Who Said Large Banks Don't Experience Scale Economies? Evidence from a Risk-Return-Driven Cost Function

39 Pages Posted: 4 Aug 2011

See all articles by Joseph P. Hughes

Joseph P. Hughes

Rutgers, The State University of New Jersey - Department of Economics

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland; University of Pennsylvania - The Wharton School

Multiple version iconThere are 2 versions of this paper

Date Written: July 31, 2011

Abstract

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.

Keywords: banking, production, risk, scale economies, too big to fail

JEL Classification: D20, D21, G21, L23

Suggested Citation

Hughes, Joseph P. and Mester, Loretta J., Who Said Large Banks Don't Experience Scale Economies? Evidence from a Risk-Return-Driven Cost Function (July 31, 2011). FRB of Philadelphia Working Paper No. 11-27. Available at SSRN: https://ssrn.com/abstract=1904527 or http://dx.doi.org/10.2139/ssrn.1904527

Joseph P. Hughes (Contact Author)

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

Loretta J. Mester

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

University of Pennsylvania - The Wharton School

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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