International Journal of Productivity and Performance Management

Modeling bank branch profitability and effectiveness by means of DEA

Ioannis E. Tsolas

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Ioannis E. Tsolas, (2010),"Modeling bank branch profitability and effectiveness by means of DEA",
International Journal of Productivity and Performance Management, Vol. 59 Iss 5 pp. 432 - 451
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IJPPM
59,5

Modeling bank branch

profitability and effectiveness
by means of DEA

432

Ioannis E. Tsolas
National Technical University of Athens, Athens, Greece

Received December 2008

Revised November 2009
Accepted November 2009

Abstract
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Purpose The purpose of this paper is to provide a framework for evaluating the overall
performance of bank branches in terms of profitability efficiency and effectiveness.
Design/methodology/approach Applying a two-stage DEA model to a sample of bank branches
of a large commercial bank in Greece this study disaggregates overall performance into profitability
efficiency and effectiveness.
Findings The results indicate that superior insights can be obtained by employing the proposed
two-stage DEA model compared to the outcomes from the analysis based on selected key performance
indicators (KPIs). Some relations between profitability efficiency and effectiveness are also
investigated.
Originality/value The study highlights the importance of encouraging increased profitability and
efficiency throughout the branch network of the commercial bank under study.
Keywords Banking, Banks, Process efficiency, Organizational effectiveness, Data analysis, Greece
Paper type Research paper

International Journal of Productivity

and Performance Management
Vol. 59 No. 5, 2010
pp. 432-451
q Emerald Group Publishing Limited
1741-0401
DOI 10.1108/17410401011052878

1. Introduction
To maintain viability and to improve competitiveness, commercial banks in Greece are
currently restructuring the operation of branch networks. Branches are a major
delivery vehicle of business volume in banking and the performance of the branch
network is bound to have a significant impact on the bank performance as a whole.
The Greek financial system is dominated by banking institutions. In the end of
2006, domestic commercial banks controlled approximately 86.5 per cent of the total
asset pool, followed by foreign owned banks operating in Greece (10.1 per cent),
cooperative banks (0.8 per cent) and special credit organizations (2.6 per cent) (Bank of
Greece, 2007). The banking sector has significant growth potential since Greek banks
have a lower branch density relative to population compared to the Eurozone average
(3.2 versus 5.4 branches per 10,000 inhabitants). As they conduct a relatively smaller
business volume from their branch networks, profitability and size can be improved by
a concerted effort to expand their network and increase their services penetration in the
economy.
The problems that Greek banks face are related to the declining income to cost ratio,
the low turnover of the retail network, the high percentage of non-performing loans, the
lengthy legal bankruptcy procedures that lower the value of collateral in case of
default, and the high cost of capital. They also face competition from foreign banks
that have a significant edge in terms of banking know-how and technology
(Hardouvelis et al., 2006).

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The banks are forced to re-evaluate their branch networks in order to identify the
business drivers and improve the performance of their branches. The availability of
performance analysis tools of bank networks can contribute positively in this effort.
Among them a linear programming-based benchmarking technique, called data
envelopment analysis (DEA), has been gaining increasing popularity as a viable
technique for the analysis of branch performance. The employment of such a technique
can assist in restructuring branch networks by gaining insight into the operation of the
branches so that managerial actions can be taken to improve their performance (Berger
and Humphrey, 1997; Oral and Yolalan, 1990; Sherman and Gold, 1985; see also
Manandhar and Tang, 2002).
DEA has successfully been used to provide bank branch benchmarks, when
multiple outputs and multiple inputs are considered. However, even though some DEA
models appeared in the literature address issues of profitability and effectiveness (Ho
and Zhu, 2004), most DEA models developed to assess bank branch performance do
not assess both profitability and effectiveness as different dimensions of performance.
This paper aims to provide a framework for evaluating the overall performance of
bank branches in terms of both profitability efficiency and effectiveness. The case
study presented here concerns a sample of branches of a large commercial Greek bank
(henceforth simply The Bank). We focus on the branch network, since The Bank
that provided the data set used in this study was interested in gaining insights into the
performance of its network of branches as a first step in comparing the results of a
DEA assessment with the results of an in-house performance measurement model
(referred to as PMM henceforth).
The current study deviates from previous studies in several respects. First, we focus
separately on both profitability efficiency and effectiveness, as components of a new
overall performance metric concept. This is the overall performance
(profitability-effectiveness measure) extracted from the DEA-profitability efficiency
and DEA-effectiveness measures. Our findings provide direct guidance for the optimal
deployment of cost input categories and the scale of outcomes produced in terms of
income categories and net income. In particular, we aim at answering the following
three questions:
(1) What is the most efficient level of cost categories in generating income?
(2) What is the most efficient level of income (interest and non-interest) in
generating profits?
(3) Is there a correlation between bank branch profitability efficiency and
effectiveness?
Second, the research is designed to measure the branch-level profitability efficiency
and effectiveness of The Bank compared to the in-house PMM by answering one more
question:
(4) Is there a correlation between DEA measures and PMM outcomes?
In Section 2 we include a brief review of the relevant literature. Section 3 provides the
conceptual framework and briefly outlines the DEA methodology and the proposed
models. The data sources along with identification of inputs and outputs for the case
study are reported in Section 4. Section 5 discusses the findings from the empirical
analysis. Section 6 concludes the paper.

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2. Survey of branch efficiency evaluation

DEA models that have been used in branch banking performance have approached the
subject from a production, intermediation and profitability perspectives (Paradi et al.,
2004; Giokas, 2008a).
In the production approach branches are considered as units that deliver services to
their clients in the form of transactions or number of accounts produced. Production
(operating) efficiency evaluates the branch operation in the use of resources (e.g. labor,
capital, space) in service production (e.g. number of transactions); see, e.g. Al-Faraj et al.
(1993), Drake and Howcroft (1994), Parkan (1987), Sherman and Gold (1985).
The intermediation approach considers various types of costs as the inputs that are
combined to support the income generating accounts. In this case, branches play an
intermediate role and the idea behind the intermediary model is to examine the banks
ability to take in deposits and sell the money in the form of loans and other
income-earning activities.
In the profitability approach it is examined how well different branches combine
their resources (i.e. expenses) to produce revenues. Profitability efficiency evaluates the
ability of branches to minimize the cost of resources for the level of revenue generated
from different activities (e.g. Athanassopoulos, 1997; Oral et al., 1992; Oral and Yolalan,
1990; Soteriou and Zenios, 1999; Manandhar and Tang, 2002). In the profitability
efficiency assessment the objective function of DEA models is the ratio of the weighted
sum of revenues to the weighted sum of expenses, i.e. an indicator of profitability (Oral
and Yolalan, 1990; Athanassopoulos, 1997; Giokas, 2008a).
Published DEA studies of branch banking are numerous, see Paradi et al. (2004) for
a recent survey, but Greek studies are relatively few, see Vassiloglou and Giokas
(1990); Giokas (1991, 2008a, b); Athanassopoulos (1997); Athanassopoulos and Giokas
(2000). Studies of DEA applied to branch banking in Greece with their specific features
are presented in Table I.
DEA studies that analyze bank branch efficiency in other countries are those of
Sherman and Gold (1985), Tulkens (1993), Drake and Howcroft (1994), Haag and Jaska
(1995), Sherman and Ladino (1995), Athanassopoulos (1998), Berger et al. (1997), Lovell
and Pastor (1997), Camanho and Dyson (1999, 2005), Zenios et al. (1999), Schaffnit et al.
(1997), Golany and Storbeck (1999), Avkiran (1999), Kantor and Maital (1999), Soteriou
et al. (1999), Cook et al. (2000), Cook and Hababou (2001), Dekker and Post (2001),
Hartman et al. (2001), Bala and Cook (2003), Portela et al. (2003, 2004), Paradi and
Schaffnit (2004) and Portela and Thanassoulis (2005, 2007).
Our work differs from previous studies by focusing on a two-stage DEA model
formulation, based on DEA-profitability efficiency and DEA-effectiveness measures,
keeping each measure independent from each another.
The two-stage concept in DEA dates back to the work by Schinnar et al. (1990) to
measure the performance of mental health care programs, see Kao and Hwang (2008)
for a recent survey. The two-stage DEA method keeping each stage in the two-stage
production process independent from one another (i.e. the second stage uses the
outputs of the first stage as its inputs) was applied by Wang et al. (1997) to assess
information technology impact on firm performance, see also Rho and An (2007) for a
survey. Other works appeared in the banking literature are those by Seiford and Zhu
(1999) to divide the production process of a commercial bank into marketability and
profitability, Chen (2002) to analyze banking operations, Luo (2003) to evaluate the
profitability and marketability efficiency of large banks and Ho and Zhu (2004) to

Inputs

Radial: CCR-O

Radial: BCC-I
Radial: BCC-I
Radial: BCC-I
Radial: BCC-I

PA

PA
TE
IA
PA

Non-radial: BCC

IA

Radial: CCR-I

Radial: CCR-I

PA

PA

Radial: CCR-I, BCC-I

Radial: CCR-I

PA

PA

171

44
44

44

47

47

68

68

17

20

Sample size (number

of branches)

Notes: PA: Production approach; IA: Intermediation approach; TE: Transaction efficiency (Giokas, 2008a), CCR-I: CCR (Charnes et al., 1978) input-oriented model,
CCR-O: CCR output-oriented model, BCC-I: BCC input-oriented model

Giokas (2008b)

Giokas (2008a)

Athanassopoulos and
Giokas (2000)

Transactions

Outputs

Weighted number of transactions:

deposit and capital transfers, credit,
foreign receipts
Number of deposit accounts, number
of credits, number of debits, number
of loan applications evaluated,
number of transactions on services
involving commissions
Total non-interest costs, total
Non-interest income, total volume of
interest costs
loans, time deposit accounts, saving
deposit accounts, current deposit
accounts
Labor hours, branch size, computer Number of transactions: easiest,
terminals, operating expenditure
medium-easy, most-difficult, credit
transactions, deposit transactions,
foreign receipts
Labor, operating cost, running costs Income from commissions, volume of
of the building
loans, accounts: time deposit,
savings deposit, current deposit,
demand deposit
Personnel costs, Running and other Value of loan portfolio, value of
operating costs
deposits, non-interest income
Personnel costs, running costs and Loan transactions, deposit
other operating costs
transactions, remaining transactions
Interest costs, non-interest costs
Interest income, non-interest income
Personnel costs, running costs,
Value of deposits, value of loans,
operating expenses
non-interest income

Vassiloglou and Giokas Labor, expenses, space (rent),

(1990)
number of ATMs
Giokas (1991)
Person hours, utilized branch space
(square meters), other operating
expenses
Athanassopoulos (1997) Number of employees, aggregate
number of ATMs and teller
machines, number of computer
terminals

Publication

Efficiency measure
(DEA model: type and
Approach orientation)

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Modeling bank
branch
profitability
435

Table I.
Studies of DEA applied to
branch banking in Greece
with their specific
features

IJPPM
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436

measure the performance of Taiwans commercial banks. Related studies are those by
Zhu (2000) to analyze the financial efficiency of firms, Sexton and Lewis (2003) to
measure the efficiency of the American Major Baseball League, Chen and Zhu (2004) to
measure information technologys indirect impact on firm performance, Kao and
Hwang (2008) to decompose the efficiency of non-life insurance companies in Taiwan
into the product of the efficiencies of the two sub-processes, and Chen et al. (2009) to
examine relations and equivalence between the approaches of Chen and Zhu (2004) and
Kao and Hwang (2008).

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3. The conceptual framework

The proposed framework, which is referred to as the overall performance model,
encompasses two performance dimensions as depicted in Figure 1. The model
specifically incorporates a direct measure of profitability efficiency and its integration
with an effectiveness model; see also Ho and Zhu (2004).
The performance metric Net income/Total cost ratio (overall performance) assesses
the level of total cost to achieve the expected level of net income generation, and could
be treated as overall performance in this study. It can be disaggregated into
profitability and effectiveness as follows:
Net income=Total cost ratio overall performance
Net income=Total income effectiveness

Total income= Total cost profitability

Net income/Total income (effectiveness) could be treated as a metric of effectiveness in
this study and is defined as the ability to achieve the expected level of income generation.
Total income/Total cost (profitability) assesses the ability of the branch to generate
income with the available resources expressed in monetary values and it is an index of
profitability.
DEA can be applied to revenue-producing organizations by converting financial
performance indicators to their efficiency and effectiveness equivalents, see also Ho
and Zhu (2004). This decomposition facilitates the examination of Net income/Total
cost ratio (overall performance) in terms of a measure of profitability (efficiency), level
of costs required to generate income and a measure of effectiveness, level of total
income to achieve the goal of net income generation. As such, Net income/Total cost
ratio encompasses measures of Net income, Total income and Total cost.
The overall efficiency model assesses performance of bank branches in terms of
profitability and effectiveness. That is, we suppose an efficient and effective bank
branch as using a minimum of resources (i.e. expenses) to generate total income and a

Figure 1.
Profitability efficiency
(stage 1) and effectiveness
(stage 2)

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minimum of total income to generate net income. The above analysis shows that
overall performance is disaggregated into profitability efficiency and effectiveness.
This approach accounts for the possible trade-off between profitability efficiency and
effectiveness in bank branch operation.
The operationalization of overall performance model, i.e. the specification of inputs
and outputs for each individual model, and their integration to reflect the causal
relationship among the performance dimensions is shown in Figure 1.
The causal relationships are operationalized by specifying the outputs of one
model (stage 1) as inputs to another (stage 2). The output of profitability efficiency
model, which is specified as the aggregate measure of total income to total cost ratio, is
an input to the effectiveness model. The outputs of profitability efficiency model
positively influence effectiveness and hence they are inputs to effectiveness model.
Our sample as described in section 4 includes branches of various sizes, hence, the
variable returns to scale (VRS) model, accounting for possible scale effects, is a natural
choice (see also Paradi and Schaffnit, 2004). Since the branches typically have little or no
direct control over the demand for services required by their customers, input-orientation
was chosen for the first (profitability efficiency) model presented in this study. For the
effectiveness approach we retain the same model orientation in order to investigate
whether the branches use the efficient level of income (interest and non-interest) in
generating profits.
For the identification of best-practice branches for each dimension the input
minimization BCC (Banker et al., 1984) model (2) is used.
Given a set of n decision making units (DMUs), i.e. bank branches, j 1, . . . , n, utilizing
k
quantities of inputs X [ (m
to produce quantities of outputs Y [ ( , we can denote xij and
th
th
yrj the amount of the i input and r output respectively used by the jth DMU.
The following VRS input oriented value-based model (Thanassoulis, 2001) can be
used to assess efficiencies.
Max h

k
X

mr yrj0 v

r1

s.t.
m
X

vi xij0 1

i1
k
X

mr yrj 2

r1

m
X

vi xij v # 0

i1

j 1; 2; :::; j0 ; :::; n

mr $ 1
r 1; 2; :::; k
vi $ 1
i 1; 2; :::m
v free on sign

Modeling bank
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438

where:
1 . 0 a convenient small positive number (non-Archimedean), see also Charnes
et al. (1994).

mr

output weights estimated by the model.

vi

input weights estimated by the model.

We can use the model (2) to identify the nature of returns to scale holding locally at
DMU jo in case that jo is Pareto-efficient:
.
If v , 0 in all optimal solutions to model (2) then locally at DMU jo decreasing
returns to scale hold.
.
If v 0 in some optimal solutions to model (2) then locally constant returns to
scale hold where DMU jo lies or is projected on the efficient frontier.
.
If v . 0 in all optimal solutions to model (2) then locally at DMU jo increasing
returns to scale hold.
The radial efficiency h derived from model (2) shows the rate of reduction to the input
levels of branch under evaluation. The dual of model (2) provides the slack values of
inputs (see Thanassoulis, 2001).
We use the inputs and outputs in stage 1 and stage 2 to characterize the profitability
efficiency and effectiveness, respectively (Figure 1). The overall efficiency is calculated
as the product of profitability efficiency and effectiveness, see also Ho and Zhu (2004).
4. Data sources and identification of inputs and outputs
Data on branches of The Bank for the year 2006 were collected as part of the diploma
thesis of I. Lamprinidis (2008). The Bank is one of the major commercial banks
operating in Greece and it has already developed an in-house performance model that
is based on its management information system (MIS) for assessing the
multidimensional performance of its branch network.
These data are likely to be considerably cleaner than standard banking data sets.
Our information is retrieved from the MIS of The Bank (i.e. a single bank) and refers to
a sample of its bank branches operating all over Greece. Moreover, the same data feed
the PMM, a model already in use in The Bank and the models used here.
DEA models are most meaningful when they are applied to observation sets of bank
branches providing similar services and using similar resources. The Bank uses its
PMM to classify the various branches according to their net interest income taking into
account the type and operations performed at each branch. To maintain homogeneity,
only the 50 best-in-class branches in selling loans according to PMM classification
were selected to form the observation set for this study.
As mentioned earlier we aim not only to analyze the profitability of bank branches
but also to assess their effectiveness. Therefore, two sets of inputs and outputs were
needed; one set for profitability analysis, and one for effectiveness assessment.
A slight deviation is introduced here in the specification of the output set of the
profitability efficiency model. Instead of using gross interest income with gross
non-interest income in the output side of DEA to assess the efficiency of resource use in
delivering income, as done through profitability efficiency model by Oral and Yolalan

(1990), origination income (net interest income), non-interest (gross) income

(commissions and other non-interest income), and the outcome of a predetermined
function mapping the performance of the bank branch in giving loans to the clients are
considered as outputs of our profitability efficiency model.
The input set for profitability analysis consisted of four elements:
x1 personnel expenses.
x2 rental expenses[1].
x3 other operational expenses (i.e. administrative expenses) excluding interest
expenses.
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x4 depreciation.
On the output side of profitability analysis a set of four outputs was considered;
namely:
y1 origination income generated from selling Banks assets (used as a proxy for
interest income).
y2 the outcome of a predetermined function mapping the performance of the
bank branch in giving loans to the clients.
y3 commissions.
y4 other non-interest income.
The assessment of the profitability efficiency of the bank branches is based on their
ability to generate short and long-term profits. By short-term profitability we indicate
the income from commissions that branches generate and by long-term profitability we
indicate the income from the lending activity of the branch (see also Giokas, 2008a).
Note that the inputs above correspond to major cost items of bank operations. The
output set of profitability assessment, on the other hand, included only two items
which accounted for a sufficiently large part of total income of a bank branch; interests
earned on loans (net interest income), and non-interest (gross) income (commissions
and other non-interest income). Another output, the outcome of a predetermined
function mapping the performance of the bank branch in giving loans to the clients is
considered in line with the PMM, a model already in use in The Bank.
With the above sets of inputs and outputs for profitability assessment, it is clear
that the ratio appearing in the objective functions of DEA models is nothing but the
ratio of weighted sum of incomes to weighted sum of expenses, hence an index of
profitability.
The input set for effectiveness assessment consisted of four elements:
x1 origination income generated from selling Banks assets (used as a proxy for
interest income).
x2 the outcome of a predetermined function mapping the performance of the
bank branch in giving loans to the clients.
x3 commissions.
x4 other non-interest income.

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The output set of effectiveness assessment, on the other hand, included only one item
which accounted for the net income of a bank branch:
y1 net income.

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440

With the above sets of inputs and outputs for effectiveness assessment, it is clear that
the ratio appearing in the objective functions of DEA models is nothing but the ratio of
weighted net income to weighted sum of income categories, hence an index of
effectiveness.
Descriptive statistics of inputs-outputs used in the assessment are presented in
Table II.
5. Results
5.1 Profitability efficiency
The profitability efficiency of the bank branches is assessed in the light of contrasting
their operating cost with the monetary outcomes (i.e. incomes) that are generated by
the branches. Such assessment is achieved by creating an input-output framework
explained in the previous section. Results concerning the distribution of the
profitability efficiency of the bank branches are presented in Figure 2. The median
efficiency is of the order of 92 per cent. Noteworthy are also the extreme values and in
particular the minimum efficiency value below the 60 per cent (Table III). The results
indicate that there is scope for efficiency improvement in profitability efficiency by
minimizing costs of about 12.4 per cent.
Out of the 50 branches 19 (38 per cent) were found relatively efficient. The model
suggests that most of the technically efficient branches (74 per cent) are operating
under constant returns to scale (CRS), three branches (15 per cent) under local
decreasing returns to scale (DRS) and the rest of the branches (11 per cent) under local
increasing returns to scale (IRS). For branches not operating on the frontier, their
returns to scale determined after elimination of pure technical inefficiency through the
projection towards the VRS frontier. Most of the branches (48 per cent) of the inefficient
branches seem to operate under IRS, eight branches (26 per cent) under DRS and the
remaining (26 per cent) under CRS. The results indicate that a possible increase in the
scale size of operations for 34 per cent of the branches will lead to increased levels of
monetary outcomes with a rate higher than that used to increase the input level
(expenses). In other words there is potential in the branch network to accommodate and
manage higher levels of business volume (Table IV).
5.2 Effectiveness
The overall results concerning the effectiveness are presented in Figure 2. As can
be seen from the results distribution the median efficiency is of the order of 98 per
cent. Out of the 50 branches 19 (38 per cent) were found to be relatively efficient
(Table III).
The results indicate that most (58 per cent) of the efficient branches operate under
CRS, four branches (21 per cent) operate under local IRS and the rest of the efficient
branches (21 per cent) operate under local DRS. In the same way as before, the model
suggests also that most of the branches (68 per cent) of the inefficient branches are
operating under IRS, eight branches (26 per cent) under DRS and the rest of the
branches (6 per cent) under CRS. The results indicate that a possible increase in the

0.137
0.131
0.083
0.051
0.162
0.021
0.511

0.991
0.639
0.861
0.643
1.048
0.254
3.653

0.112
0.069
0.096
0.076
0.125
0.041
0.390

0.054
0.026
0.054
0.038
0.061
0.011
0.138

1.817
1.162
1.403
1.265
1.724
0.993
7.270

Other operational
Origination
expenses
Depreciation
income

Notes: Q1=first quartile, Q3=third quartile

Mean
SD
Median
Q1
Q3
Min
Max

Rental
expenses

Personnel
expenses
0.030
0.021
0.024
0.018
0.032
0.009
0.124

Loans selling branch

performance
1.063
0.884
0.808
0.513
1.300
0.180
4.550

Commissions

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Net
income
1.629
1.320
1.210
1.027
1.631
0.510
7.406

Other noninterest income

0.013
0.054
0.004
0.002
0.008
0.001
0.385

Modeling bank
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441

Table II.
Descriptive statistics of
inputs-outputs used in
the assessment
(mil euros)

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442

Figure 2.
Distribution of efficiency
measures of bank
branches

scale size of operations for 50 per cent of the branches will lead to increased levels of
net profits with a rate higher than that used to increase the input level (income
categories) (Table IV). The results indicate that there is scope for efficiency
improvement in effectiveness by minimizing the income categories values of about 9.3
per cent.
5.3. Profitability efficiency versus effectiveness
To further illustrate the important difference between profitability efficiency and
effectiveness, a cross-tabulation is presented in Figure 3 and moreover, DEA scores
obtained from the profitability and effectiveness assessments are plotted in Figure 4.
Branches fall into four quadrants: stars, sleepers, dogs, and question marks similar to
the classifications done in the efficiency-profitability matrix proposed by Dyson et al.
(1990) and Boussofiane et al. (1991); see also Luo (2003), Portela and Thanassoulis
(2007), and Giokas (2008a). Splitting half by the median was used to create high-low
groups profitability efficiency and effectiveness (based on Model (2) results), see also
Luo (2003). As a result, a total of four groups (2x2 high versus low groups) is created,
each representing one of the four quadrants. It should be noted that these thresholds
are arbitrary since the managerial implications of drawing such a matrix do not really
depend on the chosen thresholds, but on the number of units close to the ideal
performance (1,1). It should be noted that different thresholds might be justified by
different magnitudes of efficiency scores.
Bank branches that achieve both higher level of profitability efficiency and
effectiveness can be classified as stars. Star branches (n 21, or 42 per cent of the
total sample) represent benchmarks to be matched by inefficient branches.
Problem branches are the branches that are in the bottom-left quadrant, with
inferior performance both in profitability efficiency and effectiveness. The results

78.66
83.63
72.57

11.23
10.24
18.23

Panel B: inefficient branches

Profitability efficiency
79.92
Effectiveness
84.94
Overall efficiency
73.51

Median (%)
92.02
97.58
83.00

Standard
deviation (%)

Panel A: efficient and inefficient branches

Profitability efficiency
87.55
13.20
Effectiveness
90.66
10.89
Overall efficiency
80.40
19.54

Mean (%)

72.39
77.94
56.89

76.26
82.15
59.94

Q1 (%)

87.30
94.78
95.16

100.00
100.00
99.83

Q3 (%)

58.62
65.62
39.95

58.62
65.62
39.95

Min (%)

98.68
99.32
99.32

100.00
100.00
100.00

Max (%)

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19
19
13

Number of
efficient branches

38
38
26

Percentage of
efficient branches

Modeling bank
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443

Table III.
Mean (standard
deviation), median,
quartiles (Q1, Q3), Min,
Max values of efficiency
measures, number and
percentage of efficient
branches

Table IV.
Returns to scale (RTS)
classification
4
11
4
19

Panel B: effectiveness
IRS
CRS
DRS
Total
21
58
21
100

11
74
15
100
21
2
8
31

15
8
8
31

68
6
26
100

48
26
26
100

Projected
Number of
Percentage of
branches
branches

Notes: IRS: increasing returns to scale, CRS: constant returns to scale, DRS: decreasing returns to scale

2
14
3
19

Panel A: profitability efficiency

IRS
CRS
DRS
Total

Efficient
Percentage of
branches

25
13
12
50

17
22
11
50

Number of
branches

444

RTS

Number of
branches

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50
26
24
100

34
44
22
100

Total
Percentage of
branches

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indicate that there are 21 problem branches, consisting 42 per cent of the sampled
branches and special attention should be paid to these branches as well as action is
needed to diagnose their problems and to improve their performance.
Sleepers experience higher level of effectiveness, but lower profitability efficiency.
There are four branches (8 per cent of the total sample) falling into the sleepers
quadrant.
Finally, dogs are those branches that earn higher profitability efficiency, but
lower effectiveness. Thus, these branches (n 21, or 42 per cent of the total sample)
should place more emphasis on generating profits.
The Pearsons correlation coefficient between profitability efficiency and
effectiveness is 0.725 ( p value 0.000), a high correlation coefficient that it is
statistically significant at the 0.01 level (two-tailed). Moreover, Kendalls and
Spearmans correlation coefficients are 0.575 ( p value 0.000), and 0.715 ( p
value 0.000), respectively. This means that, higher profitability efficiency tends to
be related with higher effectiveness as can be seen in Figure 4.

Modeling bank
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445

Figure 3.
Effectiveness
profitability efficiency
cross-tabulation

Figure 4.
Profitability efficiency
versus effectiveness

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446

5.4. Overall efficiency

The median efficiency is of the order of 83 per cent. Noteworthy are also the extreme
values and in particular the low efficiency values below the 40 per cent.
The Pearsons correlation coefficient between overall efficiency and its components
is greater (0.948; p value 0.000) for profitability efficiency compared to effectiveness
(0.903; p value 0.000). Moreover, Kendalls and Spearmans correlation coefficients
are statistically significant and higher for profitability efficiency (0.825 and 0.939,
respectively) compared to effectiveness (0.769 and 0.886, respectively).
These results indicate that the overall efficiency level is governed primarily by the
branches ability to generate income using their resources, and therefore higher overall
efficiency tends to be related with higher profitability efficiency.
5.5. PMM key performance indicator and efficiency measures
The Bank uses the net income value, the net income per employee and the total cost to
total income ratio as key performance indicators (KPI) for assessing the branch
performance. We prefer to use the net income to personnel expenses ratio and the
reciprocal of the total cost to total income ratio (i.e. total income to total cost) as KPIs
and compare them with our efficiency measures.
The Pearsons correlation and Kendalls and Spearmans coefficients of KPIs and
efficiency measures indicate that the total income to total cost ratio is highly
correlated to the overall efficiency measure (Pearsons correlation coefficient 0.790,
p value 0.000; Kendalls rank correlation coefficient 0.656, p value 0.000;
Spearmans rank correlation coefficient 0.840, p value 0.000).
Of the three KPIs used by the bank, the reciprocal of total cost to total income ratio
(i.e. total income to total cost ratio) is closest to DEA context, but it contains no direct
information about branch network best practices. Therefore, DEA which provides two
individual metrics (profitability efficiency and effectiveness) and a summary measure
(overall performance) can be used as complement to the PMM for the evaluation of
branch network. Our results indicate that superior insights can be obtained by
employing the proposed two-stage DEA (profitability efficiency and effectiveness)
model compared to the outcomes from the analysis based on selected key performance
indicators (KPIs).
6. Conclusions
We have a presented a general framework for modeling the profitability and
effectiveness in bank branch networks by means of DEA. In particular, we examined
the performance for a sample of The Banks branches and addressed four related
questions:
(1) What is the most efficient level of cost categories in generating income?
(2) What is the most efficient level of income (interest and non-interest) in
generating profits?
(3) Is there a correlation between bank branch profitability efficiency and
effectiveness?
(4) Is there a correlation between DEA measures and PMM outcomes?

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Two different input-output models are proposed for assessing the performance in
terms of profitability efficiency and effectiveness, respectively. The profitability
efficiency is assessed based on four inputs (cost categories) and four outputs (income
categories). The effectiveness efficiency is modeled by using the net income as output
and the income categories as inputs.
In both cases, the empirical results, providing answers to questions (1) and (2),
indicate that there is scope for substantial efficiency improvements; there is scope for
efficiency improvement in profitability and in effectiveness by minimizing costs of
about 12.4 per cent and income categories values of about 9.3 per cent, respectively. In
particular, we found that the real problem of bank branch inefficiency is due to
profitability inefficiency rather than ineffectiveness. Thus, the branches that acquire
higher effectiveness, but lower profitability performance should place more emphasis
on income generating activities by minimizing costs.
The efficiency improvement at the worst-performing branches can generate a
substantial increase in profit for The Bank. From the analysis of the efficiency
profitability-effectiveness matrix it becomes evident that branches can still increase
their profit through efficiency improvements. In addition, we had the opportunity to
discriminate among bank branches that have excelled in all performance dimensions
and therefore could be proposed as benchmark branches across the network.
Results, providing answers to questions (3) and (4), point out for positive links
between DEA individual measures as well as between DEA-overall efficiency measure
and one of the PMM outcomes, respectively; higher significant correlations are
observed between DEA-profitability efficiency and effectiveness, and between total
income to total cost ratio, a selected KPI, and DEA-overall efficiency measure. Another
striking result of the analysis is that the overall efficiency level is governed primarily
by profitability efficiency level, and therefore higher overall efficiency tends to be
related with higher profitability efficiency.
Future research regarding the performance of Bank branches should no doubt
consider as impressive the incorporation of environmental factors into the proposed
DEA models. These factors were excluded from our DEA models due to non-provision
from The Bank of branch-specific data like location, investment portfolio risk etc.
Note
1. Rental expenses are used as a proxy to quantify premises usage (Paradi and Schaffnit, 2004).

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About the author
Ioannis E. Tsolas is lecturer in economic analysis at National Technical University of Athens,
School of Applied Mathematics and Physics, Greece. He earned his PhD from the National
Technical University of Athens. His teaching and research interests are in economic analysis
(microeconomics, macroeconomics) and business economics. Ioannis E. Tsolas can be contacted
at: itsolas@central.ntua.gr

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