View of A SURVEY AND STUDY ON ECONOMIES OF SCALE IN BANKS FOR TENURE BETWEEN 1997-1998 TO 2015–2016

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Vol. 03, Issue 09,September 2018 Available Online: www.ajeee.co.in/index.php/AJEEE

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A SURVEY AND STUDY ON ECONOMIES OF SCALE IN BANKS FOR TENURE BETWEEN 1997-1998 TO 2015–2016

Ashok Kumar Yadav

Ass. Prof., Economics, Lalta Singh Rajkiya Mahila Mahavidyalaya, Adalhat, Uttar Pradesh

Abstract- The available investigation endeavors with examine those expense bookkeeping of the managing an account industry for uncommon concentrate on ideal measure of a bank.

It investigations the cosset structure, economies/diseconomies and additionally the ideal span of general population segment banks for the period 1997-1998 should 2015–2016.

Economies of scale identifying with 26 general population segment banks need aid acted out for chosen quite some time. Those vast banks worked during a scale, reaping economies altogether the years, those exemption being those quite a while 2004–2005 accomplishing position of the least AC. For those little banks, there need aid economies from claiming scale On the whole the chosen quite some time. Both the banks bunches didn't show diseconomies for admiration to downright cost, despite the fact that there were diseconomies connected with different distinctive expense things. The base effective span (MES) might have been achieved toward every last bit general society part banks over each of the considerable length of time chosen.

Keywords:-Cost, optimum size, cost function, economies of scale, elasticity, depreciation.

I. INTRODUCTION

The hypothesis of economies for vast scale will be by talked about in the setting of the ideal measure of the firm. As stated by the theory, normal expense may be helter skelter for a little volume of output; it declines concerning illustration yield increments until those the greater part proficient scale (optimum size) from claiming creation is arrived at Furthermore climbs once more as yield increments past that level. In the theory, it will be stated that those long-run expense work will be u-molded. Those bend proposes that At yield may be small, those normal expense may be secondary and it proceeds will decline Concerning illustration yield builds until it achieves its base. The level about yield toward this stage is known as ‘minimum cosset efficient’. For different words, the firm encounters economies of scale previously, such states. Past this phase about production, the normal expense may be higher over the minimum, and it increments Likewise yield expands. Under such conditions, the firm encounters diseconomies about scale.

Consequently, firms tend to limit their size ofoperation around the minimum cost efficient output level, where they would have availed of the maximumadvantage of the scale economies. With the reforms, there is structural and operational change in thefunctioning of the entire bankingsystem and it is meaningful to

evaluate the cost–size relationships ofthe banks. The present study attempts to analyze the cost analysis of the banking industry with specialfocus on optimum size of a bank. It studies the cost structure, economies/diseconomies as well as theoptimum size of public sector banks for the period 1997-1998to 2015–

2016. It also examines therelation between size of bank output and cost components (i.e., interest cost, wages and salaries,depreciation on banks’ property and general cost) to identify the sources of economies/diseconomies ofscale. It also tries to find out the minimum efficient size (MES) of the firm for each specified studyperiod.

The following two hypotheses are examined in this study:-

1. Large banks are expected to be more efficient than small banks at a point of time.

2. Large banks are expected to show improved performance over a period of time as compared tosmall banks.

These hypotheses are examined with reference to economies of scale and optimum size of the publicsector banks for the period 1991–2013.

II. REVIEW OF LITERATURE

A thorough review about investigations on scale economies On us saving money will be carried Toward Benston, Hanweck and Humphrey (1982) closed for confirmation

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2 for economies of scale. Rangarajan Mampilly (1972) showed with experimental proof of the acquainted u- molded normal expense bend to Indian banks. These investigations allotment an huge commitment in the schema of scale economies in the managing an account industry. Dissimilar to different industries, the significant issues in the managing an account industry would to characterizing bank’s yield its important cosset capacity similarly as banks transform heterogeneous items Also administrations. Likewise will be great known, a standout amongst the fundamental issues to take care of in front of estimating the manifestation of banks costs work is will characterize banks outputs to pick measures to them.

Since budgetary organizations transform different results As far as administrations as opposed undoubtedly recognizable proof physical products, it will be not reasonable how with characterize Furthermore measure yield.

Benston (1965, 1972) and ringer Also murphy (1968) measured aggregate yield As far as amount for store accounts advances prepared. Greenbrae (1967) evaluated true quality from claiming output, that is, terrible bank pay in the examination from claiming business banks. In the Indian context, Rangarajan Mampilly (1972) utilized downright stores as the measure about yield in the examination for cosset and extent relationship from claiming banks.In a study of Canadian banks, Allen and Liu (2007) used the intermediation approach to output, takingdifferent forms of loans as a measure of output. Todhanakasem, Lynge, Primeaux and Newbold (1986) estimated the economies of scale in USbanking for the period 1978–1980, using a risk-adjusted profit function with the assumption that it hasseveral advantages over the cost function approach.

The results indicated larger economies of scale forbranch banks than for unit banks with the average values of 1.05 and 1.45 respectively. In some of thestudies, all the variants of total cost are not included in the analysis of cost.

Clark and Speaker (1994)used only the operating cost plus interest costs as a measure of total cost and provided evidence on theextent of economies of scale and scope of banking industry in

Chicago. Empirical results indicated thatlarge and statistically significant economies of scale existed for all size classifications. For the smallestsize, the estimated overall economies of scale were 0.85 and continued for the largest firms to the valueof 0.93. Apergis and Rezitis (2004) investigated the cost structure of the Greek banking industry for theperiod 1982–1997. The significant difference of this study was that it was based on three types ofoutputs—loans, investment assets and deposits.Empirical results showed that the Greek banking industry exhibited the presence of economies ofscale with the value of scale economies in each year and in the whole time period was significantlygreater than 0.

Using Translog cost functions, Allen and Liu (2007) measured the economies of scaleof Canada’s six largest banks and their cost efficiency for the period 1983–2003. The results foundscale economies with values greater than 1 for each model which were statistically significant. Further,the results showed that banks have experienced technological progress as explained by the trendvariable and that regulatory changes have helped to reduce the production cost of banks. In a recentstudy, Stimpert and Laux (2011) examined the relationships among size, costs and profitability in theUS banking industry. Regardless of the size measure employed, the increasing size was associatedwith higher costs that increase at an increasing rate, inevitably resulting in diseconomies of scale ofthe firms.

If the industry is subject to economies of scale, larger institutions would be more efficient andwould provide services at lower cost, ceteris paribus (Benston, 1972). Research has established theexistence of scale economies, but many of these studies suggest that in a wide range of industries,minimum efficient scale, necessary to operate at the lowest point on the average cost curve, occurs atrelatively modest levels of output (Scherer, 1980). The empirical literature on bank scale economiesgenerally concludes that the average cost curve is relatively flat, with some evidence of scaleinefficiencies for both the smallest and largest banks (Clark, 1996).

Conceptually, economies of scalepermit larger firms to produce their products and provide their services at lower average

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3 costs per unitthan smaller firms (Shepherd, 1979).

III. DATA AND STATISTICAL COST FUNCTION

For mossy cup oak of the cost–size association studies, amount from claiming aggregate stores will be made concerning illustration An measure from claiming yield. To An comparative way, we likewise utilize downright stores Concerning illustration those yield variable. Costs would characterized should incorporate both the interest fetches Also working costs. Operating fetches contain the greater part costs identified with the utilization of physical work figure inputs. That cost–output association may be additionally conveyed crazy for specified cosset things of the aggregate working expense variables.

These would compensation salaries, general costs and devaluation Furthermore repairs. Premium fetches contain investment paid on constantly on depositors Also should other lenders of the bank.However,since more than 70 per cent of the total cost is accounted for by the interest cost for each bank group inthe year 1997-1998and around 80 per cent in 2015–2016, interest cost is also taken as a measure of cost.The nature of relationship between the cost and size will be subject to the empirical verification interms of the estimated values of marginal cost (b), mean average cost (AC

—) and mean elasticity of output(total deposits) with respect to specified cost items and total cost, that is, the value.

3.1 Data and Variables

That extent of the banks will be measured on the premise of stores held Also downright costochondritis measured those aggregate costs incurred by every bank to each particular period. That downright cosset is made from claiming Different expense items—interest cost, compensation salaries with employees, deterioration once banks’ property Furthermore general expense. The banks are ordered fewer than two groups: those vast banks assembly comprises of the 14 banks that nationalized On 1969 and the little banks one assembly about 12 banks.

These 12 banks are those whole about seven state banks about India (SBI) copartners Also five other banks that nationalized clinched alongside 1980. The

new bank for India may be dropped starting with those information similarly as it might have been consolidated with those Punjab national bank done 1993.

Those method of reasoning of joining those little banks Also subsidiaries may be that with reforms, the banks were settled on free Furthermore provided for self-governance should detract choice done their working Furthermore henceforth joining won't need any unfriendly impact on the execution dissection of the banks one assembly.The SBI is excluded from the analysis as its comparison withother banks is insignificant under the analysis. The economies of scale (deposit elasticity’s of total cost)relating to 26 public sector banks (excluding the SBI) are estimated for the selected years, namely1991–1992, 1995–1996, 1999–2000, 2004–2005, 2009–2010 and 2015–2016. The rationale for thechoice of the year 1997-1998is that it was the immediate year of the initiation of financial sectorreforms and for the choice of 1999–2000 is that it was also the immediate year after the second stagereforms stated in 1998. Evaluation of the performance of the public sector banks is pertinent andmeaningful for such specific years. The justification for the choice of other years is based on a gap offour or five years in the period and finally for the year 2015–2016 is the latest complete data availablefor the current study.

3.2 Statistical Cost Analysis

Assuming the linear cost–size relationship, the following cost function is adopted from Sandesara (1979).

The cost function can be written as Where,

 TC = total costs,

 X = total deposits,

 a = intercept and

 b = marginal cost.

A linear cost function implies a constant marginal cost and falling average cost curve if the intercept termis positive. To measure the extent of these economies, output (deposits) elasticity’s of total cost would becomputed at their mean value by the following formula:

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4 Where

 e = elasticity,

 X– = mean output (deposits) and

 T—C = mean total cost.

Similarly, the mean average cost would be worked out by the following formula:

Where

 A– C – = mean average cost.

The same formula would be used to work out the cost elasticity and A– C – for the cost components.

IV. ANALYSIS AND RESULTS

Cosset capacity of the straight manifestation said clinched alongside comparison (1) will be connected for each bank assembly for each chose monetary year will look at those scale operation.

That dissection about economies of scale to each bank assembly at banks together will be conveyed out to six separate a considerable length of time. Relapse for mathematical statement (1) may be performed to specified expense things on the aggregate yield (total deposits) to those chosen years, that is, 1991–1992, 1995– 1996, 1999–2000, 2004–2005, 2009–2010 2015–2016, independently to each bank aggregation Furthermore likewise at banks together. Those relapse outcomes need aid accounted further. In the recent past proceeding for the relapse analysis, a review of the information on the normal size from claiming banks and aggravator stores in each bank bunch are broke down. Worth of normal extent from claiming every bank bunch Also aggravator stores may be provided for to every year for Investigation.

4.1 Average Size and Size Range

The average size of total deposits of the small banks group was `2,589 crore in 1991–1992. Thecorresponding values for the large banks group and all banks together in a group are `10,178 crore and`6,675 crore, respectively, in 1991–

1992. There is an increase in the average size in terms of the totaldeposits for the small banks group in each period by more than two times. The average size of the totaldeposits of small banks group was

`117,171 crore for 2015–2016, which is more than 40 times than thatin 1991–

1992. Further data of the large banks

group show that the change in the average deposits wasalso visible but small banks group has more significant changes than its counterpart.We now proceed for explanations of the total cost items used in the analysis—the interest cost, wagesand salaries, depreciation on banks’

property and general expenses.

1. Interest cost: The marginal cost (b) of the large banks (0.051) was found lower than that of thesmall banks (0.070) for 2015–2016. The marginal interest cost (b) of the deposits for the largebanks appeared to be lower than that of the small banks for all the years except in 1997- 1998and2004–2005. The mean average costs (AC —) of the large banks were found lower than that of thesmall banks in each of the years selected.

2. Wages and salaries: The marginal cost (b) of the large banks (0.008) was found higher as againstthe small banks (0.003) in 2015–2016.

For all the other years too, the marginal cost (b) for largebanks was higher than that of the small banks.

The mean average cost (AC —) of both the largebanks (0.010) and small banks (0.010) were same in 2015–2016. But for the years 2009–

2010,2004–2005 and 1999–2000, the mean average costs (AC —) of the large banks were found higherthan that of the small banks.

However, the large banks performed better in mean average cost(AC ) as against the small banks in the rest of the years, that is, 1997-1998and 1995–1996.

3. Depreciation: Both the large banks and small banks were found with same magnitudes of themarginal depreciation cost (b) in all the selected years except in 1999–2000, in which the largebanks (0.001) had lower marginal cost (b) than that of the small banks (0.002). When the marginalcosts (b) are compared, the large banks showed relatively better performance than the smallbanks.

The mean average cost AC — for the large banks (0.001) was found higher than that of smallbanks (0.0002) in 2015–2016, whereas for the period 1999–2000, the large banks (0.001) hadlower mean average cost AC — than the small

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5 banks (0.002). In all of the other years, both the largebanks and small banks had equal values of mean average cost AC —.

4. General expenses: The values of b’s were same for the large banks (0.005 each) and small banks(0.005 each) in both the years 2009–2010 and 2015–2016 respectively. In other years, the largebanks had either lower magnitudes of b’s than that of the small banks or vice versa. The meanaverage cost AC — of the large banks (0.005) was lower than that of the small banks (0.006) in2015–2016. In other years, the large banks had lower mean average cost AC — than that of the smallbanks except for the period 1999–2000, in which both the banks had equal values of meanaverage cost AC — of (0.007 each).Briefly, it is observed that the large banks were more efficient than the small banks on both variants ofcost, namely marginal cost and average cost. As we discussed in detail, the values of marginal cost of thelarge banks were lower than that of the small banks in the later years 2009–

2010 and 2015–2016. Nodoubt, the large banks did have higher marginal cost (b) for the years 1997-

1998to 2004–2005. In

thesubsequent years, the large banks performed better than their counterparts. This is supported by the lowermean average cost AC — for the large banks as against the small banks in all the years with an exception in2004–2005. Cost item- wise, the marginal cost and mean average cost of the large banks were found tobe lower than that of the small banks for most of the years.

4.2 Economies of Scale

The values of ‘e’ in the range of 1. 05 alternately 0. 95 might be treated concerning illustration near 1. And the esteem from claiming ‘e’ under 0. 95 or more than 1. 05 exhibited economies for scale or diseconomies for scale. The registered values of the mean versatility about specified expense things with admiration to the downright stores to every bank one assembly at banks together would provide for in for chosen a considerable length of time. The mean

versatility from claiming downright expense for admiration to yield (e) might have been short of what 1 for those extensive banks (e = 0. 812) and for those little banks (e = 0. 859) over 2015–2016.

The huge banks (0. 967), however, worked during savvy scale for an ‘e’ quality for 1 as against the little banks (0. 749) operating with economies of scale in the quite a while 2004–2005.

In the remaining years, both those banks aggregations fell under the zone about scale of economies.The mean elasticity with respect to the variants of total cost items are found to be close to 1for the large banks and small banks. For the large banks, these are the unitary elasticity of interest cost(e = 0.980) for 1991–1992; general cost items (e = 1.039) for 1995–1996; wages and salaries (e = 0.998)for 2004–2005; again wages and salaries (e = 0.957) and general cost items (e = 0.982) for 2009–2010;and lastly in general cost items (e = 0.945) for the year 2015–2016. As against this, mean elasticity of thevariants of total cost for the small banks is found to be close to 1 in the case of interest cost (e = 1.012)in 1999–2000; both in depreciation (e = 1.029) and general cost items (e = 0.953) in 2004–2005; andlastly again in interest cost (e = 0.974) for 2009–2010. In the other cost items, both the banks groups haveoperated either on economies or diseconomies of scale.

V. CONCLUSIONS AND POLICY RECOMMENDATIONS

1. The analysis of cost output relation in the Indian public sector banks is important for the post reformperiod.

This analysis intends to make an up-to-date study of cost–size relationship ofIndian banking industry.

2. On the basis of statistical cost approach, economies of scale relating to 26 public sector banks areworked out for selected years, namely, 1991–1992, 1995–1996, 1999–2000, 2004–2005, 2009–2010 and 2015–2016. A linear cost function is employed using the total cost and its variants,namely interest cost, wages and salaries, general expenses and lastly depreciation and repairs asthe cost variables with the size variable denoted by total deposits.

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6 3. An average size of the large banks

was two times that of the small banks in 2015–2016.

4. The marginal costs of large banks (0.065 and 0.065) tend to be lower than that of small banks(0.070 and 0.079) in the years 2009–2010 and 2015–2016 respectively. In the other years, thesmall banks have lower marginal cost than that of the large banks. However, in terms of the meanaverage cost (A—C), the large banks have lower values than those of the small banks in all the yearsexcept for the year 2004–2005.

5. The large banks operated at a scale, reaping economies in all the years, the exception being theyear 2004–

2005, achieving position of the minimum AC —. For the small banks, there areeconomies of scale in all the selected years. Both the banks groups did not show diseconomieswith respect to total cost even though there were diseconomies associated with other individualcost items. In terms of sources of efficiency/inefficiency, the large banks were able to enjoyeconomies in some major costs of wages and salaries in four out of the six selected years;general cost (in 1997-1998and 2004–2005);

interest cost in five out of the six years;depreciation only in 1999–

2000. Diseconomies of the large banks were found in depreciationin most of the years and for the general costs in 1999–2000. For the small banks, the constantsource of economies were wages and salaries;

general cost in five out of the six years; and,lastly, interest cost in four out of six years. It is worth noting that there were diseconomies ofscale in depreciation cost for the small banks.

6. MES is estimated at the deposits of

`700 crore in 1991–1992, `1,000 crore in 1995–1996, `1,200crore in 1999–2000, `3,000 crore in 2004–

2005, `9,000 crore in 2009–2010 and `19,000 crorein 2015–2016.

This MES was attained by all the public sector banks in each of the selected years.

7. In terms of increase in efficiency with respect to economies of scale, the large banks showedgreater

improvement in both the periods of 1997-1998to 1999–2000 and 1999–

2000 to 2013–2014, but relatively the performance of small banks was not so for the same period.

Although there were evidences of superior performance by the large banks as compared to small ones onmost of the indicators of cost efficiency in this period, the former were enjoying economies of scale withsize lower than MES from 1995–

1996 onwards, suggesting a potential benefit from further expansion insize.

This implies that growth in banks generates positive effect on cost efficiency, particularly in thecase of interest cost and wages and salaries, both accounted for about 90 per cent of total cost in Indianpublic sector banks. Growth in bank size tends to alter the composition of deposits (ratio of interestbearing to non- interest bearing) and staffing pattern (ratio of subordinates to officers), thereby saving inexpenditures on interest and wages. Technological progression, provision of research and development, risk prevention/control and management become feasibly affordable with enlargement of bank size.

Outsourcing of banking functions without additional risk as found in current practices is moreadvantageous in medium size banks or large ones.This also makes a favorable case for bank takeovers (mergers and acquisitions) for attaining fasterinorganic growth as bigger size banks tend to have cost advantage over the small ones as findings ofthis research suggest. It would be significantly important to enlarge the small banks’ size by eitheracquiring weak, small banks with losses or small banks merging with big banks—private or publicsector banks.

However, it is important to mention that past mergers and acquisitions of banks in Indiasince 1991 did not improve profitability in all cases (Bishnoi & Devi, 2015). But there may be othergains associated with size growth, such as earning cost economies or postponing diseconomies ofscale, and these need not necessarily result into higher profits.

Profit is a function of both the price andcost per unit of output, and cost efficiency alone does not guarantee for higher profitability in theabsence of efficient price of product.

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