PROBLEM LOANS AND COST EFFICIENCY IN COMMERCIAL-BANKS

This paper addresses a little examined intersection between the proble m loan literature and the bank efficiency literature. We employ Grange r-causality techniques to test four hypotheses regarding the relations hips among loan quality, cost efficiency, and bank capital. The data s uggest that problem loans precede reductions in measured cost efficien cy; that measured cost efficiency precedes reductions in problem loans ; and that reductions in capital at thinly capitalized banks precede i ncreases in problem loans. Hence, cost efficiency may be an important indicator of future problem loans and problem banks. Our results are a mbiguous concerning whether or not researchers should control for prob lem loans in efficiency estimation. (C) 1997 Elsevier Science B.V.