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This paper investigates the effects of political instability resulting from successive regime changes and the 30‐year civil war on the cost efficiency of local banks in Sri Lanka. A translog cost function was used to estimate bank cost efficiency, and a multivariate regression model was used to investigate the determinants of bank cost inefficiency. On average, the cost efficiency of banks in Sri Lanka during the study period was relatively high. Sri Lankan banks performed more efficiently during the second political regime (2001–2004), which had more liberal political and economic policies to promote the private sector compared with other regimes. During this period, the government was involved in peace talks, leading to a ceasefire agreement that temporarily stopped the violence. Furthermore, the positive coefficients for the dummy variables representing the third and fourth political regimes showed that more restrictive economic policies can increase bank cost inefficiencies. The results also indicate that immediately following the civil war, Sri Lankan banks recorded a decline in cost efficiency. Cost inefficiency was positively associated with banks' risk aversion, credit risk, market share, interest rate risk and increase in GDP and negatively associated with non‐earning assets, liquidity, bank size and concentration.

This paper examines how the financial reforms introduced throughout last 30 year period have improved the managerial efficiency of firms in the banking industry in Sri Lanka. Using non-parametric data envelopment analysis (DEA), this study estimated relative efficiency of banking firms in Sri Lanka using a sample of data collected from 20 year cross section (1989-2008). The study found that the banks in Sri Lanka have recorded relatively higher level of efficiency. Both managerial decisions and scale of operation have been equally contributed to the recorded inefficiency. We found that large banks were relatively more efficient than small banks. However, medium size banks were recorded relatively lower levels of efficiency which were mainly contributed by the managerial factor.

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