Date of Award:

1975

Document Type:

Dissertation

Degree Name:

Doctor of Philosophy (PhD)

Department:

Economics and Finance

Advisor/Chair:

Kenneth Lyon

Abstract

The commercial banking industry is oft en criticized on the grounds that there is a high concentration of market power in the hands of a few firms. However, the appropriate measure of market power is Lerner's index of monopoly power, the elasticity of demand, not concentration ratios. The theoretical model developed in the paper is designed to permit the estimation of demand and supply elasticities in the banking industry. Specifically, two assets (loans and state and local funds) and one liability (time deposits) are investigated.

The empirical model focuses its attention on the demand and supply conditions. If the bank is a profit maximizer , then the banker adjusts the portfolio of assets and issues of liabilities in accordance with the Euler first order maximization conditions of the expected profits function. In this function administrative costs are expressed as a proportion of total assets. Default risks are ignored. At the optimal solution of the Euler first order conditions transaction costs generated by deposit-liability fluctuations are treated as scalers. These simplifying assumptions permit the estimation of the slope of the loan demand, of the demand for state and local funds, and of time deposit supply, which can be used to estimate the elasticities of the respective functions.

The empirical results are based on cross-sectional data for 7.89 standard economic areas in those states where there is an absence of extensive branch banking. The observations are categorized into eight bank classes by per capita income level, by hank density per capita in the standard economic area, and by economic base (agricultural or nonagricultural) in the area. It is assumed that the demand and supply functions are identical for all banks within a bank class. Using, the first order maximization conditions as behavioral equations the slopes of the supply and demand functions are estimated. These estimates are used to calculate elasticities of loan demand, state and local funds demand, and time deposit supply.

In general, it is concluded that those banks from low income areas have a lower elasticity of demand for loans than banks in high income areas. These banks have more monopoly power in the loan account. The elasticity of deposit supply is low for all classes of banks. This could be due to monopsony power, but it is more likely due to the legal ceiling on interest rates paid on time deposits. The analysis does not lead to any conclusions for the structural preconditions for the existence of monopoly power, but it does indicate that banks in certain markets may have some degree of monopoly power.

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