Bank Size, Returns to Scale and Cost Efficiency

Since the passage of Dodd-Frank, government regulators have become more interested than ever in the significant increase of bank size in the U.S. financial sector. To shed light on the reasons of the bank size increase and its effects on banks, we study the dynamic interactions between size, cos efficiency and returns to scale. Using Fourier flexible form, we show that banks of all but the largest sizes exhibit increasing returns to scale. As banks grow, they tend to benefit from cost efficiencies more, but they lose returns to scale gains. Banks seem to exploit increasing returns to scale until they become too large; however, they continue to enjoy their cost efficiency. We also analyze the effects of regulations in the past 25 years to understand whether imposing (or removing) limits on the size of banks causes real economic costs. Our findings show that both restrictive and loose regulation help larger banks, but hurt smaller banks by creating extra costs.