Do Large Banks have Lower Costs? New Estimates of Returns to Scale for U.S. Banks

Federal Reserve Bank of St. Louis Working Paper No. 2009-054E

62 Pages Posted: 25 Oct 2009 Last revised: 30 May 2011

David C. Wheelock

Federal Reserve Bank of St. Louis - Research Division

Paul W. Wilson

Clemson University - John E. Walker Department of Economics; University of Texas at Austin - Department of Economics

Date Written: May 27, 2011

Abstract

The number of commercial banks in the United States has fallen by more than 50 percent since 1984. This consolidation of the U.S. banking industry and the accompanying large increase in average (and median) bank size have prompted concerns about the effects of consolidation and increasing bank size on market competition and on the number of banks that regulators deem “too–big–to–fail.” Agency problems and perverse incentives created by government policies are often cited as reasons why many banks have pursued acquisitions and growth, though bankers often point to economies of scale. This paper presents new estimates of ray-scale and expansion-path scale economies for U.S. banks based on non-parametric local-linear estimation of a model of bank costs. Unlike prior studies that use models with restrictive parametric assumptions or limited samples, our methodology is fully non-parametric and we estimate returns to scale for all U.S. banks over the period 1984–2006. Our estimates indicate that as recently as 2006, most U.S. banks faced increasing returns to scale, suggesting that scale economies are a plausible (but not necessarily only) reason for the growth in average bank size and that the tendency toward increasing scale is likely to continue unless checked by government intervention.

Keywords: banks, returns to scale, scale economies, nonparametric, regression

JEL Classification: G21, L11, C12, C13, C14

Suggested Citation

Wheelock, David C. and Wilson, Paul W., Do Large Banks have Lower Costs? New Estimates of Returns to Scale for U.S. Banks (May 27, 2011). Federal Reserve Bank of St. Louis Working Paper No. 2009-054E. Available at SSRN: https://ssrn.com/abstract=1493261 or http://dx.doi.org/10.2139/ssrn.1493261

David C. Wheelock (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

P.O. Box 442
St. Louis, MO 63166-0442
United States

Paul W. Wilson

Clemson University - John E. Walker Department of Economics ( email )

Clemson, SC 29634
United States

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

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