MEASURING ECONOMIES OF SCALE AND SCOPE IN AGRICULTURAL BANKING

The efficient size of agricultural banks is an issue that will remain important for the rest of the 1990s. Consolidation that is occurring in the financial services industry has spilled over into agricultural banking. This has raised concerns as to whether banks that have traditionally supplied credit to production agriculture will continue to do so after consolidation. Another major concern is whether consolidation is motivated by greater efficiency, or whether consolidation is resulting in greater market power without achieving cost savings. Study of the production technology of financial institutions can determine whether and to what degree economies of size exist and how agricultural lending will fit into the overall business plans of consolidated banks. Generally, empirical studies have used either duality theory with the estimation of cost functions or nonparametric estimation methods to assess efficiency in the financial services industry. The purpose of the present study is to estimate economies of scope and scale in agricultural banking. This will be accomplished through estimation of an indirect multi-product cost function. The uniqueness of this study, when compared to previous studies of efficiency of the financial services industry, i's the disaggregation of the outputs so that agricultural lending can be evaluated. In addition, a normalized quadratic cost function is estimated with curvature properties imposed. Clark reviewed thirteen studies that measured economies of scope and scale for commercial banks, credit unions, and savings and loan associations. He found that they offered four broad conclusions: (a) overall economies of scale exist at low levels of input, (b) no consistent evidence of economies of scope exists, (c) some evidence of cost complementarities exists, and (d) the results seem to be robust among financial institutions. Humphery also reviewed studies that examine the issue of economies of scale for banks and found that little cost savings exist for increases in size alone. He concluded that significant benefits accrue from loan diversification. Humphery also reported that the differences in cost structure within the same firm size category are larger than measured cost economies. Berger, Hunter, and Timme reviewed the efficiency of financial institutions. They discovered that many of the previous studies showed the average cost curve to be relatively flat. They also suggested that differences in technologies may occur between small and large banks or that some factor that varies with bank size may be excluded from previous studies. McAllister and McManus found that the translog cost function specification gives a poor approximation when applied to all bank sizes, suggesting that nonparametric estimation procedures should be examined. In addition, they included risk as a cost factor in the estimation. Berger, Hunter, and Timme suggested that, although frontier estimation methods are theoretically correct, studies that have compared results of frontier methods to those of more traditional estimation methods have found only small differences for scale measures.