Empirical Testing of
Competitive Conditions in
Banking
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Outline
 Scale and Scope Economies
USA Studies
UK Studies
EU Studies
 S-C-P Testing
 Contestable Markets
 DEA Studies on Efficiency
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Scale and Scope Economies (USA)
 Shaffer and David (1991) tested for the presence of
economies of scale for very large US multinational
banks.
 Traditional production cost function used with and
without hedonic terms (qualitative factors). In the
absence of hedonic terms they found evidence of
positive scale economies.
 In the equation with the hedonic terms included,
economies of scale were reduced from the level
without hedonic terms.
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Scale Economies (USA)
 Humphrey (1992) obtained estimates of scale
economies for US banks of a multitude of sizes.
the intermediation measure of output was initially used.
 His study results suggest diseconomies of scale for all
sizes of bank.
 However, when alternative measures of output
(production approach) were used, Humphrey found
significant economies of scale for small banks,
constant costs for medium sized banks and scale
diseconomies in large banks.
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Scale Economies (USA)
This study however raised an important
question.
Which measure of output should be used?
The author suggested that stock measure was
more accurate than flow measure of output.
The study overall results suggest there are
slight economies of scale for small banks,
but slight diseconomies for large US banks.
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Scope Economies (USA)
 Gilligan and Smirlock (1984) study supported the
hypothesis of economies of scope.
 Mester (1987) concluded there was no strong
evidence to either support or refute the presence of
economies of scope.
 Lawrence (1989) reached similar conclusions
 Hunter et. al.(1990) found no evidence of cost
complementaries.
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Scale Economies (UK)
Hardwick (1990) tested for scale and scope
economies using UK building society data and a
marginal cost approach.
Overall economies of scale were found - except for
very large building societies, where strong
diseconomies were present.
Drake (1992) found no evidence to support this.
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Scope Economies (UK)
 Hardwick did not find evidence either for or against
economies of scope for large building societies.
 However, he found significant diseconomies of scope
for building societies with assets worth £1.5 billion or
less.
 The results of the study showed no case for
diversification of most building societies into broader
banking market.
 Drake (1992) largely agreed, but found that building
societies with assets in the range of £500m-5 billion
displayed diseconomies of scope.
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Scale Economies (EU)
 Altunbas and Molyneux (1993) examined the
cost structure in four European countries
(France, Germany, Italy and Spain).
Italy – economies at all levels of output.
Spain – economies only for smallest banks.
France – economies at all levels of output.
Germany - diseconomies of scale at all levels
of output.
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Scope Economies (EU)
 Italy - diseconomies for all sizes.
 Spain - scope economies evident for banks with
assets of < $1.5 billion.
 France - middle sized banks showed economies
of scope.
 Germany - largest banks showed scope
economies, smaller banks showed
diseconomies.
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S-C-P vs Relative Efficiency (USA)
Berger and Hannan (1989) conducted direct
tests of the SCP and relative efficiency
models.
The concentration variables were found to be
negative, implying more concentrated the market
the lower the rate paid on deposits (consistent
with SCP).
Jackson (1992) that ‘price’ is a non-linear U
shape. This supports the relative efficiency
model.
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S-C-P vs Relative Efficiency (EU)
Molyneux and Forbes (1993) tested the
SCP vs relative efficiency hypothesis using
European data.
The authors agreed with Berger and Hannan
They concluded that the SCP hypothesis is
supported by this European sample.
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Contestable Banking Markets (US)
 A contestable market is one in which sunk costs
are largely absent.
This implies will set price according to marginal
cost and consumer surplus will be maximised.
 Shaffer (1982) used Rosse-Panzer Statistics to
test for contestability in US banking. He
concluded that banks in the sample behave
neither as monopolists nor as perfect
competitors in the long run.
 Nathan and Neave (1989) concurred with this
conclusion for the Canadian Banking Sector.
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Contestable Banking Markets (EU)
 Molyneux et. al. (1994) tested for contestability
in German, British, French, Italian and Spanish
markets
 The authors found the RPS for Germany, the
UK, France and Spain, to be positive and
significantly different from zero and unity.
 Their conclusion was that in these markets,
commercial bank revenues behaved as if they
were earned under monopolistic competition.
For Italy, the authors could not reject a hypothesis
of monopoly.
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Efficiency (USA)
Rangan et.al. (1990) used DEA with data
from 215 US banks using the
intermediation approach of output.
They break down the efficiency score into
technical inefficiency (wasted resources)
and scale inefficiency (non-constant return
to scale).
The study showed the efficiency score of
0.7 implying 30% wastage, all due to
technical inefficiency.
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Efficiency (USA)
Humphrey (1992) measured productivity
and scale economies using flow and stock
measures of banking output. He obtained
measures of total factor productivity by
using 202 US banks.
Banking productivity had been flat
Only moderate increase in TFP
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Efficiency (UK)
 Field (1990) applied DEA to a cross section
of 71 UK banks. The results were that 80%
were found to be inefficient due to scale
inefficiencies.
 Drake et.al. (1991) used DEA to analyse
building societies in 1988 after deregulation
in 1987. 37% of these societies showed
increase in their overall efficiency postderegulation.
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