Economies of scale is a well-known economic concept that relates a firm’s costs to its level of production. The idea behind economics of scale is that an industry exhibiting economies of scale spreads its fixed and variable costs over a larger amount of output, which reduces total costs per unit of output. We covered economics of scale in a previous blog post, which profiled recent research demonstrating that economies of scale are a pervasive feature of the banking industry, and detailed how the scale and size of Forum members reduces costs and allows them to pass on savings to the businesses and households they serve.
The Office of the Comptroller of the Currency’s (OCC) Spring 2019 Semiannual Risk Perspective supports this view, stating that “there is a clear advantage in economics of scale as total assets increase that is evident in the stratification of the efficiency ratios.” The efficiency ratio is simply the ratio of total costs to net income so a bank with a lower efficiency ratio exhibits a lower costs per dollar of income earned. Figure 1, from the OCC’s report, shows the efficiency ratio for banks based on their size, with Forum members in the “total assets greater than $100 billion” category.
As the chart makes clear, banks with over $100 billion in assets have consistently exhibited the lowest efficiency ratio since 2011, meaning that these banks exhibit the lowest cost per dollar of income. Moreover, not only does the OCC’s analysis show that the largest banks have the lowest efficiency ratios, each corresponding line in the chart shows an increase in efficiency with an increase in size. While banks of all sizes are needed to support the diverse, $20 trillion U.S. economy, it is clear that the largest banks are able to provide financial services to the economy at a lower cost. The reduced cost structure at the largest banks underscores the importance of having large banks in a thriving and competitive global economy.
While banks of all sizes are needed to support the diverse, $20 trillion U.S. economy, it is clear that the largest banks are able to provide financial services to the economy at a lower cost.
Economies of scale is a well-established and important feature of the U.S. banking system. The presence of economies of scale means that larger banks can produce banking products and services at lower cost and more efficiently than smaller banks. The increased production efficiency at larger banks is ultimately shared with the business, households, and communities they serve. The OCC’s recent report bolsters the evidence supporting economies of scale in the U.S. banking system and highlights its importance to the overall economy.