Research Journal of Finance and Accounting www.iiste.org ISSN 2222-1697 (Paper) ISSN 2222-2847 (Online) Vol.4, No.9, 2013 66 Modeling the Banks Efficiency in Tanzania: Panel Evidence Dickson Pastory, Xuezhi Qin, Benson Ndiege School of Management, Dalian University of Technology passtory1@yahoo.co.uk and qinxuezhi@gmail.com Abstract The paper was aimed at evaluating the efficiency of banking system in Tanzania. The study employed panel data for the period of 2006-2011. The paper utilized data from all 45 banks in Tanzania; the paper used efficiency measures, financial ratios, parametric and non-parametric approaches. In the context of parametric approach the study employed the Trans log and cob Douglas to test the profit efficiency. The findings of the study revealed that the three models to exhibited results, each model reflects and reported its efficiency score categories and the author conclude from the empirical literature that the all the three models do exhibit different efficiency score. Furthermore the study noted that the banks within the peer group were operating at higher level of efficiency but the industry at large still operates at inefficiency level but operate at higher level of profit efficiency due higher level of interest spread, large banks have been more efficient then the medium banks followed by the Non- Banking Financial institutions and finally the medium banks. Key words: Parametric and Non parametric Approach, Trans log, Cobb Douglass, Tanzania. 1.0 INTRODUCTION The implementations of the financial reforms brought the substantial impact in banking system in Tanzania, such as the increase in banks numbers; interest rate freely determined by the forces of lending and deposits, and the restoration of the operational and production efficiency (Xuezhi and Dickson 2011). Currently the banks are in the third generation of financial reforms, the first and second generations have cropped up 45 banks, cost efficient has been improved, increased in prudential guidelines and strengthen banks role in monitoring and supervision (BOT, 2011). The rapid development in financial sectors has promised optimism for further development that will benefit the Tanzania economy and hence necessitate re-evaluating the banking efficiency in general to confirm its efficiency. World Bank report of (2007) has pointed that despite of many financial reforms in developing countries many banks still operate at high level of inefficiency. The greatest inefficiency has been associated with higher interest rate spread, greater loan losses and higher operating costs. Banks efficiency is very crucial as it increases the profitability level and enhance banks competition, with the result of competition it will results the lower costs that are being charged to the consumer and improve product and service quality ( Berger 1993). Moreover efficiency of the commercial banks does increase the domestic mobilization that enhance the competition level of the banking system accompanied with fair interest rate spread (Senbet, 1994). In the context of Tanzania environment very few studies have been conducted to explain efficiency of banks in Tanzania, one example is that of Aikaeli (2008), this is somehow surprising given the economic importance of banks sector in Tanzania which offer products and services to the entire economy. The financial system is heavily relied on banking system because the development of stock market very low. Therefore the study focused on determining the level of technical efficiency in banks in Tanzania. The efficiency level will be established based on the third generation of the financial reforms. The innovation point of the paper is the adoption of the DEA model, ratio analysis and SFA model to measure the efficiency level. The study adopted both models since the measurements of efficiency through parametric and non-parametric are associated with greater criticism due to lack of precise definitions of bank output and input. Using both parametric and non-parametric approach in measuring efficiency results into different outcome due to lack of global consensus which method is superior to the other. “SFA model is associated with the statistical noise and functional form estimation which is associated with requirements of the strong assumption about the frontier design while on the other case DEA has the disadvantages of not following the functional form which is not associated with statistical noise estimation, the advantages are simpler to use with little assumption of output and input”…….. Berger and Humphrey, 1997) In other literature scholars have pointed that all parametric and non-parametric models have greater weakness of inability to accommodate the negative data, hence necessitate using the ratio analysis to measure the efficiency of the banks, but the same financial ratio has also some weakness and heavily criticized in literature. “Ratio analysis is based on the facts that different company operates under different environment therefore the comparison can be misleading, accounting data are subjected to various estimates and different assumptions, and meanwhile the use of different standards may hinder comparability”……….. Xuezhi and Dickson (2011).