Cost Economies in Eu Banking Systems

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NORTH- ~)IJAND

Cost Economies in EU Banking Systems
Yener Altunbas and Philip Molyneux

This paper examines the cost structure of four EU banking systems using the translog cost function methodology. The results indicate strong evidence of economies of scale across all output sizes for the French, German and Spanish systems. In contrast, the Italian system appears to exhibit constant and diseconomies of scale. Costs also appear to be subadditive across all output ranges apart from the Italian system. These results tentatively suggest that scale economies and the benefits of size could be important in generating economic gains in EU banking markets under the single market programme.

Keywords: European banking; Cost economies JEL classification: G21

I. I n t r o d u c t i o n
The Commission of the European Communities (7988) stressed in its 1992 single market programme that substantial benefits would accrue to those sectors which can benefit from positive supply-side effects. In particular, 'price reductions occasioned by competitive pressures will force firms to look actively for reduction in costs through the elimination of areas of low productivity or by a greater exploitation of scale economies' [European Economy 1988, p. 162]. Despite the importance of cost economies, however, few studies have investigated cost characteristics in European banking and no studies, as far as we are aware, have provided crosscountry comparisons. This paper aims to redress this imbalance by using the translog cost function methodology to evaluate evidence of scale economies and expansion path subadditivity in four large EU banking markets: France, Germany, Italy and Spain. The major conclusions from our study are as follows. Cost economies appear to be prevalent across all bank size classes in the German, French and Spanish School of Accounting, Banking and Economics, University College of North Wales, Bangor, Gwynedd, United Kingdom (YA and PM). Address correspondence to: Professor Philip Molyneux, School of Accounting, Banking and Economics, University College of North Wales, Bangor, Gwynedd, LL57 2DG, United Kingdom.

Journal of Economics and Business 1996; 48:217 230 © 1996 Temple University

0148-6195/96/$15.00 PII S0148-6195(96)00014-8

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Y. Altunbas and P. Molyneux banking systems. There is evidence of constant and diseconomies of scale in the Italian system. Cost subadditivity results also suggest a tendency for increased bank size in the German, French and Spanish systems. These findings add empirical support to the view that EU banks could benefit from cost economies in the light of the competitive forces unleashed by the single market programme. The paper is set out as follows, Section II provides a literature review of cost studies which examine both US and European banking systems. Section III outlines the methodology and Section IV describes the data and reports the scale economy and cost subadditivity results. Section V is the conclusion.

II. Cost E c o n o m i e s m A Brief Literature Review
The majority of the U.S. literature on cost economies in banking has analyzed the cost structures of relatively small banks and found that scale economies are usually exhausted somewhere around the $100 million asset size 1. A hand full of these studies [Gilligan and Smirlock (1984), Gilligan et al. (1984), Kolari and Zardkoohi (1987)] have also found scope economies again in relatively small banks. More recent studies, however, have examined cost economies for large banks (or other financial institutions) and these have found slight evidence of economies of scale and scope, [see Hunter and Timme (1986, 1987), Shaffer (1988), Evanoff and Isrilevich (1990), Hunter et al. (1990), Noulas et al. (1990, 1993), Shaffer and David (1991), and Mester (1992)]. Berger et al. (1993) suggests that these results imply, 'that the functional form employed in these studies may not be capable of incorporating the technologies of...
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