Why do estimates of bank scale economies differ?

A number of public policy issues turn on whether or not there are scale economies in commercial banking. This paper examines why empirical tests in this area have yielded differing results. Sorting out the different methodological approaches enables us to develop general conclusions on the size and significance of scale economies in banking.Economies of scale ; Banks and banking - Costs ; Bank size

Evaluation of riskiness of Indian Banks and probability of book value insolvency

Recently, a lot of questions were raised about the financial health of commercial banks in India. This paper analyzes the Indian banks' riskiness and the probability of book-value insolvency under the framework developed by Hannan and Hanweck (1988). A risk index, known as Z score, for Global Trust Bank that became insolvent in 2004 suggests that the framework developed by Hannan and Hanweck (1988) is also relevant in the Indian context. For a random sample of 15 Indian Banks (public & private sector), we determine the riskiness/probability of book value insolvency over the years and also carry out a relative comparison between public and private sector banks in India. Results obtained in the study show that the probability of book value insolvency of Indian Banks has reduced over years and the probability of book value insolvency is lower in case of public sector banks in comparison to private sector banks.Riskiness, insolvency, Z-statistic

A comparison of risk-based capital and risk-based deposit insurance

A comparison of alternative bank regulatory proposals for controlling the level of bank risk, using a model based on six FDIC variables for predicting bank failure or loss.Risk ; Capital

Market discipline by depositors: evidence from reduced form equations

This paper examines the effects of the estimated probability of bank failure on the growth rates of large time deposits and interest rates on those deposits. While riskier banks paid higher interest rates, they attracted less large time deposits in the second half of the 1980s. These results indicate that risky banks faced unfavorable supply schedules of large time deposits and, hence, support the presence of market discipline by large time depositors. The empirical analysis also considers the effects of bank size, but fails to find evidence that depositors preferred large banks.Deposit insurance

Event-Study Evidence of the Value of Relaxing Longstanding Regulatory Restraints on Banks, 1970-2000

In a partial-equilibrium model, removing a binding constraint creates value. However, in general equilibrium, the stakes of other parties in maintaining the constraint must be examined. In financial deregulation, the fear is that expanding the scope and geographic reach of very large institutions might unblock opportunities to build market power from informational advantages and size-related safety-net subsidies. This paper reviews and extends event-study evidence about the distribution of the benefits and costs of relaxing longstanding geographic and product-line restrictions on U.S. financial institutions. The evidence indicates that the new financial freedoms may have redistributed rather than created value. Event returns are positive for some sectors of the financial industry and negative for others. Perhaps surprisingly, where customer event returns have been investigated, they prove negative.

Optimal financial structure and bank capital requirements: an empirical investigation

This paper presents an empirical analysis of the determinants of the leverage ratios (the book value of liabilities divided by the total of the book value of liabilities' and the market value of equity) for 232 bank holding companies for December 1986, June 1987, and December 1987. Many theoretical models of bank behavior assume that bank capital requirements will be binding, and empirical research has generally shown that almost all- banks will meet capital guidelines. However, if the optimal leverage ratios differ among banks, then banks' responses to changes in capital requirements or to changes in factors that influence their optimal leverage ratio may vary in a cross section. the theoretical framework is a variant of the one developed in Bradley, Jarrell , and Kim (1984) . the optimal' leverage ratio balances the tax advantage of debt with the costs of bankruptcy. in addition to considering nondebt tax shields and tax rates as determinants of the optimal ratio, we analyze the simultaneity between leverage and investment in municipal securities (munis). Previous research indicates that banks utilize munis to' minimize tax liabilities.Bank capital ; Banks and banking - Taxation

Bank insolvency risk and aggregate Z-score measures: a caveat

We demonstrate that a popular approach to constructing (weighted) mean-based aggregate bank insolvency risk measures is inherently biased; we also suggest an alternative approach that avoids this problem.insolvency risk, aggregate Z-score, Jensen's inequality

Consolidation, Scale Economics and Technological Change in Japanese Banking

The paper examines the technological structure of the Japanese banking sector before the onset of the banking crisis and structural reforms of the 90s in order to shade light on the logic of the recent trend to consolidation in the industry. While diseconomies of scale are shown to be pervasive in the large banks, defying the rationale for consolidation, the paper presents evidence of an underlying technological progress that operates to significantly increase the industry’s efficient minimum size, generating economies at larger banks, thus justifying the ongoing trend in consolidation. The results suggest that, to the extent that consumers can benefit from lower costs of bank production, policies that promote a more concentrated banking structure might be consistent with public interest.http://deepblue.lib.umich.edu/bitstream/2027.42/57258/1/wp878 .pd

Banks in the securities business: market-based risk implications of section 20 subsidiaries

This paper explores whether there was an economically significant differential in market-based risk between bank holding companies (BHCs) with Section 20 subsidiaries – subsidiaries that were authorized by the Federal Reserve to conduct bank-ineligible securities activities – and BHCs without such subsidiaries. Using market returns over a period of time in which BHCs expanded into securities activities, from 1985 through 1999, this study finds evidence that BHCs that participated in investment banking exhibited significantly lower total and unsystematic risk, suggesting that banks’ participation in the securities business resulted in diversification gains. However, BHCs with Section 20 subsidiaries exhibited higher systematic risk.Securities ; Risk ; Bank holding companies

Do Consumers Pay for One-Stop Banking?

The authors use a specialized revenue function to estimate the revenue economies of scope and determine whether banks providing a broad mix of services are able to capitalize on the potential savings in transaction costs afforded their customers. Bank production costs and consumer consumption expenses are thought to be reduced through relationship banking strategies that cultivate one stop shopping for financial services. Much work has been done on estimates of production synergies that correspond to cost economies of scope. The complementarities in the consumption of bank services is potentially as important for bank profitability but it has yet to be examined in detail. Complementarities arise from reductions in user transaction and search costs associated with consuming financial services jointly from the same bank provider, often at the same location, rather than consuming these services separately from different providers at different locations. If benefits from joint consumption are strong, consumers should be willing to pay for them through higher prices at banks that provide services jointly rather than separately. The authors find no evidence of statistically significant revenue complementarities or fixed revenue effects among banks over 1978-1990. Revenues are no larger when deposits and loans are provided jointly rather than separately, and consumers do not pay for one stop banking. This holds for the average small or large bank as well as those on and off the revenue-efficient frontier. Combining revenue scope results with earlier cost scope findings suggests that synergies between bank deposits and loans are small and concentrated in joint production, rather than joint consumption. Consumers may or may not value one stop banking, but they apparently do not have to pay for it.