Are scale economies in banking elusive or illusive?: Evidence obtained by incorporating capital structure and risk-taking into models of bank production

This paper explores how to incorporate banks' capital structure and risk-taking into models of production. In doing so, the paper bridges the gulf between (1) the banking literature that studies moral hazard effects of bank regulation without considering the underlying microeconomics of production and (2) the literature that uses dual profit and cost functions to study the microeconomics of bank production without explicitly considering how banks' production decisions influence their riskiness.Various production models that differ in how they account for capital structure and in the objectives they impute to bank managers – cost minimization versus value maximization – are estimated using U.S. data on highest-level bank holding companies. Modeling the bank's objective as value maximization conveniently incorporates both market-priced risk and expected cash flow into managers' ranking and choice of production plans.Estimated scale economies are found to depend critically on how banks' capital structure and risk-taking are modeled. In particular, when equity capital, in addition to debt, is included in the production model and cost is computed from the value-maximizing expansion path rather than the cost-minimizing path, banks are found to have large scale economies that increase with size. Moreover, better diversification is associated with larger scale economies while increased risk-taking and inefficient risk-taking are associated with smaller scale economies.     

Branching,scale economies,and banking costs

In this paper, we develop and estimate a model of bank costs based on a theory of the branch cost function. First, we show that convenient branch location is important to banking customers and implies that banks do not necessarily operate branches at minimum average cost. This theoretical result provides a rationale for including branch variables in the bank cost function. Second, we estimate a statistical cost equation derived explicitly from assumptions about the branch cost function and including branch output variables. Our empirical results suggest substantial economies of scale at the branch level, but no economies from expansion by branching. Finally, we show that the resulting cost structure of the banking industry does not imply that a highly concentrated banking structure is necessary for efficiency. Thus, economies of scale would not be expected to force small banks out of the market, even if current restrictions on interstate banking are liberalized.     

Measuring our ignorance, one book at a time: New indicators of technological change, 1909-1949

New indicators of technological change in the US based on information drawn from the catalogue of the Library of Congress for the period 1909-1949 are developed and used to pinpoint the relationship, first, between technical change and economic activity, and, second, between fluctuations in innovative activity and the Great Depression. Although links between technological change, output and productivity are found, results suggest that the slowdown in technological progress in the early 1930s did not contribute significantly to the Great Depression. On the other hand, the remarkable acceleration in innovations after 1934 did play a role in the recovery.     

A note on cost structure and economies of scale in Greek banking

This note studies the Greek banking industry in 1980–1989 in order to estimate a representative cost structure functional form and search for economies of scale. The constructed model uses a translogarithmic cost function that includes the size of assets, capital, labor and technological progress. By using this model, which has been used by Benston et al. (1982), Hunter and Timme (1986) and others, we have been able to estimate for the first time an econometric form of the costs in Greek banking, and we have been able to investigate economies of scale in the Greek banking industry. Although operating-cost scale economies do exist, total-cost scale economies were not present. This has been shown through the utilization of a large sample of pooled data of all Greek banks for a period of ten years, and the use of two other samples of large and small banks. Moreover, by exploiting the properties of the model, we shall be able to show whether technological progress has been a factor which lowers bank costs.     

Banking merchants and banking houses: the hidden key to the workings of the Spanish banking system in the nineteenth century

The historical study of the Spanish nineteenth-century banking system has been almost exclusively carried out through a consideration of the experiences of the joint-stock banks. But the very scarce number of these, and their territorial distribution, makes it necessary for us to look for other financial intermediaries who were able to satisfy the demand for banking services in that time and place. We demonstrate that this role was fulfilled by the banking merchants and banking houses operating through individual firms and partnerships. The object of this work is to make their activities better known and vindicate their importance. The sources used for the study are mainly the accounting documents of several banking houses.     

An international comparison of scale economies in banking: Evidence from Turkey

In this article economies of scale are examined for Turkish banks. The literature on economies of scale in depository institutions is substantial. Yet, virtually all published articles have examined production/costs using data for developed countries, such as the United States, Canada, and Israel. Here we examine data from a country that has an economic system vastly different in terms of per capita productivity. Despite the differences, the results are similar across countries in that we find no significant evidence of economies of scale at output levels near the sample mean. This suggests that the conclusion from examining banks in developed countries—that a bank does not have to be large in order to be competitive from a cost perspective—holds in a less developed country.     

Exchange rate regimes, banking and the non-tradable sector

This paper presents a small-open-economy, two-good version of the Diamond and Dybvig model with cash constraints to analyze the implications on banking of different exchange rate regimes and monetary policies. I show that fixed exchange rates with a Central Bank providing liquidity in local currency imply Pareto efficiency, with conditions for a run equilibrium stronger than in the literature. In a flexible exchange rate regime, multiple equilibria may not be eliminated. In particular, for very a expansive monetary policy there exists an equilibrium where a fraction of patient consumers purchases dollars in the interim period, which constitutes a partial currency run. A dollarized banking system without international short-run credit may also implement the efficient allocation under certain conditions.     

Explaining banking stability in Sub-Saharan Africa

The study examined banking stability in Sub-Saharan Africa. The results reveal that banking spread (Net Interest Margin – NIM) is the main determinant of stability and the major means to achieve stability during crises periods. We however find the existence of a threshold effect in NIM.Crises in the banking sector consistently showed to reduce stability. While the results show that high percentage of foreign banks reduce stability, we find foreign banks help stabilize the banking sector in periods of crises. The results show that diversification could also have a positive impact on stability (Z-score) even though this relationship was not robust enough. The results also largely support the competition-fragility view. Particularly, we find that less competition during crises periods can help improve stability. Again, we find evidence for both concentration-stability and concentration-fragility hypotheses depending on the stability measure used. We however find that when large banks in concentrated markets are well regulated, stability could be improved. Weak regulatory environment reduces stability (Z-score) directly and matters during crises periods. Our results are robust to the use of different indicators of stability and estimation methods.     

Cross-border interbank networks,banking risk and contagion

Recent events have highlighted the role of cross-border linkages between banking systems in transmitting local developments across national borders. This paper analyzes whether international linkages in interbank markets affect the stability of interconnected banking systems and channel financial distress within a network consisting of banking systems of the main advanced countries for the period 1994–2012. Methodologically, I use a spatial modeling approach to test for spillovers in cross-border interbank markets. The results suggest that foreign exposures in banking play a significant role in channeling banking risk: I find that countries that are linked through foreign borrowing or lending positions to more stable banking systems abroad are significantly affected by positive spillover effects. From a policy point of view, this implies that in stable times, linkages in the banking system can be beneficial, while they have to be taken with caution in times of financial turmoil affecting the whole system.     

Systems theory and technological change

This paper offers a different approach to the analysis of technological change traditionally offered by neo-classical economists. Using a general systems approach, changes in technology are described by the process of adaptation of technologies to their external environment, similar to the concepts of homeostasis and self-regulation in biological and electronic systems.     

Who said large banks don’t experience scale economies? Evidence from a risk-return-driven cost function

The Great Recession focused attention on large financial institutions and systemic risk. We investigate whether large size provides any cost advantages to the economy and, if so, whether these cost advantages are due to technological scale economies or too-big-to-fail subsidies. Estimating scale economies is made more complex by risk-taking. Better diversification resulting from larger scale generates scale economies but also incentives to take more risk. When this additional risk-taking adds to cost, it can obscure the underlying scale economies and engender misleading econometric estimates of them. Using data pre- and post-crisis, we estimate scale economies using two production models. The standard model ignores endogenous risk-taking and finds little evidence of scale economies. The model accounting for managerial risk preferences and endogenous risk-taking finds large scale economies, which are not driven by too-big-to-fail considerations. We evaluate the costs and competitive implications of breaking up the largest banks into smaller banks.     

Aggregate liquidity shortages, idiosyncratic liquidity smoothing and banking regulation

This paper develops a model of banking fragility driven by aggregate liquidity shortages. Inefficiencies arise from a failure of the interbank market to smooth the available liquidity in such a shortage. We find that a standard lender of last resort policy is ineffective in restoring efficiency as it leads to offsetting changes in the banks’ supply of liquidity. In contrast, subsidizing the purchase of assets from troubled banks increases welfare by improving the banks’ liquidity holdings. The first best, however, is achieved by redistributing existing liquidity from healthy to troubled banks in a crisis.     

Conditional risk, return and contagion in the banking sector in asia

This paper investigates risk and return in the banking sector in three Asian markets of Taiwan, China and Hong Kong. The study focuses on the risk-return relation in a conditional factor GARCH-M framework that controls for time-series effects. The factor approach is adopted to incorporate intra-industry contagion and an analysis of spillovers between large banks and small banks. Finally, the study provides evidence on these relations before and after the Asian financial crisis of 1997. The results are generally consistent across the markets and with expectations.     

Investment-specific technological change and growth accounting

Greenwood et al. [1997. Long-run implications of investment-specific technological change. American Economic Review 87(3), 342-362; and 2000. The role of investment-specific technological change in the business cycle. European Economic Review 44, 91-115] and Hercowitz [1998. The ‘embodiment’ controversy: a review essay. Journal of Monetary Economics 41, 217-224] have claimed that the Jorgenson form of growth accounting is conceptually flawed and severely understates the importance of technological progress embodied in new capital goods for explaining growth. To the contrary, this paper shows that in its technology aspects their model is a special case of the Jorgensonian growth accounting model. What they call investment-specific technological change is shown to be closely related to the more familiar concept of total factor productivity (TFP) growth: statements about the one can be translated into statements about the other. Empirically, differences between their conclusions and those of growth accounting studies about the extent to which embodiment explains US economic growth are found to relate more to data than to methodology.     

Assessing competitive conditions in the Greek banking system

This paper uses the Rosse-Panzar statistic to assess empirically competitive conditions in the Greek banking system over the period 1993–1995. The competitiveness of the banking system is evaluated using a non-structural estimation technique. The results indicate that bank revenues were earned as if under conditions of monopolistic competition. The gradual elimination of exchange controls, the capital movement liberalisation, the enactment of the Second Banking Directive of the European Union and the supervisory arrangements have been related to the competitive conditions of the Greek banking system.     

On measuring concentration in banking systems

Assuming a Pareto-type distribution of bank sizes, we investigate the effect of changes in Zipf's exponent () and the sample size on the behavior of different concentration indices, such as the 3-bank concentration ratio, the Herfindahl–Hirschman index and the top 5%-concentration ratio. We derive analytical relations between these concentration indices and investigate the elasticity of these indices to changes in and in the sample size N. We show different regimes under which each index can be used most appropriately. Our results are highly relevant for policymakers who rely on such concentration measures to derive public policy recommendations in banking.     

Foreign participation and banking competition: Evidence from the Indonesian banking industry

Foreign participation in Indonesian banking has expanded from the establishment of foreign de novo banks into the acquisition of existing local banks. The increase in foreign participation has therefore not been associated with a growing number of banks. This study aims to examine the competitive behavior of foreign and local banks as a competitive banking industry is important in boosting economic efficiency and economic growth. This study also examines the role of modes of entry of foreign banks on competition, either through the establishment of foreign de novo banks or the acquisition of local banks. The recent methodological refinements of the Panzar–Rosse method developed by Bikker et al. (2011) are employed to estimate the level of competition among local and foreign banks. Generally, the foreign banks, particularly foreign de novo banks behaved more competitively than local banks, and their penetration is therefore important in creating a contestable market. This study found that in terms of assets, on average foreign de novo banks were smaller, more efficient, and had lower overhead costs, so they could offer lower loan rates and disburse more loans. The recent consolidation in the Indonesian banking industry may have an adverse impact on competition as it restricts the establishment of foreign de novo banks.     

Macroprudential policies,capital flows,and the structure of the banking sector

Using a large sample of advanced and emerging market economies over the period 1999–2012, we examine the effectiveness of macroprudential policies (MPPs) in managing cross-border bank flows. Conditioning on the structure of the banking sector in the MPP-implementing country, we find that higher regulatory quality and a higher credit-to-deposit ratio increase the effectiveness of MPPs, while a higher cost-to-income ratio has the opposite effect. If all three financial variables are evaluated at the median, the marginal effect of our preferred MPP measure leads to a reduction of international bank inflows in percent of GDP by around half a percentage point and is only marginally significant. However, when the more enhanced 25th (10th) percentiles of their respective distributions are considered, we observe, as a response to the same MPP measure, a reduction of bank inflows by 3.44 (5.39) percentage points that is highly statistically and economically significant. Additionally, we find that the structure of the domestic banking sector determines spillovers from MPPs across asset classes, while spillovers from MPPs across countries are a function of banking sector conditions both at home and abroad.