The impact of banking regulations on banks' cost and profit efficiency: Cross-country evidence

This paper uses stochastic frontier analysis to provide international evidence on the impact of the regulatory and supervision framework on bank efficiency. Our dataset consists of 2853 observations from 615 publicly quoted commercial banks operating in 74 countries during the period 2000-2004. We investigate the impact of regulations related to the three pillars of Basel II (i.e. capital adequacy requirements, official supervisory power, and market discipline mechanisms), as well as restrictions on bank activities, on cost and profit efficiency of banks, while controlling for other country-specific characteristics. Our results suggest that banking regulations that enhance market discipline and empower the supervisory power of the authorities increase both cost and profit efficiency of banks. In contrast, stricter capital requirements improve cost efficiency but reduce profit efficiency, while restrictions on bank activities have the opposite effect, reducing cost efficiency but improving profit efficiency.