Wirtschaftswissenschaftliche Fakultät der Eberhard-Karls-Universität Tübingen Market Structure, Scale Efficiency, and Risk as Determinants of German Banking Profitability Peiyi Yu Werner Neus Tübinger Diskussionsbeitrag Nr. 294 Juni 2005 Wirtschaftswissenschaftliches Seminar Mohlstraße 36, D – 72074 Tübingen Market Structure, Scale Efficiency, and Risk as Determinants of German Banking Profitability 1 2 Peiyi Yu and Werner Neus Abstract The Scale-Efficiency version of the Efficient-Structure Hypothesis and the Structure- Conduct-Performance Hypothesis find empirical support in German banking data from 1998 to 2002. Due to the acceptance of the two hypotheses and the existence of overall economies of scale, we conclude that German banks may improve their profitability by increasing their asset size and/or by consolidation. The increased banking profitability will not only come from monopolistic power (higher concentration rate) but also from the scale efficiency benefit. We also find that portfolio risk is a key factor in determining the profit-structure relationship. Keywords: Profit-structure relationship, Market Structure, Scale efficiency, Portfolio Risk JEL Classification: C33, G21, G14, L11 1 Corresponding Author; Post-doctoral researcher, Faculty of Economics and Business, University of Tübingen, Germany. E-mail:
[email protected]. 2 Faculty of Economics and Business, Department of Banking, University of Tübingen, Germany. 1 1. Introduction In a recent paper published by the IMF, Decressin et al. (2003) propose that recent weak bank profitability in Germany appears to be related with structural factors rather than the macro- economic cycle. Some anecdotal evidence and financial ratio analyses are also presented to support this claim. The motivation of this paper is to study the issue of bank profitability in a coherent and rigorous econometric framework with a large panel data set of the German bank- ing industry.