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Merger-related cost savings in the production of bank services

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  • J. Christina Wang

Abstract

This paper utilizes a new flow measure of the true output of bank services to analyze the impact of mergers on the cost and productivity of Bank Holding Companies (BHCs) over the period 1987-1999. It shows that there are conceptual problems in the output measures used in previous studies, which may be the reason for their paradoxical findings: Bank mergers are estimated to lead to significant increases in profit, without cost savings or increases in market power. This paper also points out the problematic understanding of diversification in previous studies. To remedy these problems, this paper uses a new measure that accounts coherently for risk in measuring bank service output and recognizes that the funds banks borrow and lend are a special intermediate input. Once one accounts for the better diversification resulting naturally from mergers, the commonly used, book-value-based output measure shows little improvement in cost productivity. In contrast, the new flow measure of bank output shows more improvement, although it is still insignificant-partly because the sample size is relatively small. The gap widens further when one corrects for possible bias in the new output estimate. Thus, the new measure of bank output has the potential to resolve the paradox found in the existing literature, by showing that mergers do lead to cost savings.

Suggested Citation

  • J. Christina Wang, 2003. "Merger-related cost savings in the production of bank services," Working Papers 03-8, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbwp:03-8
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    References listed on IDEAS

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    7. Berger, Allen N. & Humphrey, David B., 1997. "Efficiency of financial institutions: International survey and directions for future research," European Journal of Operational Research, Elsevier, vol. 98(2), pages 175-212, April.
    8. Berger, Allen N & Hannan, Timothy H, 1989. "The Price-Concentration Relationship in Banking," The Review of Economics and Statistics, MIT Press, vol. 71(2), pages 291-299, May.
    9. J. Christina Wang, 2003. "Productivity and economies of scale in the production of bank service value added," Working Papers 03-7, Federal Reserve Bank of Boston.
    10. Arellano, M, 1987. "Computing Robust Standard Errors for Within-Groups Estimators," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 49(4), pages 431-434, November.
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    12. J Christina Wang, 2010. "Risk and bank service output," IFC Bulletins chapters,in: Bank for International Settlements (ed.), The IFC's contribution to the 57th ISI Session, Durban, August 2009, volume 33, pages 317-333 Bank for International Settlements.
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    Cited by:

    1. Fabio Panetta & Fabiano Schivardi & Matthew Shum, 2009. "Do Mergers Improve Information? Evidence from the Loan Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(4), pages 673-709, June.
    2. Al-Khasawneh, Jamal Ali & Essaddam, Naceur, 2012. "Market reaction to the merger announcements of US banks: A non-parametric X-efficiency framework," Global Finance Journal, Elsevier, vol. 23(3), pages 167-183.

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