Cost Efficiency Level of Rural Banks in East Java, Indonesia

Rural Bank (BPR) was an important part of financial service industry in Indonesia. Their pivotal role on lending to SMEs in the rural area made their existence very strategic to rural development. However, due to its operational scale, rural bank charged higher interest rate than commercial bank. The study estimated the cost efficiency of rural banks using parametric approach. The result found that rural bank efficiency was very high. The two year cost efficiency estimated using frontier 4.1 was 95% and median was 100%. The lowest of cost efficiency level was 32%. It meant cost inefficiency of the banks under investigated was around 10%. The cost efficiency level in 2006 was on average 95% and the median was 100%. It meant that 50% or more of the observation enjoyed 100% cost efficiency. The minimum was only 67%. It meant they operated at very efficient level, leaving only 5% inefficiency. In 2007, a dramatic change on efficiency level was going on. The average efficiency was dropped from 11% to 89.9% due to increase on interest rate and price level. Key words: rural bank, efficiency, cos