Optimal size in banking: The role of off-balance sheet operations

In the 1990s, banks dramatically increased the size of their off-balance sheet (OBS) operations. A common explanation for this phenomenon is the high revenues earned in providing OBS services. This chapter looks at another possible explanation for this expansion: the existence of large cost economies of scale and scope for OBS activities. We show that an important factor in the increase of OBS activities among European banks is the realization of cost scale economies, both with respect to OBS services themselves and banks' other outputs, especially securities investments. We conclude that OBS activities provide unique opportunities for banks to efficiently increase their products and services.