Who Said Large Banks Don't Experience Scale Economies? Evidence from a Risk-Return-Driven Cost Function
Joseph P. Hughes
Rutgers University, New Brunswick/Piscataway, Faculty of Arts and Sciences-New Brunswick/Piscataway, Department of Economics
Loretta J. Mester
Federal Reserve Bank of Philadelphia; University of Pennsylvania - The Wharton School
July 31, 2011
FRB of Philadelphia Working Paper No. 11-27
Earlier studies found little evidence of scale economies at large banks; later studies using data from the 1990s uncovered such evidence, providing a rationale for very large banks seen worldwide. Using more recent data, we estimate scale economies using two production models. The standard risk-neutral model finds little evidence of scale economies. The model using more general risk preferences and endogenous risk-taking finds large scale economies. We show that these economies are not driven by too-big-to-fail considerations. We evaluate the cost implications of breaking up the largest banks into banks of smaller size.
Number of Pages in PDF File: 39
Keywords: banking, production, risk, scale economies, too big to fail
JEL Classification: D20, D21, G21, L23working papers series
Date posted: August 4, 2011
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