Economies of scale in banking : a critique

Abstract

Ranigarajan and Mampilly have produiced empirical evidence to showt that Indian banks have a U shaped cost curve and that the optimum size of banks in India is at Rs 300 crores of deposits. Such a fintd ing couild well become the basis of policy formulation for affecting the growth of banks. This article quiestions the hypothesis of a U-shaped marginal cost cuirve. It argXues that the conclu sion about the optimum scale for Indian banks is not based on firm statistical ground and that it siffers from an aggregation bias. What is required is not a global minimum for all ranges of deposit size, but local minima for diff erent ranges of deposits-so that branches can be grouped according to certain ranges of deposit size cand can converge to their group's optimumn size.