Bank Competition and Efficiency: The Case of Sri Lanka.

Abstract

The banking theory provides conflicting predictions on the competition-efficiency relationship. This paper provides quantitative estimates of cost efficiency and competition, which have been a lacking in majority of Sri Lankan banking studies. This study draws upon experiences of Sri Lankan banking system during 2003-2007 and regress bank efficiency estimated using Data Envelopment Analysis (DEA) against competition measured in terms of Hirschman-Herfindahl Index (HHI), branch expansion and GDP growth. The regression results show a strong positive effect of competition on efficiency during the period whereas expansion of branch network has a weak negative influence and the macroeconomic environment does not have a statistically significant influence on the banking system efficiency. Recent assessments provided by the study will be useful in formulating necessary institutions to mitigate social cost associated with prevailing inefficiencies and lack of competition in the Sri Lankan banking system.