Pricing, operating efficiency, and profitability among large commercial banks

Abstract

This study uses statistical cost accounting techniques to examine the relationship between bank profitability and two dimensions of operating performance — pricing and operating efficiency. The traditional statistical cost accounting model, which relates a firm's income to its asset and liability mix, is expanded to account for differences in market structure, regional demand and supply conditions, and macroeconomics factors. The study focuses on large (above $500 million in domestic deposits) banks, comparing a sample of relatively profitable banks against a matched group of much less profitable banks over the period 1970–1977. After allowing for regional supply and demand factors, the high and low-profit banks are estimated to earn equal market rates of return on individual assets and liabilities. There is virtually no evidence that differential prices are an important discriminator between the two bank groups. Some evidence is found that the high-earnings banks experience lower operating costs on some liabilities, but the opposite is true with respect to selected asset items. After taxes are taken into account, however, any such cost differentials virtually disappear. Overall, there is no compelling evidence that high-profit banks are characterized by greater operating efficiency than their low-earnings counterparts. This finding is consistent with the view that over time, and especially among relatively large banks, information flows and competitive pressures act to reduce operating efficiency differences that may appear in the short run.