AN EYE-OPENER: New Study on Size and Cost Efficiency

This month the FDIC released a 27-page study entitled “Economies of Scale in Community Banks.”

The authors analyze all community banks less than $10 billion in assets from 2000 to 2019 to measure their actual trends in economies of scale and productivity by asset size.

The major findings are below. Over two thirds of the paper present the analytical method and data used to develop their conclusions. The most significant conclusion in my view is:

“. . .our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million”

The Relevance for Credit Unions

The average credit union size on September 30, was $345 million. That is the sweet spot for peak operating gains in the study. While credit unions would not mirror the balance sheet and business model of a typical community bank, the overall conclusions seem applicable.

Moreover, it is probable that the greatest gains in efficiency occur at an ever lower average asset range in coops for three reasons. Credit unions have a consumer-focused lending specialty, which the authors cite as a factor in greater efficiency. They do not have to manage the complexity of paying federal or state income tax. Finally, credit unions achieve economies of scale and efficiencies by cooperating in local and national CUSOs that bring members convenience no single bank or firm could duplicate with its own resources.

Credit unions are undergoing some of the same consolidation pressures described for banking. The study provides needed insight for two much talked about issues in the credit union system. One is what is the ideal size for operational competitiveness. The finding that a range of $300-600 million in assets achieves 95% of efficiency gains, is easily within reach for many credit unions’ business models. Secondly, larger size does not create major gains in efficiency.

In fact, there may even be a cap on size ($3.3 billion) after which diseconomies of scale occur, that is increasing expense ratios. An example of this would be the dramatic performance decline in PenFed, the industry’s third largest institution, as it grew by $7.5 billion over the past five years. This is documented in the analysis “PenFed’s Spurious Strategy.”

The Problem We All Share Part I: PenFed’s Spurious Merger Strategy

In the extracts below, emphasized (bolded) text focuses on the most important conclusions presented by the FDIC authors.

Abstract Summary

Using financial and supervisory data from the past 20 years, we show that scale economies in community banks with less than $10 billion in assets emerged during the run-up to the 2008 financial crisis due to declines in interest expenses and provisions for losses on loans and leases at larger banks. The financial crisis temporarily interrupted this trend and costs increased industry-wide, but a generally more cost-efficient industry re-emerged, returning in recent years to pre-crisis trends. We estimate that from 2000 to 2019, the cost-minimizing size of a bank’s loan portfolio rose from approximately $350 million to $3.3 billion. Though descriptive, our results suggest efficiency gains accrue early as a bank grows from $10 million in loans to $3.3 billion, with 90 percent of the potential efficiency gains occurring by $300 million.


Economies of scale occur when the per-unit cost of production falls as the number of units produced increases. In the context of banking, scale economies exist when the cost per dollar of loans (or assets) declines as the number of loans (or assets) increases. An efficient bank is operating at the lowest cost per dollar of assets or loans, , , ,

Our estimates are not causal and do not predict how a bank’s costs would change were it to change in size. We find evidence, however, that the overwhelming majority of any gains from increasing a bank’s loan production from $10 million to the cost-minimizing loan portfolio size of $3.3 billion accrue early in the growth process. Our nonparametric results suggest that once a loan portfolio reaches approximately $300 million, a bank has achieved about 90 percent of the potential efficiencies from increased scale; by $600 million, a bank has achieved about 95 percent of potential efficiencies. . . .

Our analysis focuses on community banks—banks with less than $10 billion in assets—as these banks comprise the vast majority of banking organizations. Approximately 97 percent of all banks in the United States have less than $10 billion in assets, and roughly 90 percent of those have less than $1 billion in assets. The consolidation trend in the industry has differentially affected community banks. The number of small institutions—those with less than $100 million in assets—has declined by 92 percent since 1985. Much of the debate about bank consolidation centers on the largest financial institutions, primarily those some argue are “too big to fail.” But as consolidation in the industry has persisted in recent years, some have begun to turn the “too big to fail” designation on its head and question whether small community banks are “too small to succeed.”

Conceptual arguments that support this notion are often based upon the economics of scale. Some have suggested that increased regulatory burden affects small banks in particular because regulatory compliance cost is a relatively larger item in a small bank’s finances. Likewise, banks that operate in limited geographical areas may find expansion into new product lines less profitable. Another possibility is that technological investments, for example in credit scoring and model-based lending, may not offer enough upside to justify the investment cost for small banks to transition from slower, more cost-intensive business practices (i.e., relationship lending).

Consolidation that shifts assets from small to large banks is more than just a rearrangement of resources. Small and large banks are not interchangeable; a single $1 trillion bank is not the same as one thousand $1 billion banks. Small banks are often built around a relationship-lending business model. Bankers acquire costly but valuable private information about their customers and make lending decisions using this expertise. In contrast, large, remote banks often lack personal relationships with customers and knowledge about the local community, instead relying on a standardized approach to lending. Customers that are good credit risks to a small bank may be unable to obtain credit from a large bank that lacks local knowledge.

As the number of small banks has declined, concern about the future of small banks has extended to the future of small businesses. Small businesses generally obtain loans from small banks, especially when the businesses are in their infancy. The report of findings from the FDIC’s Small Business Lending Survey states that large banks are more than five times more likely than small banks to require minimum loan amounts for the primary loan products provided to small businesses and eight times more likely to use standardized small business loan products. Small banks are also roughly five times more likely than large banks to underwrite loans to start-up small businesses differently These businesses are sometimes described as the engine of economic growth in the United States, so a decline in credit availability to such businesses could affect the real economy.

The fate of small banks also portends that of the communities in which they operate: Kandrac (2014, p. 23) finds meaningful feedback from the failure of a bank and local economic performance, stating, “The disruption of banking and credit relationships is an important channel through which bank failures affect economic performance.” Scale economies in banking thus transcend the domain of business policy into that of public policy. . . .


Consolidation and growth have been hallmarks of the banking industry since the 1980s. The number of institutions has decreased by more than two-thirds while the size of the remaining institutions has increased. Although the problem of “too big to fail” has been frequently discussed within the corridors of government, academia, and the media, community bankers have begun to question if a “too small to succeed” problem also exists. Such concerns are commonly motivated by notions of economies of scale, whether due to cost efficiencies, expanded business opportunities, or the allocation of regulatory costs across a wider asset base.

Using financial and supervisory data on banks and thrifts with less than $10 billion in assets, we study economies of scale within the banking industry using nonparametric kernel regression and translog cost estimation. Our estimation period spans both sides of the financial crisis, enabling us to distinguish pre-crisis trends from post-crisis trends. We find that total costs have generally been declining over time. The crisis temporarily halted this trend, at least for some institutions, but the trend resumed in force post-crisis. With economies of scale, lending specializations matter: agriculture banks show less evidence of scale economies than commercial banks, while mortgage banks display the strongest signs of economies of scale.

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