The purpose of this paper is to investigate the role of institutional developments – market economy, financial deepening, private sector, property rights and rule of law – affecting the bank efficiency in China.
First, profit efficiency and cost efficiency scores of banks at the firm‐year level were estimated using a stochastic efficiency frontier approach. Then the results were aggregated at the regional level. Regional differences in the timing and extent of the institutional developments impacting bank efficiency were exploited.
It was observed that most institutional variables play an important role in affecting bank efficiency and additionally banks tend to operate more efficiently in those regions with greater presence of private sector and more property rights awareness.
The data on a number of important institutional variables such as property rights and rule of law are not easily available or importantly do not vary that much across years. However, based on whatever information available, it is apparent that institutional development is crucial to bank performance and also eventual economic growth.
This paper is believed to be the first attempt to empirically examine the role of institutional factor affecting bank efficiency especially in a transition country.
