Determinants of commercial banks’ efficiency in Rwanda

Abstract

This study investigates the drivers of cost efficiency of 10 Rwandan commercial banks for the 2012Q1-2021Q3 period,
using the true fixed effects model, which makes it possible to integrate unobserved bank-specific heterogeneity in the
inefficiency function at the mean level. This study is in line with the central bank’s role of ensuring financial stability.
The study builds on Gisanabagabo and Ngalawa (2017), the only study about the subject matter in Rwanda, to make
the necessary adjustments: First, this study uses a larger sample with respect to time and number of commercial
banks; Second, the study also uses a more flexible translog cost function, rather than a linear function and it models
heterogeneity across banks as part of the inefficiency term rather than using individual dummy variables as this may
lead to over-parameterization; Finally, the study deals with correlation among variables in both the inefficiency function
and the cost function by implementing a single-step estimation procedure. Empirical estimations show that credit
risk positively affects inefficiency while intermediation ratio, bank funding structure, and capital ratio negatively affect
inefficiency, especially since 2018. The estimated efficiency score stands at 81.3 percent compared to 88.56 percent
obtained by Gisanabagabo and Ngalawa (2017), and the differences are due to the employed methodologies and samples.
The paper recommends that Rwandan commercial banks should strengthen existing measures to further mitigate credit
risk, and increase intermediation, funding structures, and capitalization so as to deal with macro-financial shocks.