Tuesday, October 27, 2009
I have repeatedly pointed out that big banks are not more efficient than smaller banks.
For example, I previously noted that an article in Fortune concluded:
Now, James Kwak has done some sleuthing and discovered that even Fed economists don't buy the bigger-is-more-efficient argument. Kwak points out that New York Fed economist Kevin J. Stiroh found that most of the increase in efficiency during part of the time in which banks were consolidating was due to the increased use of information technologies:
The largest banks often don't show the greatest efficiency. This now seems unsurprising given the deep problems that the biggest institutions have faced over the past year.
"They actually experience diseconomies of scale," [Celent analyst Bart] Narter wrote of the biggest banks. "There are so many large autonomous divisions of the bank that the complexity of connecting them overwhelms the advantage of size."
His main explanation for the productivity growth is not consolidation, but information technology: “The finding of steady productivity growth, in particular, is important since it is consistent with the idea that the massive investment in new technology is working to improve the performance of the banking industry.” This is not proven in this paper, but Stiroh went on to write a bunch of other papers on the link between information technology and productivity. For example, this paper (on the entire economy, not just banking) concludes:Stiroh also wrote a paper on banks in Switzerland, concluding:
“IT-producing and IT-using industries account for virtually all of the productivity revival that is attributable to the direct contributions from specific industries, while industries that are relatively isolated from the IT revolution essentially made no contribution to the U.S. productivity revival. Thus, the U.S. productivity revival seems to be fundamentally linked to IT.”
The kicker is that Stiroh is the main source cited by those claiming that bigger banks produce greater efficiencies.
“We find evidence of economies of scale for small and mid-size banks, but little evidence that significant scale economies remain for the very largest banks. Finally, evidence on scope economies is weak for the largest banks that are involved in a wide variety of activities. These results suggest few obvious benefits from the trend toward larger universal banks.”
The bottom line is that there is absolutely no reason not to break up the too big to fails.