1.1.1 Efficiency in Commercial Banks
Efficiency can be defined as a level of performance that describes a process that uses
the lowest amount of inputs to create the greatest amount of outputs. Aikeli, (2008)
posits that an efficient banking system reflects a sound inter mediation process and
hence the banks’ due contribution to economic growth. The Efficiency ratio (ER) can also be used as part of fundamental analysis to evaluate
bank efficiency. Hays, Stephen, and Arthur (2009) define the ‘Efficiency ratio’ as a
ratio that measures the level of non-interest expense needed to support one dollar of
operating revenue, consisting of both interest income and non-interest or fee income
and provides its calculation by dividing overhead expenses by the sum of net interest
income and non-interest or fee income. Koch and Scott MacDonald (2003) as cited by
Forster and Shaffer (2005), state that the efficiency ratio is considered the most
popular ratio to evaluate a bank’s performance, in part because it reflects operations
both on and off the balance sheet. Further to this Sibbald & McAlevey (2003) add that
both banking practioners and researches use it alike. Based on the calculation of the
efficiency ratio and how it is derived it therefore follows that the lower the ratio is for
a banking firm, the better the performance and efficiency and vice versa. Sibbald &
McAlevey (2003) attest to this by stating in their study that greater efficiency is
denoted by smaller values of ER which can either be attributed to supply-side
efficiencies whereby a given level of services is being provided at lower cost or
demand-side efficiencies whereby services are of higher quality and thereby
command a higher price in the marketplac
1.1.1 Efficiency in Commercial Banks Efficiency can be defined as a level of performance that describes a process that uses the lowest amount of inputs to create the greatest amount of outputs. Aikeli, (2008) posits that an efficient banking system reflects a sound inter mediation process and hence the banks’ due contribution to economic growth. The Efficiency ratio (ER) can also be used as part of fundamental analysis to evaluate bank efficiency. Hays, Stephen, and Arthur (2009) define the ‘Efficiency ratio’ as a ratio that measures the level of non-interest expense needed to support one dollar of operating revenue, consisting of both interest income and non-interest or fee income and provides its calculation by dividing overhead expenses by the sum of net interest income and non-interest or fee income. Koch and Scott MacDonald (2003) as cited by Forster and Shaffer (2005), state that the efficiency ratio is considered the most popular ratio to evaluate a bank’s performance, in part because it reflects operations both on and off the balance sheet. Further to this Sibbald & McAlevey (2003) add that both banking practioners and researches use it alike. Based on the calculation of the efficiency ratio and how it is derived it therefore follows that the lower the ratio is for a banking firm, the better the performance and efficiency and vice versa. Sibbald & McAlevey (2003) attest to this by stating in their study that greater efficiency is denoted by smaller values of ER which can either be attributed to supply-side efficiencies whereby a given level of services is being provided at lower cost or demand-side efficiencies whereby services are of higher quality and thereby command a higher price in the marketplac
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