The definition of output is not straightforward for a bank. Scaly and Lindiy (1977) argued that earning assets (loans, securities, etc.) comprise bank outputs, so deposits, capital, and labor should be treated as inputs.
In the more recent literature, in an attempt to recognize the multiproduct nature of the firm, outputs typically include loans, other earning assets (e.g., securities, interbank assets), deposits, and noninterest income, which acts as a proxy for off-balance-sheet “output.”
Inputs include the cost of physical capital (proxied by non-interest expenses/fixed assets) and the price of financial capital (proxy: interest paid/purchased funds).
Measuring Bank Output
The measurement of the “output” of services produced by financial institutions has special programs because they are not physical quantities. So both the productivity and quality of banking services are difficult to account for.
In aggregate, bank output. Tor the purposes of a country’s national accounts should be value-added, i.e., adjusted operating profits less the cost of shareholder equity. However, empirical studies employ a “production” or “intermediation” interpretation.
| The Production Approach | The Intermediation Approach |
|---|---|
| This approach treats banks as firms that use capital and labor to produce different deposits and accounts. | Outputs are measured by the number of deposit and loan accounts or transactions per account. |
| Outputs are measured by the number of deposit and loan accounts or the number of transactions per account. | The value of loans and investments measures outputs. |
| Total costs are all operating costs used to produce these outputs. | Total cost is measured by operating costs (the cost of factor inputs such as labor and capital) plus interest costs. |
| Output is treated as a flow that is the amount of “output” produced per unit of time, and inflation bias is absent. | Output is treated as stock, showing the given amount of output at one point in time. |
Productivity studies use the Intermediation Approach. Most banks use this approach because there are fewer data problems than the production approach.
Problems with the Production Approach:
- There is the question of how to weigh each bank service in the computation of output;
- The method ignores interests costs;
- Data from banks in countries using different accounting systems may not be comparable, making accurate relative efficiency measures difficult to obtain.
Loopholes in the two approaches:
- Risks attached to each loan are ignored
- Maturity structure is ignored
- Changes in the banking market distort output measures.