
Contents
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8.1 Introduction 8.1 Introduction
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8.2 Banking Technology and Performance 8.2 Banking Technology and Performance
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8.2.1 Banks’ Risk Menu and Conflicting Incentives for Risk-Taking 8.2.1 Banks’ Risk Menu and Conflicting Incentives for Risk-Taking
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8.2.2 The Empirical Measurement of Banking Technology and Performance 8.2.2 The Empirical Measurement of Banking Technology and Performance
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8.2.3 The Structural Approach to Bank Efficiency Measurement: Cost Minimization, Profit Maximization, X-Inefficiency, and Managerial Utility Maximization 8.2.3 The Structural Approach to Bank Efficiency Measurement: Cost Minimization, Profit Maximization, X-Inefficiency, and Managerial Utility Maximization
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8.2.4 The Non-structural Approach to Bank Efficiency Measurement 8.2.4 The Non-structural Approach to Bank Efficiency Measurement
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8.2.5 Specifying Outputs and Inputs in Structural Models of Production 8.2.5 Specifying Outputs and Inputs in Structural Models of Production
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8.2.6 Specifying Capital Structure in Performance Equations 8.2.6 Specifying Capital Structure in Performance Equations
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8.2.7 Specifying Output Quality in the Performance Equation 8.2.7 Specifying Output Quality in the Performance Equation
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8.3 Applications of the Structural Approach 8.3 Applications of the Structural Approach
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8.3.1 Performance in Relation to Organizational Form, Governance, Regulation, and Market Discipline 8.3.1 Performance in Relation to Organizational Form, Governance, Regulation, and Market Discipline
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8.3.2 Uncovering Evidence of Scale Economies by Accounting for Risk and Capital Structure 8.3.2 Uncovering Evidence of Scale Economies by Accounting for Risk and Capital Structure
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8.4 Applications of the Non-Structural Approach 8.4 Applications of the Non-Structural Approach
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8.4.1 Measuring the Value of Investment Opportunities (“Charter Value”) 8.4.1 Measuring the Value of Investment Opportunities (“Charter Value”)
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8.4.2 Measuring the Performance of Capital Strategies 8.4.2 Measuring the Performance of Capital Strategies
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8.4.3 Measuring the Performance of Business Strategies 8.4.3 Measuring the Performance of Business Strategies
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8.4.4 Relationship of Ownership Structure to Bank Value 8.4.4 Relationship of Ownership Structure to Bank Value
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8.5 Conclusions and Policy Implications 8.5 Conclusions and Policy Implications
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Acknowledgments Acknowledgments
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References References
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8 The Performance of Financial Institutions Modeling, Evidence, and some Policy Implications
Get accessJoseph P. Hughes is Professor of Economics at Rutgers University. He has been a Fellow of the Wharton Financial Institutions Center and a Visiting Scholar at the Federal Reserve Bank of Cleveland, the Federal Reserve Bank of Philadelphia, the Federal Reserve Bank of New York, and the Office of the Comptroller of the Currency. His research has been published in such journals as the American Economic Review, the Journal of Banking and Finance, the Journal of Economic Theory, the Journal of Financial Intermediation, the Journal of Financial Services Research, the Journal of Money, Credit, and Banking, and the Review of Economics and Statistics. He received his Ph.D from the University of North Carolina at Chapel Hill.
Loretta J. Mester is president and chief executive officer of the Federal Reserve Bank of Cleveland. In addition, she is an Adjunct Professor of Finance at the Wharton School, University of Pennsylvania, and a fellow at the Wharton Financial Institutions Center. She is the managing editor of the International Journal of Central Banking and a co-editor of the Journal of Financial Services Research. In addition, she is an associate editor of several other academic journals and serves on the management committee of the International Journal of Central Banking. Her publications include research on the organizational structure and production efficiency of financial institutions, the theory and regulation of financial intermediation, agency problems in credit markets, credit card pricing, central bank governance, and inflation. Her research has been published in the Journal of Finance, the American Economic Review, the Review of Financial Studies, and the Review of Economics and Statistics, among other journals. She received her Ph.D in economics from Princeton University.
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Published:06 November 2019
Cite
Abstract
The unique capital structure of commercial banking—funding production with demandable debt that participates in the economy’s payments system—affects various aspects of banking. It shapes commercial banks’ comparative advantage in providing financial products and services to informationally opaque customers, their ability to diversify credit and liquidity risk, and how they are regulated, including the need to obtain a charter to operate, and explicit and implicit federal guarantees of bank liabilities to reduce the probability of bank runs. These aspects of banking affect a bank’s choice of risk versus expected return, which, in turn, affects bank performance. Banks have an incentive to reduce risk to protect their valuable charters in periods of financial distress but also an incentive to increase risk to exploit the cost-of-funds subsidy of mispriced deposit insurance. The balance of these contrasting incentives is tied to bank size. Measuring bank performance and its relationship to size requires untangling cost and profit from decisions about risk. This chapter gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature. One application explains how better diversification available at a larger scale of operations generates scale economies that are obscured by higher levels of risk-taking. Studies of commercial banking cost that ignore endogenous risk-taking find little evidence of scale economies at the largest banks, while those that control for this risk-taking find large-scale economies at the largest banks—evidence with important implications for regulation.
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