domestic violence and terrorism. Government effectiveness measures the quality of public service provision, the quality of the bureaucracy, the competence of civil servants, the independence of the civil service from political pressures, and the credibility of the government’s commitment to policies.