A Theory of Production for the Financial Firm

162 Pages·1991·6.032 MB·English

by  Diana Hancock (auth.)

A THEORY OF
PRODUCTION FOR
THE FINANCIAL FIRM
Innovations in Financial Markets
and Institutions
Series Editors:
Robert A. Eisenbeis and Richard W. McEnally
University of North Carolina at Chapel Hill
Chapel Hill, North Carolina, U.S.A.
Other books in the series:
1. England, C. and Huertas, T.:
THE FINANCIAL SERVICES REVOLUTION
2. Gup, B.:
BANK MERGERS: CURRENT ISSUES AND PERSPECTIVES
3. Kormendi, R., Bernard, V., Pirrong, S., and Snyder, E.:
CRISIS RESOLUTION IN THE THRIFT INDUSTRY
ATHEORY OF
PRODUCTION FOR
THE FINANCIAL FIRM
Diana Hancock
Department of Finance
Leavey School of Business and Administration
Santa Clara University
Springer Science+Business Media, LLC
Library of Congress Cataloging-in-Publication Data
Hancock, Diana, 1955-
A theory of production for the financial firm / Diana Hancock.
p. cm. - (Innovations in financial markets and institutions)
Includes bibliographical references and index.
ISBN 978-94-010-5722-6 ISBN 978-94-011-3870-3 (eBook)
DOI 10.1007/978-94-011-3870-3
1. Banks and banking-Mathematical models. 2. Financial
institutions-Mathematical models. 3. Production (Economic theory)
-Mathematical models. 4. Monetary policy-Mathematical models.
I. Title. II. Series.
HD1588.H36 1991
332.1 '01 '51-dc20 90-26964
CIP
Copyright 1991 by Springer Science+Business Media New York
Originally published by Kluwer Academic Publishers in 1991
Softcover reprint ofthe hardcover Ist edition 1991
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
systemor transmitted in any form orby any means, mechanical, photo-copying, recording,
or otherwise, without the prior written permission of the publisher, Springer Science+B
usiness Media, LLC
Printed on acid-free paper.
Contents
Chapter 1 Introduction and Summary
1.1 The Need for a Theory of Production for Financial Firms 1
1.2 Issues in Technology and Regulation 4
1.3 User Cost Derivation 5
1.4 A Model of the Financial Firm 6
1.5 Data and Data Construction 7
1.6 Specification and Hypothesis Testing 7
1. 7 Empirical Results 8
Chapter 2 Issues in Technology and Regulation of Financial Firms
2.1 Introduction 9
2.2 Cost Function Approach 11
2.2.1 Output Separability 12
2.2.2 Non-Joint Technology 13
2.3 Profit Function Approach 15
2.4 Outputs, Inputs, and the "Classification Problem" 18
2.5 Regulations and the Financial Firm 19
2.5.1 Reserve Requirements 20
2.5.2 Interest Rate Ceilings 22
2.5.2.1 Deposit Interest Rate Ceilings 22
2.5.2.2 Loan Interest Rate Ceilings - Usary Laws 23
2.5.3 Deposit Insurance Premium Rates 24
2.6 Concluding Remarks 25
vi
Chapter 3 User Cost Derivation for Financial Firms
3.1 User Costs for Assets and Liabilities 27
3.2 Implementation Problems 33
3.2.1 Expectations of Future Prices 33
3.2.2 The Discounting Rate 33
3.2.3 Depreciation Rates 34
Chapter 4 A Model of the Financial Firm
4.1 Introduction 35
4.2 An Intertemporal Production Model of the Individual
Financial Firm 36
Chapter 5 Data and Data Construction
5.1 Introduction 51
5.2 Labor Services 54
5.3 Materials Services 57
5.4 Physical Capital Services 61
5.5 User Costs for Financial Services 67
5.5.1 Assets 67
5.5.1.1 Introduction 67
5.5.1.2 Investments 68
5.5.1.3 Real Estate Mortgages 70
5.5.1.4 Installment Loans 70
5.5.1.5 Credit Card Loans 71
5.5.1.6 Commercial, Agricultural and Other Loans 71
5.5.1. 7 User Cost for Aggregate Loans 72
5.5.1.8 Cash 74
5.5.2 Liabilities 75
5.5.2.1 Demand Deposits 75
5.5.2.2 Time Deposits 76
5.5.2.3 Non-Deposit Liabilities 78
5.5.2.4 Time Deposits and Borrowed Money 78
5.5.3 Financial Capital 80
5.6 Variable Profits 80
5.7 Concluding Remarks 82
vii
Appendix Functional Cost Data on Capital 83
Chapter 6 Specification and Hypothesis Testing
6.1 Introduction 87
6.2 Profit Function and Net Supplies 89
6.3 Regularity Restrictions 91
6.4 Tests of Bank Technology 94
6.4.1 Introduction 94
6.4.2 Existence of Monetary Sub aggregates 95
6.4.2.1 Introduction 95
6.4.2.2 Money Supply Definition:
Cash and Demand Deposits 97
6.4.2.3 Money Supply Definition:
Cash, Demand and Time Deposits 99
6.5 Econometric Issues 100
6.5.1 Exogeneity of Prices and Quantities 100
6.5.2 Pooling Time Series and Cross Section Data 102
6.5.2.1 Bank Effects 102
6.5.2.2 Branching Regulation Effects 103
6.5.2.3 Deregulation Effects 104
6.6 Concluding Remarks 105
Appendix Derivation of Hessian - Variable Profit Function 107
Chapter 7 Empirical Results
7.1 Introduction 109
7.2 Elasticities of Transformation, Demand and Supply 111
7.3 Regularity Tests 113
7.4 Estimation of Transformation, Supply and Demand
Elasticities 119
7.5 Rate of Return on Capital 127
7.6 Policy Implications: Monetary Policy and Bank
Behavior 128
7.6.1 Introduction 128
7.6.2 Interest Rate Effects 129
7.6.3 Reserve Requirement Costs 132
7.6.4 Deposit Insurance - FDIC Regulation 133
viii
7.7 Tests of Monetary Aggregation 134
7.8 Concluding Remarks 140
Bibliography 143
Index 155
A THEORY OF
PRODUCTION FOR
THE FINANCIAL FIRM
Chapter 1
INTRODUCTION AND
SUMMARY
1.1 The Need for a Theory of Production for
Financial Firms
This monograph develops a theory of production for individual financial
firms. A financial firm is a profit maximizing entity engaged in the pro
duction of intermediation services between borrowers and lenders. These
services are related directly or indirectly to the financial assets and lia
bilities held by the firm, such as loans and deposits. The financial firm
issues its own liabilities, typically deposits of various types. Services other
than financial intermediation, such as safe deposit provision, estate man
agement and equipment leasing, are excluded from this study. Financial
firms include commercial and savings banks and savings and loan associa
tions. Synonymously, "depository institutions" are used to describe these
firms.
The focus of this monograph is on national banks subject to regulation
by the central bank, though the theory developed can be applied to other
financial firms. This permits an examination of money supply aggregates
and regulatory policies such as reserve requirements
The need for a micro economic theory of the financial firm has been
pointed out by Tobin [1961]
The intellectual gulf between economists' theory of values of
goods and services and their theories of value of money is well
known and periodically deplored. Twenty-five years after Hicks'
1