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New evidence on returns to scale and product mix among U.S. commercial banks

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  • David C. Wheelock
  • Paul W. Wilson

Abstract

Numerous studies have found that banks exhaust scale economies at low levels of output, but most are based on the estimation of parametric cost functions which misrepresent bank cost. Here we avoid specification error by using nonparametric kernal regression techniques. We modify measures of scale and product mix economies introduced by Berger et al. (1987) to accommodate the nonparametric estimation approach, and estimate robust confidence intervals to assess the statistical significance of returns to scale. We find that banks experience increasing returns to scale up to approximately $500 million of assets, and essentially constant returns thereafter. We also find that minimum efficient scale has increased since 1985.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1997-003.

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Date of creation: 1997
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Publication status: Published in Journal of Monetary Economics, June 2001, 47(3), pp. 653-74
Handle: RePEc:fip:fedlwp:1997-003

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Keywords: Banks and banking ; Banks and banking - Costs ; Economies of scale;

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References

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  1. Allen N. Berger & Anil K. Kashyap & Joseph Scalise, 1995. "The Transformation of the U.S. Banking Industry: What a Long, Strange Trip It's Been," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 96-06, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Allen N. Berger & Loretta J. Mester, 1997. "Inside the black box: what explains differences in the efficiencies of financial institutions?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1997-10, Board of Governors of the Federal Reserve System (U.S.).
  3. Berger, Allen N. & Hanweck, Gerald A. & Humphrey, David B., 1987. "Competitive viability in banking : Scale, scope, and product mix economies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 20(3), pages 501-520, December.
  4. Wolfgang Hardle & Oliver Linton, 1994. "Applied Nonparametric Methods," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1069, Cowles Foundation for Research in Economics, Yale University.
  5. Kaparakis, Emmanuel I & Miller, Stephen M & Noulas, Athanasios G, 1994. "Short-Run Cost Inefficiency of Commercial Banks: A Flexible Stochastic Frontier Approach," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 26(4), pages 875-93, November.
  6. Jalal D. Akhavein & Allen N. Berger & David B. Humphrey, 1996. "The Effects of Megamergers on Efficiency and Prices: Evidence from a Bank Profit Function," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 96-03, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Allen N. Berger & David B. Humphrey, 1990. "The dominance of inefficiencies over scale and product mix economies in banking," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 107, Board of Governors of the Federal Reserve System (U.S.).
  8. Gallant, A. Ronald, 1982. "Unbiased determination of production technologies," Journal of Econometrics, Elsevier, Elsevier, vol. 20(2), pages 285-323, November.
  9. Allen N. Berger & David B. Humphrey, 1992. "Megamergers in banking and the use of cost efficiency as an antitrust defense," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 203, Board of Governors of the Federal Reserve System (U.S.).
  10. Hunter, William C & Timme, Stephen G, 1995. "Core Deposits and Physical Capital: A Reexamination of Bank Scale Economies and Efficiency with Quasi-Fixed Inputs," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 27(1), pages 165-85, February.
  11. Berger, Allen N. & DeYoung, Robert, 1997. "Problem loans and cost efficiency in commercial banks," Journal of Banking & Finance, Elsevier, vol. 21(6), pages 849-870, June.
  12. Mitchell, Karlyn & Onvural, Nur M, 1996. "Economies of Scale and Scope at Large Commercial Banks: Evidence from the Fourier Flexible Functional Form," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 28(2), pages 178-99, May.
  13. Barnett, William A. & Geweke, John & Wolfe, Michael, 1991. "Seminonparametric Bayesian estimation of the asymptotically ideal production model," Journal of Econometrics, Elsevier, Elsevier, vol. 49(1-2), pages 5-50.
  14. Gallant, A. Ronald, 1981. "On the bias in flexible functional forms and an essentially unbiased form : The fourier flexible form," Journal of Econometrics, Elsevier, Elsevier, vol. 15(2), pages 211-245, February.
  15. Allen N. Berger & David B. Humphrey, 1997. "Efficiency of financial institutions: international survey and directions for future research," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 1997-11, Board of Governors of the Federal Reserve System (U.S.).
  16. McAllister, Patrick H. & McManus, Douglas, 1993. "Resolving the scale efficiency puzzle in banking," Journal of Banking & Finance, Elsevier, vol. 17(2-3), pages 389-405, April.
  17. Ferrier, Gary D. & Lovell, C. A. Knox, 1990. "Measuring cost efficiency in banking : Econometric and linear programming evidence," Journal of Econometrics, Elsevier, Elsevier, vol. 46(1-2), pages 229-245.
  18. Allen Berger & John Leusner & John Mingo, 1994. "The Efficiency of Bank Branches," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 94-27, Wharton School Center for Financial Institutions, University of Pennsylvania.
  19. Clark, Jeffrey A, 1996. "Economic Cost, Scale Efficiency, and Competitive Viability in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 28(3), pages 342-64, August.
  20. John H. Boyd & Stanley L. Graham, 1991. "Investigating the banking consolidation trend," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr, pages 3-15.
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