Efficiency and Consolidation in Nepalese Banking: A Bias-Corrected DEA Approach

Abstract

This study assesses the technical efficiency of Nepalese commercial banks during the consolidation period from FY 2017 to FY 2024, triggered by the NRB’s FY 2015/16 capital mandate. Output-oriented VRS technical efficiency scores are estimated using a smoothed bootstrap DEA procedure with 2,000 replications on 199 bank-year observations. A truncated regression with bootstrapped standard errors is subsequently used to identify key determinants of efficiency. The results confirm that conventional DEA substantially overstates efficiency. The average bias-corrected efficiency scores range from 0.722 to 0.873, significantly below the original estimates of 0.796 to 0.914. Most notably, banks that appeared fully efficient under standard DEA were substantially inefficient after the bias correction. Efficiency decomposition suggests that operational factors rather than scale were the primary source of inefficiency. Scale efficiency, however, deteriorated significantly after 2022, suggesting the emergence of post-consolidation diseconomies. Based on bias-corrected scores, public-sector and joint-venture banks performed at broadly comparable levels, with efficiency scores of 0.845 and 0.836, respectively, while domestic private banks remained noticeably behind at 0.766. The second-stage regression results, however, reveal that once bank-industry level and macroeconomic characteristics are taken into account, ownership type does not significantly influence efficiency. Other key second-stage efficiency drivers include bank size, income diversification, and capital adequacy, while market concentration and merger activity have a negative effect on efficiency. These findings indicate that the ongoing consolidation wave in the banking industry has generated short-run efficiency losses and regulators need to prioritize operational integration and scale optimization within the sector.