The primary focus of this paper is the modeling and estimation of total factor productivity growth in banking. The measured total factor productivity growth is decomposed into its main components: 1) scale economy and output growth, 2) branching effect, and 3) technological change effect. Our findings indicate that total factor productivity grew at an annual average rate of 7.8% for the 1979-t982 period but this growth has slowed down to only 2.9% for the 1981-1982 period. Scale economy and output growth have contributed to about four-fifths of the growth, whereas branch growth and technical change have contributed to one-fifth of the growth. An important observation is the increasing importance of both branch growth and technical change throughout the period, especially for smaller banks.
Except for studies of economies of scale (and recently of scope) little attention has been given to the general area of productivity analysis in commercial banking-one of the major sectors of the (service) economy) It is quite obvious that the economic performance of financial firms (banks) may substantially affect the ability of monetary policy to operate efficiently. Thus, the measurement and analysis of total factor productivity (TFP) growth is important, especially when juxtaposed on the trend of increasing input prices, decreasing profitability, and a decline in banks' share of total financial intermediafion.
The primary focus of this paper is on the modeling and estimation of TFP growth in banking. Moreover, we decompose the measured TFP growth into its main components: 1) scale effects, 2) branching effect, and 3) technological change effect. The methodology used is applied to a longitudinal sample of banks in Israel.
The measurement of TFP growth in banking is complicated by several issues. First, banks produce a large variety of financial services (outputs) which, in the absence of a consistent output aggregate, complicates the measurement of banking technology and its associated characteristics. 2 *The refereeing process of this paper was handled by J. van den Broeck~