Adapting to Changing Prices Before and After the Crisis: The Case of US Commercial Banks

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.