Determinants of cost efficiency in Commercial banks of Ethiopia

Abstract

Efficiency of a banking sector is crucial for its performance, competitiveness, and profitability. In the context of Ethiopia, analyzing the efficiency of commercial banks is essential particularly at this point in time when the country is liberalizing the sector thereby allowing foreign banks to operate in the country. Thus, this study analyzes the determinants of efficiency of 13 commercial banks,those have at least the latest ten years‟ experience, in Ethiopia by using panel data from 2010 to 2020 obtained from National Bank of Ethiopia and World Bank‟s World Development Indicators. To achieve the objective of this study, explanatory research design is adopted. The study employs fixed effect estimation approach for the empirical analysis. The results show that variables such as bank size, net-interest margin, loan intensity, and non-interest income have positive and significant impact on total cost of banks; and hence they reduce bank efficiency. In the contrary, return on asset and return on equity have negative and significant effect on banks‟ total cost; and as such they enhance bank efficiency. In addition to bank level determinants, this study included inflation and GDP growth as potential macro-economic variables that determine efficiency of commercial banks. The result shows that GDP growth significantly reduces total cost thereby improving bank efficiency while inflation significantly raises total cost hence reducing bank efficiency. The results imply that improving economic growth by increasing GDP growth and stabilizing the economy by reducing inflation is crucial to promote bank efficiency in Ethiopia. The commercial banks and policy makers are recommended to enhance the banks‟ efficiency by reducing total cost of the banks in Ethiopia.