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Guest Post: Big Banks Are NOT More Efficient

By George Washington of Washington’s Blog.

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:

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.”

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:

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:

“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.”

Stiroh also wrote a paper on banks in Switzerland, concluding:

“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 kicker is that Stiroh is the main source cited by those claiming that bigger banks produce greater efficiencies.

The bottom line is that there is absolutely no reason not to break up the too big to fails.

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11 comments

      1. Mannwich

        I’ve witnessed these “diseconomies of scale” first-hand from the inside and it ain’t pretty. It’s a giant dysfunctional, bureaucratic, political, client-unfriendly mess that does nobody any good, well, besides the bank execs, of course. Follow the money

  1. i on the ball patriot

    Its not the size and efficiency of the rapist that is the problem.

    It is the crime of rape (enslaving usury purchased by corruption) and the number of rapists that is the problem.

    Deception is the strongest political force on the planet.

  2. MyLessThanPrimeBeef

    The universe is the only thing too big to fail, as far as I am concerned.

    Check that. From my own perspective, I am also too big to fail.

  3. mmckinl

    Banks?

    What we are looking at are huge financial corporations that also have brokerages, investment bank arms and insurance companies.

    What we have seen is that the most profitable subsidiaries, almost always the Investment Banks, get favored treatment to the detriment of the other businesses.

    There are also conflicts of interest whereby risk is transfered from the Investment Banks to the other businesses and almost always on to the tax payer’s backs.

    Too big and too integrated makes for a lethal combination as we have seen … yet hardly a peep about reimposing Glass-Steagal …

  4. Fernando Philadelphia

    I worked for First Union/Wachovia. I was in the Specialty Lending Division. They hired us to get our retail bank basic mortgage and HELOC and commercial loans into the hands of Mortgage Brokers. The mortgage brokers completely dominated the first mortgage business. I tried to build a relationship with Wachovia Securities, which at that time, was HQ in Richmond, VA. They had a real estate services director who was surprised to hear from me. The point of the big Glass Steagall Act abandonment was to build huge economies of scale, one stop shopping, synergy, etc. Well, the retail bank, not the Mortgage Company with its full array of conventional Fannie Mae loans, could do loans very competitively and do Home Equity 2nd mortgages as lines of credit or term loans. Again, very cost effectively. They amount of licensed brokers numbered in the thousands and the mortgage deals were approaching $1bil and the real estate services had not fully rolled out across all of Wachovia Securities. I asked who was doing all of the loan currently for the securities side? Countrywide, was the answer, I can’t get anyone from the retail bank to even talk to me. Oh, I said, what do you want? RE Services said, 50bps and all of the business is yours, we should be doing business together, wasn’t that cross selling gold mine the whole point of buying all of these brokerages? Needless to say, when I took this mountain of business back to my superiors, well…. Too Big to fail? Try too big to get blood to flow up to the brain.

  5. craazyman

    Yes, It’s True

    I personally did a study of big bank efficiency.

    I found that more than 130% of the efficiency gains offered by Big Banks could be explained by the fact that the the Executive and Legislative branches of the US Government are effectively employees, but are not paid salaries, wages or benefits.

    I have developed the following formula to explain this state of affairs:

    P = Ex X LaX

    where P = Productivity, Ex = Employees and Lax = Legislative and Executive Branches

    P also equals Poop, which is produced by ExLax.

    Ho ho

    So “Ex” also equals “Productivity” divided by “Legislative and Executive Branches”

    As explained by my Poop Theorem, each bank employee can be measured in terms of Productivity per elected official, which explains the high compensation for bank executives.

    This is a Nobel Prize idea!

    Booowahahahah ahahaha ahahaha ahahaha:)

  6. CrocodileChuck

    when one looks at cost:income ratios of banks, one finds a frontier around 40-45%, ie no banks below this globally

    so, with all the agglomeration/m&a frenzy of banks this decade, its curious that this is the case

    in australia, St. George Bank in its last annual report reported a ratio of 41% (lower than ANY of the Big 4, who are many times its size: Westpac, ANZ, Commonwealth or nab).

    in my opinion, for a lot of banks, the necessary integration between them and their systems never gets completed. citi is a example of this, and one read also recently that BOA never did this in the US

    so WHY do they do it? two reasons, imo:

    – TBTF
    – CEO egos (and remuneration ambition)

  7. MarinusWA

    As as software architect I have to say this doesn’t surprise me at all. Increased efficiency from just being big mostly just benefits the sales department (Look at how big we are, me must be doing something right!). Any internal efficiency has to come from ICT solutions and as such heavily depends on the quality of said solutions.

    Scalability in software is extremely important for large organizations. If your internal software scales poorly then increasing the size of your organization will actually start to reduce efficiency because overhead will increase (the software will start to work against you rather then assist you).

    Now how scaleable does one think a mishmash of software from a ton of different divisions and acquired companies is going to be? That’s right, not scaleable at all. This can actually get to the point where it becomes faster and cheaper to do things by hand rather then using the software.

  8. Skippy

    GW sort of like the American military eh.

    Skippy…Geez when are those guys going to turn a profit for once.

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