Adapting to Changing Input Prices in Response to the Crisis: The Case of U.S. Commercial Banks

Abstract

Substitution elasticities quantify the extent to which the demand for inputs responds to changes in input prices. They are considered particularly relevant from the perspective of cost management. Because the crisis has drastically altered the economic environment in which banks operate, we expect to find changes in banks’ substitution patterns over time. This study uses a dynamic demand system to analyze U.S. commercial banks’ substitution elasticities and adjustment time to input price changes during the 2000 - 2013 period. After the onset of the crisis, banks’ response to input price changes became more sluggish and the substitutability of most input factors decreased significantly. Yet the substitutability of labor for physical capital rose remarkably, which we attribute to the continuing adoption of online banking technologies. Our results confirm that, with only few exceptions, the crisis has significantly reduced the substitutability of banks’ input factors and thereby the possibilities for cost management. Nevertheless, we find that even after the onset of the crisis banks continued to control their costs by substituting labor for purchased funds and - to a lesser extent - labor for physical capital and core deposits for purchased funds. The results are consistent across banks of different sizes.