You own a small bank in a state that is now considering allowing interstate banking. You oppose interstate banking because it will be possible to for the large money center banks in New York, Chicago, and San Francisco to open branches in your bank's geographic market area. While proponents of interstate banking point to the benefits to consumers of increased competition, you worry that economies of scale might ultimately force your now profitable bank out of business. Explain how economies of scale (if significant economies of scale in fact do exist) could result in your bank being forced out of business in the long run.

Take a shot, what do you think?

Hint: economies of scale imply a declining average cost curve

Economies of scale refer to the cost advantages that businesses can achieve as they increase their production or scale of operations. In the banking industry, larger banks typically have economies of scale due to their ability to spread fixed costs over a larger customer base and generate higher revenue.

If interstate banking is allowed and large money center banks from major cities like New York, Chicago, and San Francisco are permitted to open branches in your bank's market area, it could potentially lead to several challenges for your small bank:

1. Lower cost structure: Larger banks with economies of scale can benefit from lower average costs per transaction, allowing them to offer competitive pricing and potentially attract customers away from smaller banks like yours. They may be able to offer lower interest rates on loans or higher interest rates on deposits, making it harder for your bank to compete.

2. Greater resources and services: Large banks often have more resources, technological capabilities, and a wider range of services to offer customers. They can invest in advanced digital banking platforms, offer more convenient and innovative products, and provide better customer service. Small banks may struggle to keep up with these offerings, potentially leading to customer attrition.

3. Enhanced marketing and brand power: Larger banks can afford to invest significant amounts in advertising, marketing campaigns, and branding efforts. This allows them to establish a stronger presence in the market and attract a larger customer base. It may be challenging for your small bank to compete with their marketing efforts, resulting in a smaller market share and potential loss of customers.

4. Negotiating power with suppliers: Large banks can leverage their size and negotiating power to secure better deals with suppliers and vendors. They can often obtain lower prices on equipment, technology, and other supplies necessary for banking operations. This cost advantage may not be available to smaller banks, leading to higher operating expenses.

5. Regulatory burdens: Large banks often have more influence and resources to navigate the complexities of regulatory compliance. As regulations evolve, smaller banks may face challenges in keeping up with the compliance requirements, potentially resulting in higher operational costs and administrative burdens.

In the long run, if your small bank is unable to effectively compete with the economies of scale enjoyed by larger banks entering your market area, it may face declining profitability, loss of customers, and ultimately be forced out of business. It is crucial to understand and evaluate the potential impact of interstate banking on your bank's competitive position and consider strategies to adapt and differentiate your services to mitigate these risks.