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Determinants of profitability of community banks in the USA: a cost-frontier-based decomposition approach

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  • Guohua Feng

    (University of North Texas)

  • Chuan Wang

    (Zhongnan University of Economics and Law)

Abstract

This paper investigates the determinants of the poor profitability of community banks relative to that of large banks in the USA over the period 2001–2017, by decomposing the relative profitability of community banks into five multiplicative cost-frontier-based explanatory factors. To compute these explanatory factors, we estimate a Bayesian true fixed effects stochastic cost frontier model, which has the advantages of allowing the unobserved heterogeneity term to be correlated with the observed explanatory variables and providing statistical inferences on the cost-frontier-based explanatory factors. Our decomposition shows that community banks’ lower profitability was attributable mainly to their lower technical change, lower scale efficiency and higher funding costs. In addition, the latter two factors were also the two main contributors to the deterioration in the profitability of community banks.

Suggested Citation

  • Guohua Feng & Chuan Wang, 2021. "Determinants of profitability of community banks in the USA: a cost-frontier-based decomposition approach," Empirical Economics, Springer, vol. 60(6), pages 2969-2992, June.
    • Handle: RePEc:spr:empeco:v:60:y:2021:i:6:d:10.1007_s00181-020-01952-x
    DOI: 10.1007/s00181-020-01952-x
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    References listed on IDEAS

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    More about this item

    Keywords

    Community and large banks; Profitability; Productivity and efficiency; Stochastic cost frontier model;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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