Costs of Banking Activities--Interactions Between Risk and Operating Costs

Abstract

THE CONSOLIDATION of risks is one of the main functions of banks and other financial institutions. Insofar as different depositors and debtors of a bank are independent of each other, a larger number of customers implies relatively smaller risks of reserve and capital losses, and enables the bank to maintain relatively smaller inventories of cash assets and capital accounts. The role and significance of scale economies accountable to uncertainty, and related topics, are discussed in [2] . Most of the existing literature on economies of scale in banking (see [1], [4], [5], [6], [ 10], [ 1 1 ], [ 12], [ 13] and [ 19] ), on the other hand, neglects 'financial' aspects and risk almost completely and restricts itself to an analysis of 'operating expenses' (labor, real resource costs) as a function of some measure of bank output. This paper is an attempt to demonstrate that there are important links between a bank's expenses of resource costs (operating expenses) and its financial (risk) characteristics, so that these two aspects should not be looked at separately, but in conjunction. Uncertainty means that the future cannot always be anticipated correctly, and thus implies the possible occurrence of emergency situations. A firm may end up a period with a deficit, or a dangerously low amount of cash and/or capital account. To remedy such a situation, the firm has to rearrange its portfolio within a short period of time, which causes costs and requires the use of resources. The greater the uncertainty, the more resources will be used in this way. (Of course, the probability