Scale Economies in Banking: A Restructuring and Reassessment

THE ISSUE OF scale economies in banking has a rich history. Most earlier studies report modest operating cost scale economies for small institutions (those with less than about $50 million of deposits in 1968 dollars) but are unclear where these economies might end, if at all. Unfortunately, these studies are limited in four important respects. First, those that were well specified did not measure the total cost of banking operations but concentrated on estimating scale economies for individual banking functions (e.g., demand deposits separately from commercial loans). Second, an average cost curve that could take a U shape over the full range of banks was not fitted, either because larger banks were not included or because of the functional form used (Cobb-Douglas). Consequently, the optimum or minimum cost size of a bank or office could not be determined. Third, the variables measuring the costs of branching were misspecified. Fourth, the branch