The Technical Efficiency of Nigerian Banks: Microeconomic Theory

Six different views on what constitutes banks’ input and output are recognized. These are production approach (Shearman and Gold, 1985; and Frevier and Lovell, 1990), intermediation theory (Humphrey, 1985), asset approach which is related to financial intermediations theory (Nyong, 2005), user-cost approach (Humphrey, 1991), value-added approach and the modern approach (Ziorklui, 2001).
The Production Approach applied the traditional microeconomic theory of the firm to banking. It considers banks to be producers of bank deposits and loans. The actual output is specified as the number of bank deposit and loan transactions that are processed. Traditional production factors viz; land, labour and capital are used as inputs to produce outputs (Denizer, 2000), which are services for account holders. The output measure used is number of accounts or number of transactions (Nyong, 2005). Ziorklui went further to break down the total cost under this approach to include cost of supplies, expenditure on materials, occupancy costs and expenditure on furniture and equipment. Under this approach, it is believed that an efficient banking system may lead to a lower transaction cost of providing banking services to the public. One major set back of this approach is the measurement of outputs. Another criticism is failure to account for financial intermediation of banks.
Intermediation Theory considers banks as mobilizers of surplus funds, which are then transformed, into loans and other assets. In other words, depository financial institutions are viewed as producers of services related directly to their role as intermediaries in financial markets. In this approach, the deposits collected and funds borrowed from the financial markets are the inputs while the outputs are measured by the volume of loans and investments outstanding. Nyong adds labour employed as part of the inputs while Clerk recognizes both capital and labour as inputs. Proponents of this approach define the banks’ various naira volumes of earning assets including securities investments as measure of output. Other outputs specified under this approach are interbank loans, loans and advances for customers. Costs are defined to include both interest expense and total costs of production. This approach complements the production approach. Mester, however, notes that the choice between production approach and intermediation approach often depends on available data. Here
The Asset Approach is related to the financial intermediation theory. It considers banks as intermediating between liability holders and fund beneficiaries or debtors. Loans and other assets are considered as outputs while the various deposit categories are considered as inputs. The production of deposit services is viewed as merely payment in kind for the use of funds from which to make loans. In effect, Humphrey calls it a “reduced form” model of the banking firm. The main criticism of this approach is its inability to account for transaction services, which many small banks perform or deliver to their depositors.
The User- cost Approach sees the net revenue generated by a particular asset or liability as the main determinant of whether a financial product is an input or output. If the financial returns on an asset exceed the opportunity cost of funds, then the financial instrument should be considered as an output. Thus demand deposits are seen as outputs while time deposits are inputs. Humphrey’s identification of output categories with the exception of time deposit is consistent with that identified in this approach to differentiate bank inputs from outputs. These are five namely; payments and safekeeping output (associated with demand deposits and savings and small denomination time deposits) as well as intermediation and loan outputs (associated with real estate loans, consumer installments and credit loans, commercial, industrial and agricultural loans.