Banks provide transaction services and payment systems; an efficient banking system has significant positive externalities,

which increases the efficiency of economic transactions in general.

Efficiency measurement in this sector is not straightforward because it is difficult to define and measure both the inputs
and outputs of a bank.

Public and private sector banks may have different objectives and may face different constraints in respect of the variables
that they can choose,

Review of Literature
The literature on the efficiency of financial institutions is by now quite large despite its relatively recent origin. Numerous
attempts have been made to study the efficiency of banks in developed countries. By contrast, studies analysing the
efficiency of banks in developing countries, are far fewer DAS, et al. (2005)

There are two common approaches to variable selection in bank performance appraisal in DEA: intermediation
approach and production approach 5. In the intermediation approach where the banks are considered as
intermediaries, the role of deposits is considered as an input to the production process where as in the
production approach where the banks are considered as service providers, the deposits are considered as an
output involving the creation of value added for which customers bear an opportunity cost.

Casu and Molineux (1999) argued that the intermediation approach may be superior for evaluating the
importance of frontier efficiency to the profitability of financial institutions because minimisation of total costs
is needed to maximize profits and not just minimisation of production costs alone.

Evaluation of commercial banks efficiency is a need of developing and developed countries. In developed countries,
a number of studies have been carried out by the researchers to evaluate the efficiency of banks but in developing
countries, like Pakistan, studies are scarce on this issue. In the measurement of efficiency, estimation of the frontier
is the main issue, for which, two principal methods are used: Data Envelopment Analysis and Stochastic Frontier
approach. TANVIR AND ZULFIQAR (2007)

The performance of the financial institutions is a major concern for both, the regulators and the policy makers, since
it has a strong linkage with the performance of the economy. Gupta, Doshit, and Chinubhai (2008)

The type of efficiency measured depends on the data availability and appropriate behavioural assumptions
(Yin, 1999).

Examining banking performance has been a common practice among many banking and finance researchers
for a number of years. The main reason for continued interest in this area of research is the ever changing
banking business environment throughout the world.

Many researchers take a different approach, an Intermediation Approach, also called as an Asset Approach. It is
based on activity model. A typical bank borrows money in form of a deposit and lends it in form of a loan. This is
the primary function of a bank. Thus banks act as intermediaries between owners of funds and users of funds. The
contribution of physical inputs to value addition is minimal. Hence, in this approach, unlike production approach,
inputs and outputs are considered in monetary values. Typically, inputs are monetary value of inputs such as labour,
capital and funds. Thus interest cost, labour cost, other operating costs are considered inputs. The outputs are the
monetary value of earning assets such as value of advances, value of deposits, investments, gross income, etc. Gupta,
Doshit, and Chinubhai (2008)

5. LITERATURE REVIEW OF STUDIES ON EFFICIENCY OF BANKS

Many researchers using different methods have analyzed the performance of the banking sector. The standard
method of comparing financial parameters and financial ratios has its limitations, as it fails to capture long-term
trends and also does not identify the determinants. Comparisons based on the cost, allocative, and technical
efficiency, using various techniques, has attracted the attention of several researchers, particularly in the USA.
Gupta, Doshit, and Chinubhai (2008)

Berger et al. (1993) and Berger and Humphrey (1997) review the empirical studies of efficiency of banking industry
in the world.

Jackson and Fethi study on Turkish banks found that the profitable banks are more likely to operate at higher levels
of technical efficiency and the capital adequacy ratio has a statistically significant adverse impact on the
performance of banks. Casu and Molyneux study concluded that debt equity ratio had no effect on efficiency; more
profitable banks were more efficient, listed banks were more efficient than non-listed banks and commercial banks
were more efficient than cooperative banks.