Determinants of profitability of community banks in the USA: a cost-frontier-based decomposition approach

Guohua Feng () and Chuan Wang
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Guohua Feng: University of North Texas
Chuan Wang: Zhongnan University of Economics and Law

Empirical Economics, 2021, vol. 60, issue 6, No 12, 2969-2992

Abstract: Abstract This paper investigates the determinants of the poor profitability of community banks relative to that of large banks in the USA over the period 2001–2017, by decomposing the relative profitability of community banks into five multiplicative cost-frontier-based explanatory factors. To compute these explanatory factors, we estimate a Bayesian true fixed effects stochastic cost frontier model, which has the advantages of allowing the unobserved heterogeneity term to be correlated with the observed explanatory variables and providing statistical inferences on the cost-frontier-based explanatory factors. Our decomposition shows that community banks’ lower profitability was attributable mainly to their lower technical change, lower scale efficiency and higher funding costs. In addition, the latter two factors were also the two main contributors to the deterioration in the profitability of community banks.

Keywords: Community and large banks; Profitability; Productivity and efficiency; Stochastic cost frontier model (search for similar items in EconPapers)
JEL-codes: C23 D24 G21 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s00181-020-01952-x

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