The impact of regulation on the performance of banking industry in Australia and future policy directions

Over the last decade, a number of changes have occurred in the regulation of Australia's banking and financial industry. These changes stem from the recommendations of the Wallis Inquiry (1997) which were aimed at streamlining the regulatory framework to directly stimulate competition and indirectly improve efficiency. This paper investigates the success of the implemented regulatory changes by examining the technical efficiency of 10 Australian banks over the period of 1996 to 2005. By using mathematical techniques, we examine how efficient the banks are in converting their inputs into outputs (pure technical efficiency) and their divergence from the most productive scale size (scale inefficiency). The results reveal that the extent of technical efficiency varies across the banks and over the years. The National Australia Bank, Commonwealth Bank and Macquarie Bank are found to be technically efficient, whereas Adelaide Bank, the Bank of Queensland and Westpac Bank are found to be prominently inefficient. This demonstrates that banks of different sizes can be technically efficient. We find that pure technical efficiency has improved over time, however, scale efficiency has deteriorated. In terms of merger policy, we add further insight into the ongoing debate over the removal of the 'four-pillar' policy. The removal of such policy in the current environment may lead to lower competition and efficiency and increase the disparity between small and large banks. Greater benefits may arise from encouraging consolidation across smaller banks. We also outline directions and implications for future policy-making which should focus on the revolution that is currently taking place within the banking and financial services industry. This revolution can be attributed to technological innovation, a changing competitive environment, and current and future banking conditions.