Credit market freedom and cost efficiency in US state banking

This paper investigates the dynamics between the credit market freedom counterparts of the economic freedom index drawn from the Fraser institute database and bank cost efficiency levels across the U.S. states. We consider a sample of 3809 commercial banks per year, on average, over the period 1987-2012. After estimating cost efficiency scores using the Data Envelopment Analysis (DEA), we develop a fractional regression model to test the implications of financial freedom for bank efficiency. Our results indicate that banks operating in states that enjoy a higher degree of economic freedom are more cost efficient. Greater independence in financial and banking markets from government controls can result in higher bank efficiency. This effect emerges in addition to the efficiency-enhancing effects of interstate banking and intrastate branching deregulation.