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Who said large banks don't experience scale economies? Evidence from a risk-return-driven cost function

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Listed:
  • Joseph P. Hughes
  • Loretta J. Mester

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, the authors 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. The authors show that these economies are not driven by too-big-to-fail considerations. They evaluate the cost implications of breaking up the largest banks into banks of smaller size.

Suggested Citation

  • Joseph P. Hughes & Loretta J. Mester, 2011. "Who said large banks don't experience scale economies? Evidence from a risk-return-driven cost function," Working Papers 11-27, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:11-27
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    References listed on IDEAS

    as
    1. Hughes, Joseph P. & Mester, Loretta J. & Moon, Choon-Geol, 2001. "Are scale economies in banking elusive or illusive?: Evidence obtained by incorporating capital structure and risk-taking into models of bank production," Journal of Banking & Finance, Elsevier, vol. 25(12), pages 2169-2208, December.
    2. Joseph P. Hughes & Loretta J. Mester, 2008. "Efficiency in banking: theory, practice, and evidence," Working Papers 08-1, Federal Reserve Bank of Philadelphia.
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    More about this item

    Keywords

    Production (Economic theory); Risk; Systemic risk; Banks and banking;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D20 - Microeconomics - - Production and Organizations - - - General

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    This paper has been announced in the following NEP Reports:

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