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

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