Determinants of Banks and Financial System Efficiency in Nigeria: A Stochastic Frontier Approach (SFA)

Abstract

This study adopts the relatively novel stochastic frontier analysis approach in examining cost efficiency and its determinants in the Nigerian banking sector, focusing on the dual effects of bank specific factors and macroeconomic variables. Data were sourced from the annual reports of sixteen Nigerian commercial banks over a 13-year period, spanning from 2006 to 2018. The results show that Nigeria banks are generally cost-efficient with asset quality and regulatory quality enhancing the efficiency, while inflation and financial capital undermines it. The efficiency score measures how efficient banks are in the combination of labour, capital, and financial capital to produce an optimal combination of deposits collection and loans creation. The banks are estimated to be efficient at 82 percent given their strategy of transforming deposits into short- and long-term loans, with macroeconomic stability contributing significantly to banks and financial system efficiency.