Apparent characteristics of the Hungarian banking market such as large profits and high margins suggest weak competitive pressures. Weak competition in turn, may reduce efficiency in a lack of pressures to converge to marginal cost and to stimulate managerial efforts to reduce X-inefficiency. Such conditions call for a gauging of efficiency of banks to better assess what is needed for a competitive and well-functioning banking system. Although the level of efficiency is only an indirect measure of competitive pressures, it may be superior to other ones available for international comparison. Concentration ratios are only a very imperfect measure, moreover, the Hungarian banking market structure with one larger and several somewhat smaller banks of similar sizes would suggest an even playing field. In fact, different market segments show very different degrees of concentration and several conditions for a competitive market are missing. Moreover, interest margins, particularly on mortgage loans are high in international comparison and the downward stickiness and lagged reaction of retail lending rates to money market rates also suggests weak competitive pressures. In a lack of readily available data to obtain mark-ups, which would be a better measure of competition than concentration measures or interest margins, this paper estimates cost efficiency scores that allow for grasping the size of competitive pressures indirectly. Cost efficiency is estimated in the EU 25 context given that cross-border competition can be important in some market segments and that cross-border lending is significant in Hungary. The paper uses the stochastic frontier analysis with a Fourier-flexible specification of the cost function and a time-varying decay model. A specific feature of the methodology is that bank lending is corrected for non-performing loans. This way, the categorising of banks that boost their loan portfolio by excessive risk-taking - i.e. produce large amounts of bad loans - as efficient can be partly avoided. The results show that in Hungary, bank efficiency is not particularly high in either European or regional comparison. Competition could be the major push for efficiency gains and the paper lists a series of measures that could be adopted to boost competitive pressures.

This paper relates to the 2010 Economic Survey of Hungary.