Adapting to Changing Prices before and after the Crisis: The Case of US Commercial Banks

Abstract

For banks, cost management has gained importance in the current environment of low interest rates. In this environment, banks' revenues from interest are under pressure, leading to renewed interest in the substitutability of banks' input factors. Substitution elasticities typically depend on two factors: cost technology and economic conditions (relative input prices or cost shares). Technological shifts and policy changes are therefore expected to affect firms' elasticities of substitution. This study estimates U.S. commercial banks' substitution elasticities during the 2000-2013 period. It analyzes the total effects of the technological shifts and policy changes on banks' substitution elasticities during that period. An endogenous-break test divides the sample into a precrisis period (2000-2008) and a crisis period (2009-2013). During the pre-crisis period, banks' inputs are inelastic substitutes. After the onset of the crisis, especially the long-run substitutability of most input factors decreases to even lower levels due to changes in both cost technology and economic conditions. At the same time, banks' response to input price changes becomes more sluggish. The results indicate that the availability of substitutes is substantially worse during the (post-) crisis period, which limits banks' possibilities for cost management.