The Effects of Financial Regulation on Cost Efficiency: Evidence From the Hong Kong Banking Industry

Abstract

This paper constructs a transcendental logarithmic cost function for describing the production technology of banks. Rather than adopting traditional approaches, this paper develops a new approach to specify the essential outputs and inputs of banks. It is finds that banks had to tolerate higher operating costs in the first few years after the removal of regulations. In response, banks sought for new revenue by expanding fee-based financial services rather than reduced operating costs by adjusting their input combinations or output combinations. The deregulation also forced banks to pursue active technical progress, and larger banks performed better than smaller banks.