Cost Economies in Eu Banking Systems

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

References: Allen, L. and Rai, A. 1993. Global Financial Intermediation: UniL,ersal L~ersus Specialised Banking. Paper presented at the 20th Annual Meeting of the European Finance Association, Copenhagen Business School, Aug. 26-28. Published in Section II-D of The proceeding, pp. 1-33 (forthcoming Journal of Banking and Finance). Baldini, D. and Landi, A. 1990. Economie di scala e complementariteta ' di costa nell 'indutria bancaria italiana. L 'lndustria 1:25-45. Barnes, P. and Dodds, C. 1983. The structure and performance of the UK building society industry 1970-78. Journal of Business, Finance and Accounting 10:37-56. Barren, A. P. 1969. Maximum likelihood estimation of a complete system of demand equations. European Economic Ret~iew Sept./Dec.( 1): 12-34. Berger, A. and Humphrey, D. 1992. In Measurement of Efficiency in Banking in Grilliches. (2nd ed.) Output measurement in the service sectors. Chicago: NEBR, pp. 245-279. Berger, A. N., Hanweck, G. A. and Humphrey, D. B. 1986. Competitit;e Viability in Banking." Scale, Scope and Product Mix Economies. Research papers in banking and financial economics. Washington, DC: Federal Reserve Board. Berger, A. N., Hanweck, G. A. and Humphrey, D. B. 1987. Competitive viability in banking: Scalc, scope and product mix economies. Journal of Monetary Economics 20:501-520. Berger, A. N., Hunter, W. C. and Timme, S. G. 1993. The efficiency of financial institutions: A review and preview of research past, present, and future. Journal of Banking and Finance 17:221-249. Berndt, E. R., Hall, B. E. and Hausman, J. A. April 1974. Estimation and inference in nonlinear structural models. Annals of Economic and Social Measurement 3:653-665. Christensen, L. R. and Greene, W. 1976. Economies of scale in U.S. power generation. Journal of Political Economy 84:655-676. Christensen, L. R., Jorgenson, D. E. and Lau, L. J. 1973. Transcendental logarithmic production frontiers. Ret~iew of Economics and Statistics 55:28-45. Cost Economies in EU Banking Systems 229 Clark, J. A. Sept./Oct. 1988. Economies of scale and scope at depository financial institutions: A review of the literature. Federal Reserve Bank of Kansas City Economic Review 73:16-33. Commission of the European Communities. March 1988. European economy: The economics of 1992. Brussels: European Commission. Conigliani, C., De Bonis, R., Motta, G. and Parigi, G. Feb. 1991. Economie di scala e di diversificazione nel sistema bancario italiano, Banca d 'Italia. Temi di discussione del Servizio Studi 150. Cossutta, D., Di Battista, M. L., Giannini, C. and Urga, G. 1988. Processo produttivo c struttura dei costi nell 'industria bancaria Italiana. In 'Banca e Mercato ' a cura di F. Cesarini (M. Grillo, M. Monti and M. Onado, eds.). Bologna: I1 Mulino. Dietsch, M. 1993. Economies of scale and scope in French commercial banking industry. Journal of Productivity Analysis 1 (forthcoming). Dietsch, M. 1988. Economies d 'Echelle et Economies d 'Envergure dans les Banques de Deposts Francaises. Mimeo. Strasbourg, France: Institut d 'Etudes Poiltiques de Strasbourg. Drake, L. and Weyman-Jones, T. G. 1992. Technical and scale efficiency in UK building societies, Applied Financial Economics 2:1-9. Drake, L. 1995. Testing for expense preference behaviour in UK building societies. The Service Industries Journal 15(1):50-65. Evanoff, D. D. and Israilevich, P. R. July/Aug. !991. Productive efficiency in banking. Federal Reserve Bank of Chicago: Economic Perspectives 15(4): 11-32. Fanjul, O. and Maravall, F. 1985. La Eficiencia del Sistema Bancario Espafiol. Madrid: Alianza Universidad. Gilbert, R. A. 1984: Bank market structure and competition: A survey. Journal of Money, Credit and Banking 16:617-644. Gilligan, T. and Smirlock, M. March 1984. An empirical study of joint production and scale economies in commercial banking. Journal and Banking and Finance 8:67-77. Gilligan, T., Smirlock, M. and Marshall, W. 1984. Scale and scope economies in the multi-product banking firm. Journal of Monetary Economics 13:393-405. Gough, T. J. 1979. Building society mergers and the size efficiency relationship. Applied Economics 11:185-194. Hardwick, P. 1989. Economies of scale in building societies. Applied Economics 21: 1291-1304. Hardwick, P. 1990. Multi-product cost attributes: A study of UK building societies. Oxford Economic Papers 42:446-461. Hunter, W. C. and Timme, S. G. 1986. Technical change, organisational form and the structure of bank production. Journal of Money, Credit and Banking 18(2):152-166. Hunter, W. C. and Timme, S. G. Jan./Feb. 1987. Concentration and innovation: Striking a balance in deregulation. Federal Reserve Bank of Atlanta Economic Review 72(1):11-20. Hunter, W. C., Timme, S. G. and Yang, W. K. 1990. An examination of cost subadditivity and multiproduct production in large US banks. Journal of Money, Credit and Banking 22(4):504-525. Hunter, W. C. and Timme, S. G. 1995. Core deposits and physical capital: A re-examination of bank scale economics and efficiency with quasi-fixed inputs. Journal of Money, Credit and Banking 27(1):165-185. Kolari, J. and Zardkoohi, A. 1990. Economies of scale and scope in thrift institutions: The case of Finnish cooperative and saving banks. Scandinavian Journal of Economics 92(3):437-451. Lang, G. and Welzel, P. 1994. Efficiency and Technical Progress in Banking, Empirical Results for a Panel of German Cooperative Banks. Working Paper No. 117. Augsburg, Germany: Institut fiir Volkswirtschaftslehre der Universitat Augsburg. 230 Y. Altunbas and P. Molyneux Levy-Garboua, L. and Renard, F. 1977. Une etude statistique de la rentabilite des banques en France en 1974. Cahiers Economiques et Monetaires 5. Martin, F. and Sassenou, M. May 1992. Cost Structure in French Banking: A Reexamination Based on a Regular CES-Quadratic Form. Paris: Casisse des Depots et Consignations. McKillop, D. G. and Glass, C. J. Oct. 1994. A cost model of building societies as producers of mortgages and other financial products. Journal of Business, Finance and Accounting 21(7):1031-1046. Mester, L. J. 1992. Traditional and non-traditional banking: An information-theoretic approach. Journal of Banking and Finance 16:545-566. Noulas, A. G., Ray, S. C. and Miller, S. M. 1990. Returns to scale and input substitution for large U.S. banks. Journal of Money, Credit and Banking 22(1):94-108. Noulas, A. G., Miller, S. M. and Ray, S. C. Sept. 1993. Regularity conditions and scope estimates: The case of large-sized U.S. banks. Journal of Financial Sertrices Research 235-248. OECD. 1992. Economies of Scale and Scope in the Financial Services Industry: A Review of Recent Literature. Paris: Organization for Economic Cooperation and Development. Pulley, L. and Humphrey, D. 1993. The role of fixed costs and cost complementarities in determining scope economies and the cost of narrow banking proposals. Journal of Business 66(3):437-462. Rodriguez, J. R. O., Alvarez, A. A. and Gomez, P. P. 1993. Scale and Scope Economies in Banking: A Study of Savings Banks in Spain. Tenerife, Spain: Universidad de la Laguna. Roller, L. 1990. Proper quadratic cost functions with an application to the Bell system. ReL,iew of Economics and Statistics 72:202-210. Shaffer, S. 1988. A revenue-restricted cost study of 100 large banks. Federal Reser~e Bank of New York Research Paper No. 8806. Sbaffer, S. E. D. 1991. Economies of superscale in commercial banking. Applied Economics 9(1):159-179. Sheldon, G. and Haegler, U. 1993. Economies of scale and scope and inefficiency in Swiss banking. In Banking in Switzerland (N. Blattner, H. Genberg and A. Swoboda, eds.). New York: Weidelberg, pp. 103-134. Sheldon, G. 1994. Economies, Inefficiency and Technical Progress in Swiss Banking. Paper presented at the Societe Universitaire Europeene de Rechercbes Finanzieres (SUERF) Colloquium on the Competitiveness of Financial Institutions and Centres in Europe, May 19-21, Dublin. Vennet, R. V. 1993. Cost Characteristics of Credit Institutions in the EC. Paper presented at the 20th Annual Meeting of the European Finance Association, Copenhagen Business School, Aug. 26-28, Published in Section II-D of the proceeding, pp. 1-38. Zellner, A. 1962. An efficient method of estimating seemingly unrelated regression and tests for aggregation bias. Journal of the American Statistical Association 57:348-368.