MAHMOUD A. EL-GAMAL AND HULUSI INANOGLU

SUMMARY
Recent studies have stressed the importance of privatization and openness to foreign competition for bank
efficiency and economic growth. We study bank efficiency in Turkey, an emerging economy with great
heterogeneity in bank types and ownership structures. Earlier studies of Turkish banking had three limitations:
(i) excessive reliance on cost-function frontier analyses, wherein volume of loans is a measure of banking
output; (ii) pooling all banks or imposing ad hoc heterogeneity assumptions; and (iii) lack of a comprehensive
panel data set for proper analysis of productivity and heterogeneity. We use an estimation–classification
procedure to find likelihood-driven classification of bank technologies in an 11-year panel. In addition, we
augment traditional cost-frontier analysis with a labour-efficiency analysis. We conclude that state banks
are not particularly inefficient overall, but that they do utilize labour inefficiently. This partially supports
recent calls for privatization. We also conclude that special finance houses (or Islamic banks) utilize the same
technology as conventional domestic banks, and do so relatively efficiently. This suggests that they do not
cause harm to the financial system. Finally, we conclude that foreign banks utilize a different technology
from domestic ones. This suggests that one should not overstate their value to the financial sector. Copyright
 2005 John Wiley & Sons, Ltd.