Economies of Scale in Credit Unions: Further Evidence

STUDIES ON ECONOMIES OF scale in most financial institutions have consistently found small, but significant economies when employing the Benston-Bell-Murphy cost specification [1, 2, 3, 4, 7, 9]. Yet, when utilizing the same approach, significant non-increasing returns have been discovered for credit unions [5, 6]. Flannery [5] contends that this was because most credit unions receive subsidies in the form of donated office space and equipment from sponsoring organizations and volunteer labor from their members. These subsidized inputs do not enter into their observed costs, and if the degree of subsidization declines with credit union size, then economies might well exist when subsidies are taken into account. However, Koot [6] claims to have found diseconomies of scale, even after correcting for subsidies, thus refuting Flannery's contention. The purpose of this paper is to correct the analysis of Professors Koot and Flannery and shed some light on the apparent anomalous cost conditions between credit unions and other financial institutions.' Specifically, we are able to demonstrate that Koot and Flannery misspecified their empirical cost equations, which when corrected, reverses their results regarding economies of scale. Second, we demonstrate that Koot incorporated labor subsidies incorrectly. Moreover, when subsidies are correctly included, they consistently increase the estimated scale economies, as Flannery predicted.