Are European Banks Too Big? Evidence on Economies of Scale

Abstract

This paper investigates the level of economies of scale, as well as their determinants, for 103 European listed banks over the period 2000-2011 by employing a Stochastic Frontier Approach. The results reveal that economies of scale are widespread and move together for all size classes, although small and medium-sized banks experience the lowest economies of scale and even diseconomies of scale in some of the years under analysis. At country level, the smallest financial systems (Iceland, Belgium and Finland) and the countries most affected by the financial crisis (Ireland, Iceland, Belgium, Portugal and Spain) experience the lowest economies of scale (if not even diseconomies of scale) probably due to the small/reduced use of their production capacity. With regard to the effects on economies of scale of risk-taking, diversification in the business model and profitability, higher economies of scale are documented for banks more oriented towards investment banking (in all periods), banks with a higher liquidity but only up to a liquidity ratio of about 5.3 percent (convex curve during the crisis only), banks with less Tier 1 (concave, although almost flat, curve during the crisis only), and banks contributing less to systemic risk (during the crisis only). The main policy implication concerns the too big to fail regulation, and especially the fact that the break-up hypothesis seems not to find support from our evidence.