Does Size Matter? Economies Of Scale In The Banking Industry

Abstract

This study uses 2007 data from more than 1,200 banking institutions to examine the relationships among size, costs, and profitability in the banking industry. Our results suggest that the relationship between size and firm performance is complex. We find that while costs decline and profitability increases as bank size increases, these relationships do not hold indefinitely and diseconomies of scale are experienced by larger banks. When size is measured by total assets, larger banks begin to encounter lower levels of net income, but the very largest banks are able to enjoy net income that increases at an increasing rate as size increases. When size is measured by total deposits, net income increases at an increasing rate for a wide range of bank sizes and only begins to decrease for the largest banks. Regardless of the size measure employed, we find that increasing size is associated with higher costs that increase at an increasing rate, inevitably resulting in diseconomies of scale with implications for both theory and practice.