Relationship Lending and Lines of Credit In Small Firm Flnance* I. IntroductIOn * The view:. expre:..;;ed here are our~ dnd do not nece~~ar I\Y reflect those of the BOdrd of Governors of the Federal Reserve or Its staff We thank the plimary editor, Doug 01.1mond, and the dnonymOU'i referee dod second editor for many helpful suggeshon<; that Improved the paper greatly We also thank

b~aqThis paper surveys 130 studies that apply frontier efficiency analysis to financial institutions in 21 countries. The primary goals are to summarize and critically review empirical estimates of financial institution efficiency and to attempt to arrive at a consensus view. We find that the various efficiency methods do not necessarily yield consistent results and suggest some ways that these methods might be improved to bring about findings that are more consistent, accurate, and useful. Secondary goals are to address the implications of efficiency results for financial institutions in the areas of government policy, research, and managerial performance. Areas needing additional research are also outlined. q The opinions expressed do not necessarily reflect those of the Board of Governors or its staff. The authors thank Sigbjorn Berg, Bill Cooper, Gary Ferrier, Joaquin Maudos, and Jesus Pastor for insightful comments on earlier drafts and Knox Lovell for bringing us up to date on stochastic DEA. We also thank Seth Bonime and Emilia Bonaccorsi for outstanding research assistance. * Fmc iencv of Financial lnstit~ons: International Survev a nd Direction s for Future Researc h I introductionThe first task in evaluating the performance of financial institutions is to separate those production units that by some standard perform well from those that perform Poorly. This is done by applying nonparametric or parametric frontier analysis to firms within the financial industry or to branches within a financial firm. The information obtained can be used either:(1) to inform government policy by assessing the effects of deregulation, mergers, or market structure industry, different on efficiency; (2) to address research issues by describing the efficiency of an ranking its firms, or checking how measured efficiency may be related to the efficiency techniques employed; or (3) to improve managerial performance by identifying "best practices" and "worst practices" associated with high and low measured efficiency, respectively, and encouraging the former practices while discouraging the latter.At its heart, frontier analysis is essentially a sophisticated way to "benchmark" the relative performance of production units. Most financial institutions, with varying degrees of success, benchmark themselves and/or use industry consultants to perform this task. The power of frontier analysis is twofold. First, it permits individuals with very little institutional . knowledge or experience to select "best practice" firms within the industry (or 'best practice" branches within the firm), assign numerical efficiency values, broadly identify areas of input overuse and/or output underproduction, and relate these results to questions of government policy or academic research interest. Second, in the hands of individuals with sufficient institutional background, frontier analysis permits management to objectively identify areas of best practice within complex service operations, a determination not always possible with traditional benchmark...

This paper addresses a little examined intersection between the problem loan literature and the bank efficiency literature. We employ Granger-causality techniques to test four hypotheses regarding the relationships among loan quality, cost efficiency, and bank capital. The data suggest that problem loans precede reductions in measured cost efficiency; that measured cost efficiency precedes reductions in problem loans; and that reductions in capital at thinly capitalized banks precede increases in problem loans. Hence, cost efficiency may be an important indicator of future problem loans and problem banks. Our results are ambiguous concerning whether or not researchers should control for problem loans in efficiency estimation.