Efficiency Change , Technical Progress and Productivity Growth in Banking : The Initial Post Liberalization Experience of Turkey

This study uses the methodology of X-efficiency theory to examine the impact of liberalization of the Turkish banking sector on the efficiency and productivity of banking firms. The basic proposition of X-efficiency theory is that market structure aspects are critical in determining the optimal behavior of firms in production of services and goods. The degree of competitiveness in a firm’s market, the extent to which it is formed as a part of public sector bureaucracy, the nature of regulatory regime under which a firm operates are among the primary factors that may explain the variations in X-efficiency (Leibenstein, 1978). Also, as the quiet life theory suggests, the lower the intensity of environmental pressures, the lower is the effort expended by managers to derive the maximal output from a given amount of inputs. Moreover, the extent to which a firm has the right organizational or ownership form that presents the necessary managerial skills and incentives to adapt to rapid changes in the operating environment and the extent to which a firm has international outlet for its idle resources or access for new technology are other possible sources of variations in X-efficiency. The economic theory of firm maintains that as entry and exit barriers are reduced, new financial instruments and institutions are allowed, expansion to new markets and regions are permitted, competitive pressures will rise and inefficient banks will either quit or take measures to improve their productivity and efficiency. Thus, in the past twodecades , the policy-makers of many developed or developing countries have undertaken radical liberalization policies to improve the performance and competitive viability of banking sectors. They expected that heightened competition would result in improvements in resource allocation and productivity and efficiency of the financial system, which could bring about reductions in prices and expansions in the amount and quality of services for consumers. As a reflection of the financial liberalization program that was implemented throughout the 1980s, the Turkish financial system has undergone important structural, institutional and legal changes. The abolition of directed credit policies, liberalization of deposit and loan interest rates, liberal exchange rate policies, relaxation of entry barriers, introduction of new financial markets, institutions and services and adoption of international best standard banking regulations among other measures were the main attributes of the 1980s, which have fostered competition in the financial services industry and accelerated the integration of the economy with the world. In the spirit of Leibenstein (1978), this paper is to study the sources of productivity and efficiency developments in banking by ownership, drawing particularly on the initial post liberalization experience of public, private and foreign banks operating in Turkey. A close examination of different groups of banks is very important for policy and research concerns especially in the new environment. First and foremost, to detect the extents and sources of inefficiency (waste of resources) in each organizational form is the first step for policy makers towards writing right prescriptive measures to tackle the current and future problems of these institutions. Second, like virtually in all emerging markets, banks are the dominant financial institution in Turkey, as they control most of the financial flows and possess 75% of the total assets in the financial system. Given the fact that majority of non-bank financial institutions are also affiliates of banks, the dominance of banks in the financial system becomes even greater. Thus, their successes or failures strongly affect the health of the economy at large as demonstrated repeatedly in recent years. Bank markets in emerging economies differ considerably from those in industrialized economies. For instance, in developing countries, institutions are limited in number and type, thus competition is weak; capital markets are narrow and shallow; market participants for financial products are few; asymmetric information problems are substantial, thus transaction costs are high; regulations are inadequate and often used for other purposes than the soundness of the financial system; 1 and the underlying economies are relatively poor and unsophisticated (Akcaoglu, 1998). In addition, banking sectors of these economies are highly concentrated. While three-bank concentration ratio is 0.19 for the U.S. and 0.22 for Japan, it is 0.44 for Turkey, 0.65 for Egypt, 0.69 for Peru, 0.74 for Pakistan and 0.87 for Uruguay (Demirguc-Kunt and Levine, 1999). It is possible that banks of concentrated markets become less motivated to operate efficiently and productively, as they do not face strong competition from new banks and non-bank financial institutions. The lack of