Financial deregulation and allocative efficiency in banking

This study examines the comparative efficiency of banks when they fail to minimize costs. We use an extension of the general framework after Lau and Yotopoulos (1971) to model allocative inefficiency in a non competitive environment. We use the generalized of absolute price inefficiency. We apply this model to a unique data of 45 commercial banks from Pakistan for the period 1991 to 2005. To study the temporal relationship, we divide the sample into pre$deregulation (1991$96) and post$deregulation (1997$05) phases. The joint estimation of the equation system for the generalized translog model is achieved by Iterated SUR model. Our results provide strong evidence of allocative inefficiency, which confirms that Pakistani banks failed to minimize costs due to sub$optimal allocation of banking inputs. Estimates of time variant allocative inefficiency suggest that over$utilization of banking inputs gradually comes closer to unity or to a point where there is absence of allocative inefficiency. These results confirm that deregulation policies in Pakistan’s banking sector have been partly successful in reducing mis-allocation of banking inputs.