The Evolution of Scale Economies in U.S. Banking

Continued consolidation of the U.S. banking industry and a general increase in the size of banks has prompted some policymakers to consider policies that discourage banks from getting larger, including explicit caps on bank size. However, limits on the size of banks could entail economic costs if they prevent banks from achieving economies of scale. This paper presents new estimates of returns to scale for U.S. banks based on nonparametric, local-linear estimation of bank cost, revenue and profit functions. We report estimates for both 2006 and 2015 to compare returns to scale some seven years after the financial crisis and five years after enactment of the Dodd-Frank Act with returns to scale before the crisis. We find that a high percentage of banks faced increasing returns to scale in cost in both years, including most of the 10 largest bank holding companies. And, while returns to scale in revenue and profit vary more across banks, we find evidence that the largest four banks operate under increasing returns to scale. Forthcoming, Journal of Applied Econometrics ∗Wheelock: Research Department, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166– 0442; [email protected]. Wilson: Department of Economics and School of Computing, Division of Computer Science, Clemson University, Clemson, South Carolina 29634–1309, USA; email [email protected]. This research was conducted while Wilson was a visiting scholar in the Research Department of the Federal Reserve Bank of St. Louis. We thank the Cyber Infrastructure Technology Integration group at Clemson University for operating the Palmetto cluster used for our computations. We thank three anonymous referees for comments, and Peter McCrory and Paul Morris for research assistance. The views expressed in this paper do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. JEL classification nos.: G21, L11, C12, C13, C14.