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2 What mathematical form of cost function would be most appropriate to use to test the existence of economies of scale in banking?

2 What mathematical form of cost function would be most appropriate to use to test the existence of economies of scale in banking?

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
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2 What mathematical form of cost function would be most appropriate to use to test the existence of economies of scale in banking?
10:59 M 4 ET • in the United States. Shaffer and David examined economies of scale in 'superscale' banks, that is banks with assets ranging from $2.5 billion to $120 billion in 1984. They estimated that the minimum efficient scale of these banks was between $15 billion and $37 billion in assets, and that these larger banks enjoyed lower average costs than smaller banks. Many of the studies have been summarized by Clark in the USA. In particular, Clark's conclusions were that there are only significant economies of scale at low levels of output (less than $100 million in deposits). Furthermore, it appeared that economies of scope were limited to certain specific product categories, for example consumer loans and mortgages, rather than being generally applicable. Questions 1 What shape of long-run average cost curve appears to be appropriate for the commercial banking industry? 2 What mathenmatical form of cost function would be most appropriate to use to test the existence of economies of scale in banking? 3 What factors might cause the LAC curve to flatten out at high levels of output? 4 In view of the empirical evidence, what factors do you think might be responsible for the current trends of increasing size and mergers? ?
Transcribed Image Text:10:59 M 4 ET • in the United States. Shaffer and David examined economies of scale in 'superscale' banks, that is banks with assets ranging from $2.5 billion to $120 billion in 1984. They estimated that the minimum efficient scale of these banks was between $15 billion and $37 billion in assets, and that these larger banks enjoyed lower average costs than smaller banks. Many of the studies have been summarized by Clark in the USA. In particular, Clark's conclusions were that there are only significant economies of scale at low levels of output (less than $100 million in deposits). Furthermore, it appeared that economies of scope were limited to certain specific product categories, for example consumer loans and mortgages, rather than being generally applicable. Questions 1 What shape of long-run average cost curve appears to be appropriate for the commercial banking industry? 2 What mathenmatical form of cost function would be most appropriate to use to test the existence of economies of scale in banking? 3 What factors might cause the LAC curve to flatten out at high levels of output? 4 In view of the empirical evidence, what factors do you think might be responsible for the current trends of increasing size and mergers? ?
10:57 M 4 ET • l ll GD ס There are various theoretical reasons why economies of scale should occur in the banking industry: 1 Specialization of labour. There is considerable scope for this as cashiers, loan officers, account managers, foreign exchange managers, investment analysts and programmers can all increase their productivity with increased volume of output. 2 Indivisibilities. Banks make use of much computer and telecommunications technology. Larger institutions are able to use better equipment and spread fixed costs more easily. 3 Marketing. Much of this involves fixed costs, in terms of reaching a given size of market; large institutions can again spread these costs more easily. 4 Financial. Banks have to raise finance, mainly from depositors. Larger banks can do this more easily and at lower cost, meaning that they can afford to offer their depositors lower interest rates. There are also reasons why banks should gain from economies of scope; many of their products are related and banks have increasingly tried to cross-sell them. Examples are different types of customer account, accounts and credit cards, accounts and mortgages or consumer loans, and even banking services and insurance. There has also been a spate of bank mergers and acquisitions in recent years, often involving related institutions like building societies, investment banks and insurance companies. Many of these institutions
Transcribed Image Text:10:57 M 4 ET • l ll GD ס There are various theoretical reasons why economies of scale should occur in the banking industry: 1 Specialization of labour. There is considerable scope for this as cashiers, loan officers, account managers, foreign exchange managers, investment analysts and programmers can all increase their productivity with increased volume of output. 2 Indivisibilities. Banks make use of much computer and telecommunications technology. Larger institutions are able to use better equipment and spread fixed costs more easily. 3 Marketing. Much of this involves fixed costs, in terms of reaching a given size of market; large institutions can again spread these costs more easily. 4 Financial. Banks have to raise finance, mainly from depositors. Larger banks can do this more easily and at lower cost, meaning that they can afford to offer their depositors lower interest rates. There are also reasons why banks should gain from economies of scope; many of their products are related and banks have increasingly tried to cross-sell them. Examples are different types of customer account, accounts and credit cards, accounts and mortgages or consumer loans, and even banking services and insurance. There has also been a spate of bank mergers and acquisitions in recent years, often involving related institutions like building societies, investment banks and insurance companies. Many of these institutions
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