Bank Capitalization and Cost: Evidence of Scale Economies in Risk Management and Signaling
With seemingly minor amendments to the standard techniques of measuring banking technology, we have uncovered important empirical phenomena that point to the crucial role played by financial capital in banking and financial intermediation. The authors employ a standard cost function, conditioned on the level of financial capital, but they model the demand for financial capital so that it can logically serve as a cushion against insolvency for potentially risk-averse managers and as a signal of risk for less informed outsiders. This allows scale economies to be computed without assuming that the bank chooses a level of capitalization that minimizes cost. Hence, a wider range of cost configurations is accommodated. ; The authors find evidence that bank managers are risk averse and use the level of financial capital to signal the level of risk. For any given vector of outputs, risk-averse managers increase the level of financial capital to control risk and employ additional amounts of labor and physical capital to improve risk management and to preserve capital. When scale economies are calculated, increasing size and the consequent improvement in diversification allow risk-averse banks to economize on their costly tradeoff and achieve significant scale economies. When these roles of financial capital are ignored in analyzing banking costs, the measured scale economies disappear. Our results seem to reconcile the disparity between the finding of constant returns to scale of previous studies that ignored financial capital and assumed risk-neutral bank managers and the recent wave of large bank mergers, which bankers claim are driven in part by scale economies.
(This abstract was borrowed from another version of this item.)
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||03 Feb 1997|
|Date of revision:|
|Contact details of provider:|| Postal: New Jersey Hall - 75 Hamilton Street, New Brunswick, NJ 08901-1248|
Phone: (732) 932-7363
Fax: (732) 932-7416
Web page: http://economics.rutgers.edu/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Loretta J. Mester, 1994. "How efficient are Third District banks?," Business Review, Federal Reserve Bank of Philadelphia, issue Jan, pages 3-18.
When requesting a correction, please mention this item's handle: RePEc:rut:rutres:199601. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.