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April
1961
LY REVIEW
Is the Cottle Cycle Changing?
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page
Importance of Size and Other Factors
Affecting Bank Costs . .
Current Statistics
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.
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3
page 10
. page 16
FEDERAL RESERVE BANK
OF KANSAS UITY
Suhscriptions to the Mo THLY HEvmw are available to the public without charge. Additional
copies of any issue may be obtained from the
Research Department, Federal Reserve Bank of
Ka nsas City, Kansas City 6, Missouri. Permission
is granted to reproduce any material in this
publication.
ls the Cattle Cycle Changing?
business requires
long-range planning. In making such
plans, some expectations regarding cattle inventories and prices must b e formulated . Accu rate prediction of cattle numbe rs js nev r
'asy, and it has h 'C ll ·s peciall y diffi ult in
r c ' nt y •;us. Th' mos t r ce nt contraction
phase of the cattle cycle-1955 to 1958- was
shorter in length and smaller in amount th an
that of any previous cycle. The current expansion phase of the cycle also has behaved
in an unusual manner-numbers increased 1
million last year, as compared with a 6 million increase in the corresponding year of the
previous cycle.
Contributing to the uncertainty about cattle numbers is the recent revision in annual
estimates for 1955 throu gh 1960, which was
made after 1959 censu s data became available. The large magnitu<le of th e revision-a
reduction of 5.2 per cent in total numbers
from the original estimates made for 1960has caused considerable confusion concerning the interpretation of recent livestock forecasts.
Historically, cattle inventories have varied
cyclically around a long-run, upward trend .
In addition, irregular movements have occurred from time to time, resulting from such
diverse factors as droughts, wars, supplies of
competitive products, and changes in economic activity. The cyclical and irregular
movements have b een responsible for much
of the instability in the cattle industry. While
there is little hope for eliminating all cyclical
S
UCCESS IN THE CATTLE
Monthly Review •
April 1961
and irregular movements, it may be possible
to minimize them through a better understanding of the nature of changes in cattle
numbers. Such a minimization of instability
would b ben fj ial to catt] producers, feeders, suppli ers, finan ·ial :1gcncics, mark tin g
firms , and ·ons um ,,·s.
Trends
In the 95 years for which annual estimates
are available, total cattle numbers have expanded from a low of 28.6 million to a high
of 97.l million, an increase of 240 per cent.
The average increase of 729,000 per year
tends to be misleading because it includes
several types of changes. The long-term
trend line in Chart 1 indicates a rate of increase of 560,000 annually for the 1867-1961
period. This probably is a more realistic estimate of th e upward trend, since it is not influ enced by shorter-run irregular movements
to the same extent as the preceding estimate.
Cattle inventories vary in such a way that
it is difficult to fit a linear, long-term trend
line to the data. Such a trend is influenced
by the d ifferential rates of growth for the
periods 1867-1890, 1890-1928, and 1928-1961.
In the first period, a trend line fitted by visual inspection indicates an average rate of
growth of 1,455,000 h ad per year. A similar
trend line for the s cond period shows an annual increas of only ,'380,000, while the third
period trend shows a growth rate of 1,090,000
head p r year. Durin g the first period, the
fronti er was moving rapidly westward and
3
Is the Cattle Cycle Changing?
Chart 1.
Total Cattle Numbers and Trend s
United States
MILLION
HEAD
JANUARY I , INVENTORIES
100
veal. Strong demand, improvements in productivity, and ample feed supplies in recent
years induced the strong growth rate that has
prevailed since 1928.
II
Cyclical Movements
90
80
70
60
50
40
30
Actual Numb ers
Short - Period Trends
- - LonQ - Term Trend
0 L.L-L_j___J_..J._-'---.J_-'--L-l-1....-1-'-'---'--:-"-:--'----:-:.'-::--'---:':
1867
'80
'90
1900 '10
'20
'30
'40
'50
'61
NOTE : The short-period trends were fitted by vi sual Inspection and
the long-term trend was fitted mathemati cally by the least squares
method .
SOURCE : U. S. Department of Agriculture .
cattle production was being expanded in the
Great Plains area. This was the p eriod following the Civil War when the first transcontinental railroads were built, the Plains
Indians were restricted to reservations, and
the vast buffalo herds were exterminated. Toward the end of the period, the homest ad
movement was gaining momen tum and the
op n rang was giving way to barbed wire
and the plow.
Cattle production xpanded fast r than demand duri11g the first period, and by 1890,
cattle numbers were disproportionately large.
During the second period , declining per capita beef consumption was a weakening factor,
but it was more than offset by population
growth. Consequently, the beef cattle industry
was able to continue expanding in this period.
During the present period , consumer incomes
hav ris n greatly from th <lepre sion lows
of the ea rly 1930's and this has contribut d
to a substantial incr as ·n per apita onsump tion . In addition , population has increased more rapidly since World War II ,
further iucreasing the demand for beef and
4
Since 1867, th re have be n sev 11 p riods
of incr asing cattle numbers an<l si periods
of <leer asing numbers. These mov ments
have been largely cyclical, with th length of
the cycle being closely related to the time
r quired to build up and liquidate a cattle
herd. High or in reasing cattl pric s apparntly stimulat produ · rs to buil l up hre <ling hercl s and to h Id fc cl rs to h ·avi ·r
w igh ts. This r 'slri -ts ·urr ·nt marketings,
whi ·h stimulal ·s furth e r pri · in 'reascs. The
cycl, r inforc 'S its ,lf until nough ti m has
lapsed for the withholding of animals to be
translated into increasing suppli s of b eef
and veal. The resulting increase in supplies
tends to depress prices and to reverse the
cycle. Since there is no restraint on the rate
of liquidation comparable to the restraint on
the rate of inventory buildup imposed by the
time required for gestation, growth, and fattening, th downward movement can transpire mor · rapidly th an th e upward mov ment.
Th compara tive amplitudes and 1 ngths of
the yclical movements ar shown in Table
1. Since the first period was not characterized by a complete cyclical movement, it
serves primarily as a base for the fol1owing
movements. The first "low" ( in 1876) was
determined statistically by removing the trend
influence as shown in Chart 2. In terms of
absolute numbers, there has been littl change
in the upward amplitude of the ycles sine
I 90 but, in p ' r e ntag t rms, th av rag
mer ase in the ·urr nt p 'riod has be n smaller than it was in th e s cond. The downward
changes hav be n considerably small r than
the upward chan ges and th y have becom
incr asingly smaller during the current pe-
Is the Cattle Cycle Changing?
Table 1.
Characteristics of Cyclical Movements in Total Cattle Inventories
United States
Absolute
Change
Period
Fast
growth
Year
Cycle
Position
Inve ntory
Numbers
(Mi llion)
1876
Lowt
36.1
1890
High
60.0
Relative
Change*
I
low
High
to
to
high
low
(Million)
+23.9
I
Low
High
to
to
high
low
(Per Cent)
Low
1904
High
- 19.8
Low
14
+29.8
High
16
Low
55.7
14
High
73.0
16
-24.1
Low
16
+25.9
1945
High
10
Low
65.2
1958
High
Low
11
7
+27.0
11
85.6
- 10.8
4
76.8
10
+22.8
+19.8
1955
4
-1 3.1
-8.8
1949
6
74.4
+20.4
Ill
Fast
growt
10
57.3
- 9.2
1938
6
+27. 0
+ 17.1
1934
8
- 17.6
- 15.7
1928
8
66.4
+ 17.3
1918
High
to
high
6
49.2
- 10.7
19 12
I
(Years)
Low
to
low
20
+17.2
II
Slow
growth
High
to
low
14
+49.6
- 10.8
1896
Length of Cycle
Low
to
high
96.6
-
.4
6
- 5.8
3
9
91.2
* Ea ch rela ive change was calc ul ated by dividing the differen ce between the high and low by the avera ge of the two In order to
eliminate th upward bias inheren t in perccn .1ge changP. expre ssions .
t The low in 1876 wa
ermiOP c1 stati st1rally by removing trend (see Chart 2).
SOURCE : U. S. Department of Agriculture .
rio<l. Th av rag m n ber of years of the
upswings appar .ntly chang d c ry li tl " between th
econcl and bird pe iods, while
that of the downswings changed cons 'derably.
During t e second eriod, the downward
ovements increased in length from 6 years
to 10 years, whi e iI I e t ir peri d, they
have decreased to
yea s in length.
s a
resu lt, th over-all cycles have decreased
from an av rag of about 15 years in th
second p riod to about 10 y ars in the third .
The purely cyclical movements in total
cattle numbers, after the trend and irregular
movements were removed statistically, are
shown in Chart 2. T he eye es have been conMonthly Review •
April 1961
tracting both in length and amplitude. The
upward deviation from the trend line declined from a maximum of 14 per cent in the
1918 peak to 8 per cent in the 1954 peak.
Only the depression peak of 1934 rose above
the trend by a smaller amount than the most
recent high point of the cycle and, since it
began from a much lower level, its total rise
was greater. The downward amplitudes
have contracted ev n more than the upward
amplitudes - from 14 per cent in the 1896
trough to 4 per cent in that of 1959. The
over-all amplitudes from low to high and high
to low d clin d by about one half from the
second to the third period.
s
Is the Cattle Cycle Changing?
Chart 2.
Cyclical Movements and Rates of Change
In Total Cattle Numbers
United States
PER
CENT
+30
I
m
lI
+20
+10
0
- 10
- 20
- - Cyc li c al Movemen ts
-
- 3 0 '--'--'---'--'---'-
186 7
' BO
'9 0
L
1900
L
'1 0
Rotes of Change
~
'2 0
'30
l
'40
' 50
' 61
NOTE : The cy cli cal mov ement s were computed a perce nt ag e devia ti ons of Inventory numb er from a tr nd curve fill ed 111at11 ematl cally by th e I ast squares meth od. Th e irr gul ar movement s were
removed by mean s of a moving av erage . The rate s of change were
computed as percentage change s in inventory numbers from year
to year .
The rate of change in cattle numbers from
year to year reveals a great deal about the
nature of the cattle inventory cycles. The
rates of change depicted in Chart 2 were
calculated from the original data and, consequently, reflect trend and irregular movements as well as cyclical variations. The turning points in rates of change have usually
preceded the turning points in inv ntory numbers by about 2 years, indicating that th e
buildups and liquidations usually begin to
lose momentum some time before the turning points of the inventory cycles. The amplitude of the rate-of-change cycle seems to
have changed very little, except for the drastic liquidation period in the early 1890's and
the Government liquidation program in 1934.
Since the rate-of-change amplitude has remained constant, the contraction of the inventory amplitude must be explained by the
shorter lengths of the cycles.
Inventory Changes by Classes
While movements in total cattle numbers
are of considerable interest, they tend to obscure many important divergencies in move6
ments among the different classes of cattle .
An especially significant difference has occurred between cattle and calves kept fo r
milk and those not kept for milk. The proportion of the cows 2 years ol<l and over
which were kept for milk d eclined fro m 71
per cent in 1928 to 43 p er cent in 1961. Similarly, the proportions of h eifers 1-2 years old
kept for milk dropped from 62 to 42 per cent
and calves from 37 to 21 p er cent. This should
not be interpreted as a shift from dairy breeds
to b eef breeds b ecause much of the ch ange
has b een the result of a shift from dual-purpose animals to speciali zed animals. Pd or to
World War ll , man y beef cattl e ra is 'rs milk d
th eir ·ows durin g the flu sh season and solcl
crea m. Both da iry and b eef pro h1 'lion have
become more highly p ccializ cl in r cent
years and , while fewer b eef and dual-purpose
cows are milked , dairy h erds still provide a
substantial amount of beef and veal.
The growth of specialization in dairy production has been accompanied by a considerable increase in average milk output per
cow. Since this increase has occurred during
Chart 3.
Cyclical Changes In Dairy Cattle
Numbers By Classes
United States
PER CENT
+40
+20
- - Cows
- - Heifers
- - Heifer Calves
- 40
1928
'35
'40
'45
'50
'55
'6 1
NOTE : The cyclical movements for each cla ss were computed as
percentage deviations cf inventory numbers from a trend lin e
fitted mathematically by the least squares method .
Is the Cattle Cycle Changing?
Chart 4.
Cyclical Changes In Beef Cattle
Numbers, By Classes
United States
PER CENT
+4 0
+20
,A
0
- 20
-----
-40
192 8
Co ws
H e if er s
Calv es
St eer s
been the least irregular, reflecting the influence of longer-run production plans. In addition, there has been considerable variation
between trends for the different classes, with
cows having the strongest upward trend and
calves being second. Steers and h ifers 1-2
years old have incr ased the least of the
group, although both increas d more than
any class of dairy cattle.
The trend line for all beef cattle indicated
an increase of 1,108,950 per year based on
a linear regression equation fitted to the 192561 data. A similarly calculated trend for d airy
cattl indi at d an in r a of only 7,440 p r
year . . in ·c World War 11 , h ·d attl num bers hav mo v cl upwar I even more strongly,
whil ' dairy cattl numb rs have de lined .
' 35
NOTE: The cyclical movements for each class were computed as
percentage deviations of inventory numbers from a trend line fitted
mathematically by the least squares method .
a period of slow growth in the demand for
milk, fewer and fewer milk cows have been
needed. Dairy cattle numbers, which trended
upward from 1921 to 1944, have followed a
downward trend since then, particularly for
milk cows 2 years and older. Chart 3 shows
that cycl
xist in dairy cattle numbers, but
comparison with Chart 4 shows that they differ consid rably from the cycles in b ef cattle numbers. The amplitud of the dairy
cattle cycle has been smaller and the turning
points have tended to precede those of beef
cattle. It is usually assumed that the culling
of dairy herds is influenced by slaughter cattle prices and that this causes some similarity
in the cyclical patterns.
Chart 4 shows that the cyclical movements
among the different classes of b ef cattle have
tended to coincide in timing and direction
but not in amplitude. Steer numbers have
been the most irregular, often moving opposite to the others. This probably is a reflection of the single purpose and more ready
marketability of steers. Cow numbers have
Monthly Review •
April 1961
Meat Production and Slaughter Prices
Beef and veal production are used to measure production responses because they reflect
the influence of variations in slaughter
weights as well as slaughter numbers. Cattle
and calf prices tend to respond immediately
to changes in beef and veal production-a.sChart 5.
Deflated Beef Cattle Prices and Per Capita
Beef Production
United Sta tes
PER CE N T OF 19 10
25 0
200
150
100
50
- De flated Pric~s
- - Per Ca pi ta Pro du c tion
0 ~'-'-'-...........-'-'-c'-'-'-LJ....L.'-'-'-,'-L--L -'-"-'--'-'-'...J-L.LL..L.L.L..L.J...L.l..,LJ....LL..L.L.L..L-'-LJ
19 10
' 20
' 30
'40
'50
' 60
NOTE : Deflated prices were computed by dividing average prices
re ceived by farm ers for beef cattle by the index of prices paid by
farmers for comm odi ties used in produ ction . Per capita production
was comput ed by di viding total beef produ ction by civilian populat ion .
SOURCE : U. S. Departments of Agriculture and Commerce .
7
Is the Cattle Cycle Changing?
suming that demand conditions and supplies
of substitutes remain the same. Production,
for reasons discussed earlier, responds more
slowly to the influence of price incentives,
although responses tend to be more rapid for
veal than for beef production. Chart 5 shows
the movements in cattle prices and beef production from 1910 to 1960. The prices were
deflated by the index of prices paid by farmers, and per capita production was derived by
dividing total beef production by civilian
population. Use of this procedure gives a
truer picture of the cyclical movements in the
beef market. Cyclical movements in b ef cattl pric s w 'r larg ly obscur d b y a generally rising pri e 1' vel from 19.34 to 1951, but
a strong y ·Ji al mov m nt s ems to hav d 'veloped since th n. Per capita production of
beef has shown a moderate although fairly
regular cycle.
Calf prices and veal production display a
comparatively regular cyclical movement, as
shown in Chart 6. This apparently reflects
Chart 6.
Deflated Calf Prices and Per Capita
Veal Production
United States
PER CENT OF 1910
250
200
50
- - 0efloted Prices
- - Per Ca pito Production
0 .............._.........,__......__._.L..L..L.-'-'--'-.LJ...J.....L..L..l-'--UW-1-LLLL.L...L.LL..L.LJ...J.~-'--UL..J...L.LLLL..J
19 10
'20
'30
'40
'60
'50
NOTE : Deflated prices were comput ed by dividing average pri ces
received by farmers for ca lves by the index of prices paid by
farmers for commo dities used in produ ction. Per capi ta production
was co mputed by div id ing total veal produ ction by civilian population .
SOURCE : U. S. Departments of Agriculture and Commerce .
8
the greater responsiveness in veal production.
The amplitudes of the cyclical movements in
veal production and calf prices are similar,
whereas those of beef production are considerably smaller than those of cattle prices .
Veal and beef production are not, of course,
unrelated. The responsiveness of veal production prevents great r variations in beef
production b y absorbing much of th e shock
of abrupt changes in demand or supply conditions and, in the case of increased calf
slaughter, by decreasing the potential supply
of beef. The ratio of calf slaughter to the calf
crop offers some advance indication of
hang s in cattl numbers. Thi · ratio usuall y
r a ·h ·s a low and begins to rise about 2
y ars h fore total caltl ' in v 'nlori c · r ac h ,l
peak and b gin to d dine. Further, the ratio usually reaches its high and b egins to
decrease about 4 years b efore inventories
reach a low and begin to rise.
Concluding Remarks
Livestock numbers display so e regularities of movement but sufficient irregularity
exists to make forecasting difficult. Year-toyear predictions often miss by a wide margin
and longer-term predictions are especially
hazardous. Nevertheless, changes in cattle
production require such a long time that producers and capital suppliers must formulate
some sort of expectations for as much as 5
to 10 years in advance. In view of this necessity and the sharp fluctuations which occur
in livestock prices and feed costs, livestock
production and financing are hazardous occupations from an economic standpoint.
A statistical projection of the trend curve
and cyclical pattern in total cattle numbers is
shown in Table 2. The figures ar not a prediction of future cattle numbers but simply a
first and second approximation based on an
extension of past conditions into the future.
The trend shows a figure of 95.3 million for
1958 with a continuous rise to 120.5 million
Is the Cattle Cycle Changing?
Table 2.
Statistical Projection of Total Cattle Numbers
United States
Year
Trend
Values*
(Million)
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
95.3
97.2
99.1
101.2
103.3
105.5
107.8
110.1
112.6
115.1
117.8
120.5
Cyclical
Statistical Inventory
Deviations** Estimatest Numbers
(Per Cent)
(Million)
(Million)
- 5.3
- 5.0
- 1.9
+3.0
+6.9
+7.9
+6.7
+4.0
- 0.3
- 3.3
- 3.8
- 3.4
90.2
92 .3
97.2
104.2
110.4
113.8
115.0
114.5
112.3
111.3
113.3
116.4
91.2
93.3
96.2
97.1
• Ba se d on a trend curve fitted mathematically by the lea st
sq uare s m thod .
•• Bas ed on smoothed p r ccntagc r c latlon shlp between Inventory
numb r s and tr end value s in l ast full cyc l e.
t Ba se d on t rend valu es adjusted for cyclical deviations .
in 1969. Superimposing the most recent cycle
pattern ( from 1949 to 1957) on these figures
indicates 90.2 million for 1958, rising to 115.0
million in 1964, declining to 111.3 million in
1967, and climbing to 116.4 million in 1969.
That the pattern of the current cycle differs
from that of the previous cycle is shown by
Monthly Review •
April 1961
comparing th e inventory numbers with the
statistical es timates for 1958 throu gh 1961 .
The in ventory numbers differed from the stc tistical estimates by only 1 million in each
of the first 3 years, but they were 7 million less than the estimate in 1961. This ma
pr sage a shorter buildup in this cycle than
in th e last.
The turning point of th present cycle
s ms highly uncertain . If the patt rn of th e
most recent cycles were repeated, the p eak
would occur in 1964. However, th er is some
indication tha t it may occur soo n r. The rate
of incr as dropp cl off in J960 and , . in this
has usuall y pn.' cedcd a peak in nurnhcrs hy
about 2 y 'ars, it incli 'ates a possihlc peak
in 1962 or 1963. 'uch a hri ,f h11ild11p wcmld
b the shortest on re ord and ther is little
in the previous history of cattle cycles to
support such an expectation except that the
last liquidation was also the shortest on record. In any event, the amplitude of th e cycles has declined in recent years, and if it
continues to decline, th e cattle cycle may
eventually assume negligible proportion s.
9
Importance of Size and Other Factors
Affecting Bank Costs
preceding issu es of
this Review dealt with the relationship
between size and costs at member banks in
the Ten th Federal Reserve District. M asurecl as a p er cent of assets, costs at a sample of abou t 270 District member b anks during the period 1956-59 were found to decline
significan tly with increasing size. The cost
advantages of la rger-scale op rations w ere
shown to rdlc t tli ' ability of Jarg 'r banks
lo opC'rat' with srnalJer numbers of unpJoy 'Cs
per dollar of assets ancl with a high 'r prop rtion of nonofficial employe s to officers. 1 hes
cost advan tages seem to stem partly from
opportunities to perform ordinary banking
functiorts in more efficient ways , and partly
from the ability of larger banks to carry on
transactions for loans and investments in
larger dollar amounts.
In the two previous articles, attention was
focused on the average relationship b etween
bank size ancl costs without consid ri ng the
importance of iz in r lation to oth r factor
that influ nc bank cost ratios. Is th size of
a bank th e dominant chara t ristic influencing its expenses as a p r c nt of a sets, or
are other characteristics of greater significance? The first portion of this article presents a discussion of the relative importance
of various factors that influence bank cost
ratios, and is based on the same statistical
analysis used in the earlier articles.
second and related topic d eals with
chang s in the r lative importance of fa ctors
influencing costs during the years 1956 to
1959. This p eriod witnessed strikin g changes
in the volume and composition of assets and
liabilities of District memb r banks. A study
of the ch anging relative importance of various facto rs associated with b ank costs during
A
10
RTICLES IN THE TWO
these 4 years sheds light on the way in which
District banks respond ed to a sharp upswing
in th eir loans and deposits and to the spread
throu gh th banking sys tem of higher int rest
ra tes on tim deposits.
Factors Identified as Cost Determinants
Methods of statistical analysis do not permit isolation of all of th many factors that
accou11t for cliff r ·nc 'S in ·osts among hanks.
Sp ' ·i, il c irc111nsla11 -cs tl1at ar' 1rniqu' to an
indi vidu ul bank oft '11 a· ·ount for a significant shar ' of th ' cliff rcn e betw en its costs
and those of other banks similar in size and
in other respects. Moreover, there are some
forces responsible for cost differences among
banks that cannot easily b e m easured or for
which the necessary d ata are unavailable.
The statistical method employed to investigate the relationship between bank size and
costs also sought to find an association betwe n b ank cos ts and major characteristics of
as ts and liabilities for which data ar readily availabl from m mb r bank r 'ports of
onclition. A bri f discussion of th reasons
for s lectin g the chara t ristics included in
the study provides a helpful b ackground for
the discussion to follow.
The division of a bank's assets among major
classes-loans, securities, and cash-is certain
to have a significant effect on its costs. The
structure of assets by major classes is represented in the analysis by two factors: ( 1 )
th per cent of total ass ts in the form of
loans, and ( 2) the per ent of total assets
held as s curities other than U. S. Governmen t issues . Given thes two p ercentage fi gures, th e proportion of b ank assets in liquid
form ( cash and U.S. Government se urities)
is automatically allowed for, since Joans, se-
Importance of Size and Other Factors Affecting Bank Costs
curities, and cash assets add up to virtually
100 per cent of total assets at almost all banks.
Since analysis showed that the distribution
of liquid assets between cash and Government securities was not closely related to
b ank costs, this possibk consideration can be
safely ignor d.
There ar' four principal categories of Joans
xtended by District banks- loans to businesses, nonguaranteed farm credits, real-estate mortgage loans, and loans to individuals
or consumers. The proportion of total loans
extended to consum rs was found to exercise
a strong upward influence on hank cos t ratios. 011 tl1c other hand , no significant association w;1s discovered between costs and the
proportio11 of loans cxl<.'1 1dcd to businesses, to
farm ers, or to th e mortgag ' market. 1 his onclusion , which may seem surprising, might
well indicate that the administrative costs
of making a loan are determined not so much
by the type of borrower as by characteristics
of the individual loan transaction, particularly
the size of loan. Consumer loans are high
cost assets because they are small loans and
because the bulk of them are repaid in instalments. The average size of other types of
Joans d ep end s primarily on the size of bank,
and so t ·nds to be refJ 'cted in the cost advantages enjoyed b y larger banks.
On the liability side of the balance sh et,
time deposits involve substantially larger costs
than demand balances, since interest payments are forbidden on demand accounts.
The amount of expense incurred on time deposits depends both upon the average rate of
interest paid on time accounts and on the percentage of deposits in time accounts. These
arc not, however, unrelated characteristics.
Indeed , th e association between average
rates paid on time deposits and the proportion of deposits in time accounts was so
strong that their influ ence on cos ts of th e
sample banks could not be separated statistically. Therefore, the latter characteristic
Monthly Review •
April 1961
alone was employed to represent both influences on costs.
The statistical analysis also showed that,
among larger banks, the percentage of dem:md deposits in the form of correspondent
balances was associated with bank costs. Other thin gs equal , ratios of cos ts to assets tended
to be lower for banks with a high perc ntage
of interbank demand deposits.
Results of an earlier study-pu blished in the
July 1960 issue of this Review- suggested that
banks with high growth rates tended to have
higher ost ratios. The present study confirms
this association and yield s additional information 011 the re lationship betwceu hank growth
rates and h:111k costs.
Direct Influence on Costs
Tog ' th r with bank size, the characteristics
of assets and liabilities mentioned in the precediug section account for 62 per cent of the
variation in ratios of total costs to assets
among the sample banks over the period
1956-59. Each factor separately, or directly,
accounts for part of the variation, while an
additional portion is explained by the joint
influ ence of the several factors. The direct
influence of each factor provid es the best
initial guide to its relative importance as a
d terminant of bank cost ratios, and therefore will be discu sed first. Measures of direct influence on cost ratios, as shown in
Table 1, can be compared with one another
readily, since each measure expresses the percentage of variation in cost ratios among the
banks that a particular factor explains.
The first four characteristics listed in the
table each explain directly from 9 to 14 per
cent of the variation in ratios of total costs
to total assets among the sample banks. Although each of the four accounts for a slightly different percentage of total cost variation,
the differenc s are not large enough to be assigned any important weight. The appropriate inference is that differences among the
11
Importance of Size and Other Factors
Table 1.
Measures of Direct Influence On
Total Cost Ratios
Sample of Tenth District Member Banks, 1956-S9
Bank Characteristic
1. Asset size
2. Relative volume of time deposits
3. Percentage of assets in loans
4. Percentage of loans extended
to consumers
5. Growth rate of assets, 1956-59
6. Percentage of assets in
non-Treasury securities
Per Cent of Variance
in Total Cost Ratios
Explained
13
9
JO
14
2
2
NOrE :
The data in the table are based on the function :
X1 = f(log X2 , X3 . . . X7 ) , where X 1 Is the ratio of total costs
to tot al dsse ts, X:i is asset size in millions , X3 is the r~tio of time to
total deposits, X4 Is the ratio of total loans to total assets, Xs is the
ratio of non-Trea sury securities to total assets, X6 is the ratio of
co nsum er to total loans, and X7 i s the percentage Increase In
a se t s, 1956-59, with al l ratio s expressed in percentage term s.
Tho function wa s f i tted to data for Individual banks obta ined by
ave ragi ng annua l figure s for th e years 1956-59 . The mea ures
shown arc sq uare s of the beta (s tandard ized partial re gression)
coefficie nts, expressed In percentage term s.
banks in size, in the relative amount of tim
deposits, in the p rcentage of assets in the
form of loans, and in the percentage of loans
made to consumers all were of approximately
equal significance in explaining differences in
total cost ratios. However, the comparative
importance of these four factors in accounting for differences in ratios of wages and salaries to total assets was quite different. Bank
size, which explain d directly about 28 per
nt of th variation in wage and salary ratio , was by far the most important d t rminant.
Rates of growth in assets and the percentage of assets held as securities other than U.S.
Government issues, the last two characteristics shown in the table, exerted a substantially
smaller direct influence on total cost ratios
than the other four characteristics. The proportion of demand deposits in the form of
interbank accounts - a characteristic not
shown in th table - was found to account
directly for about 2 per cent of th variation
in total cost ratios among sample banks with
ov r $25 million in assets. Clearly, then,
m asures of dir ct influ ence point to th
first four charact ristics in Table 1 as exerting the dominant influence on total cost ratios.
12
The previous articles in this series dis cussed
in some detail th e average relationship between size and costs, and it is of in terest to
note how cost ratios chang , on th a rage,
with changes in the oth r three principal factors affecting costs. The top panel of the
chart shows th way in which ratios of total
cost to ass ts t nd to rise with high r ratios
of time accounts to total deposits, aft r removing the influen e on costs of all other
Relationship Between Total Cost Ratios and
Characteristics of Assets and Liabilities
Sample of Tenth District Member Banks, 19S6-S9
Per Cent
Total Costs to Total Assets
3.2
Tl ME DEPOSITS
2.8
2.4
2 .0
1.6
Per Cent, Time Deposits to Total Depos its
0
10
20
30
40
50
60
3.2
TOTAL LOANS
2 .8
2.4
2 .0
1.6 / . Per Cent, Total Loans to Total Assets
0
10
20
30
40
50
60
3 .2
CONSUMER LOANS
2 .8
2.4
2 .0
1.6
Per Cent, Consumer Loans to Total Loans
0
10
20
30
40
50
60
NOTE: The charts are based on the function described In th e note
to Table 1. The line in the top panel is obtained by setting vari ables X2 , X4 . . . . X7 at their mean values and then graphically
portraying the resulting relation between X 1 and X3 • Lines in th e
second and third panels are obtained by an analogous procedure .
For each characteristic , the lines are drawn to cover the range of
variation which is found among the sample banks . For example,
few banks have ratios of total loans to total assets of less than
15 per cent , so the line in the second panel is not extended below that figure.
Affecting Bank Costs
charact ristics identifi d as cost determinants.
The cost ratio rises by .16 percentage points,
on the average, for each 10 percentage point
increase in the ratio of time to total deposits.
Similarly, as displayed in the second and
third panels, the total cost ratio rises .22 percentage points for each 10 percentage point
increase in the ratio of total loans to total
assets, and .16 p 're ·ntage points for each 10
percentage point increase in the proportion of
total loans extended to consumers.
Joint Influences on Costs
Additional insight into the r lativ importan ·c of the various ·haractc risti ·s may he
gai ned hy 1·x:1mi11ing their joint infl11cn ·c on
·ost ratios. To clarify th · meaning of joinl influence , it may b' h 'lpful to use a simple il lustration from ano ther field.
Suppos a person earning $10,000 gives 10
per cent of his income, or $1,000, for charitabl e purposes. When his income increases to
$15,000, he gives 15 per cent to charity, or
$2,250. Of the $1,250 rise in his contribution ,
no more than $500 is accounted for directly
by the growth in his income-$500 being the
product of the increase in income times the
initial contribution rate of 10 per cent. Simi larly, no more than $500 is accoun ted for
directly by the in rease in contribution rate,
since th 5 percentage point ris in contribution rate times the original incom of $10,000
is $500. The $250 not accounted for directly
by either the increase in income or the increase in contribution rate is properly described as the joint influence of both changes.
Had the contribution rate dropped to 5 per
cent when the income figure rose to $15,000,
the direct eff cts would have been plus $500
for the hangc in income and minus $500 for
th ' chang in contribution rate,
bile the
joint effect of both changes vould be minus
$250.
In a similar manner, characteristics of bank
assets and liabilities have both direct and
Monthly Review •
April 1961
joint effects on costs. For example, sample
banks with either high ratios of loans to total
assets or high ratios of time to total deposits
tended to have higher cost ratios, as noted
above. These characteristics, however, arc
not independent-usually, banks with relatively high time deposit ratios have above
average loan ratios. Con equ ntly, these banks
tend to have above av ·rage cost ratios for
three reasons: their comparatively high volume of loans, th ir higher percentage of time
deposits, and because both loans and time
deposits are relatively high.
As wilh the dir ct influenc on osts discuss cl ahove, the joint influcnc<.' of any two
cost d 'lcnni11a11ts may he expressed in terms
of the r ,ta ti ve amount of varialion in cost
ratios among hanks that it a · ·ounts for. Table 2 show th joint effect on costs of each
pair of characteristics listed in Table 1. A
red figure indicates that the joint effect is
negative-as in the illustration above when
the contribution rate declined.
These measures of joint influence disclose
several interesting aspects of bank cost experienc . First, the joint influence of bank
size and the three other major determinants
of costs arc all negative. This resu lts from
the fact that, among District member hanks ,
ratios of tim ' to total deposits , total Joans to
total ass ts, and consumer loans to to al loans,
all tend generally to increase with larger bank
size. Thus , while increasing size is associated
with decreasing costs, part of the cost advantage of larger size is offset by changes in
the structure of a sets and liabilities which
make for higher costs.
This should not b e taken to imply, however, that ratios of time to total d eposits ,
total Joans to assets, ancl consumer Joans to
total loans rise continu o11sl with size of bank
throughout the full range of bank sizes in th e
District. For although the very large t banks
in th District tend to have the highest ratios of loans to assets , banks with assets in
13
Importance of Size and Other Factors
Table 2.
Measures of Joint Influence on
Total Cost Ratios
Sam ple of Tenth District Member Banks, 1956-59
Per Cent of Variance
in Total Cost Ratios Explained
NonGrowth Trea sury
Total Consumer Rate, SecuriAsset Time
Loans
1956-59 ties
Size Deposits Loans
Asset size
Time deposits
Total loans
Consumer loans
Growth rate,
2
1
6
4
4
1
3
2
2
2
1956-59
Non-Treasury securities
* Less than 0.5 per cent. A red figure indicates that th e joint
effect is negative.
NOTE: The data in the table are based on the function desc ribed
1n the note to Table 1. The figure s represent twice th e crossproduct o f the relevant beta coefficients times the si mple corre lation coefficie nt for each pair of varia ble s, expressed in percentage terms . The algebraic su m of th e direct effects shown in Table
1 and the /·oi nl effe t s indicated above I equal to th e sq uare
of th
mul ipl e corre lation coe ffi cie nt In perce nta ge t erm s (62)
excep t for a differen ce due to rounding.
th range of $10-$50 million hav th highes t ratios of time deposits and the largest p ercentage of their loans xtended to consumers.
Larger banks than this, which are typically
downtown banks in larger cities, usually have
relatively smaller amounts of time deposits
and consumer loans.
A second notable feature is the substantial
amount of cost variation explained by the
joint influence of time deposits and two charact ristics of asset structure. Banks with high
ratios of time accounts to total d posits also
tend to have a relativ ly large portion of their
a sets in loans and a higher-than-averag p rcentage of their loans extended to consumers.
Presumably, this reflects the attempt by banks
with relatively large amounts of time deposits
to search for assets carrying higher yields as a
means of covering interest expenses on their
time accounts.
Differences in total cost ratios among the
sampl banks also were accounted for to a
consid rable degree by th joint influ nee of
their growth rates with oth r cost-cl termining characteristics. In fac t, the joint influence
of growth rates and other characteristics explains 8 per cent of the variation in total cost
ratios among the sample banks, while the di14
rect influence of growth rates on costs explains but 2 per cent. This implies that the
relatively high costs found among the more
rapidly growing banks resulted primarily
from bank characteristics that are associated
with rapid growth. Sample banks whose
growth rates were high had relatively high
ratios of time accounts to total deposits ( and
paid above average rates of int rest on time
deposits), high percentages of loans to total
assets, and high percentages of consumer
loans to total loans.
Banks whose growth rates wer higher than
av rage over th e years 1956-59 were spread
broadl y over all J islri t stat s; th list inc- lucl ccl some clow11lown hanks ,1s well as s11h11rhan hanks , and hanks in rural ·ommu11iti s
as well as in urban areas. It thus se ms appropriate to view their favorable growth experience as resulting in considerable measure
from management policies conducive to
growth-including a willingness to pay higher
interest rates to attract time deposits, and the
adoption of aggressive policies to accommodate loan customers. Interestingly, the characteristics of assets and liabilities associated
with more-than-average growth over the
years 19.56-59 also were associated with mor than-av rag ' growth over th e long r p riod
from 1947 to 1959.
Changing Relative Importance of Cost
Influences
The years from 1956 to 1959 witnessed significant changes in the comparative importance of the four principal characteristics that
account for differences in bank cost ratiosthat is, among bank size, the percentage of
deposits in time accounts, the perc ntage of
assets in loans, and the proportion of loans
extended to consumers. Th se changes are
refl ct d ad quately in the measur s of their
direct influence on total cost ratios for each
of the individual years 1956 through 1959,
as shown in Table 3.
Affecting Bank Costs
Table 3.
Measures of Direct Influence on
Total Cost Ratios, 1956-59
Sample of Tenth District Member Banks
Per Cent of Variance in
Total Cost Ratios Explained
1956
1.
2.
3.
4.
Asset size
16
Relative volume of time deposits 6
Percentage of assets in loans
13
Percentage of loans extended
to consumers
12
1957
1958
1959
16
13
10
7
10
11
8
12
11
15
10
8
NOTE : The figures in the table are squares of the beta (s tandardized partial r egression) coefficients of the fun ctio n described 1n
the note to Table 1, fitted to each of the individual years 1956
through 1959.
Th . most striking change that took pla 'e
was the large in -rcasc in th' rclativ irnporta11<·e of time d ·posits as a clctcrmi11n11t
of total ·os t ratios. Between 1956 and 1959,
average effective rates of int res t on tirn a counts at the sample banks rose from 1.57
per cent to 2.19 p r c nt, with most of this
change taking place after January 1957, when
legal maximum rates payable on time deposits were raised from 2 1/2 per cent to 3 per cent.
Meanwhile, time accounts increased from
17.3 per cent of total deposits in 1956 to 22.0
p er cent in 1959. To be sure, these changes
were widespread among District banks , as
well as in other s ctions of the country, hut
that <lid not prevent ratios of time to total
deposits from be oming a more important
factor in explaining ost differences among
the banks. A given increase in interest rates
on time accounts affects costs most at banks
where ratios of time to total deposits are
relatively high. Similarly, a given increase in
the percentage of time accounts affects total
cost ratios most at banks paying higher-thanaverage rates to their time deposit customers.
Thus, the result of these changes was a sharp
rise bctwe n 1956 and 1959 in the importance
of time deposit ratios in accounting for cost
differenc s among District members.
This increasing significance of time deposit
ratios itself tends to lower the measures of
relative importance for other characteristics
Monthly Review •
April 1961
of banks that influence th eir expenses. 1 The
declining influence of total loans on costs is,
however, too large to be attributed to this influence alone. It results mainly from bank
responses to the vigorous upswing in loan
volume that took plac from 1956 to 1959.
At th group of sample banks in -luded in
th study, average loan volume in 1959 was
about one-fourth higher than in 1956. The
average ratio of loans to total assets among
the banks advanced from 32.9 per cen t jn
1956 to 36.3 per cent in 1959. The largest
part of this surg in loan volume took place
in th e relatively short span of 2 years- from
mid - 19.57 to niicl - lD.59. To handle lh<' incr<'asi ng volt11ll(' or loans , il W.IS 11ol IH'CC'SS:H y for
tlic hanks lo in -rease proportional( ly their
staffs of offi · •rs and crnployc 'S; rather, existing staffs were used more intensivel y, with
the result that bank costs became less closely
associated with the relative amount of their
assets in loans . Consequently, the growth of
loans in relation to other assets added to the
banks' net earnings rates not only because of
the shift to assets with higher gross earnings
rates, but also because administrative costs
per dollar of loans were held down.
o ·hanges of funclam ' ntal significanc arc
evident, however, in th relative importance
of hank size or in th ~ proportion of loans extended to consumers as cost influences from
1956 to 1959. The measures for consumer
loans shown in Table 3 vary erratically from
one year to the next, suggesting only that the
weight as a cost determinant is more appropriately judged by data that are averaged for
several years. The measure for bank size is
lower in 1959 than in earlier years because
the year witnessed a relatively larger increas
1 This is becaus the effe t is to increase the variance
of total costs. Thu s, if the partial regression oefficient
of, say, bank size and th variance of bank size are
unchanged, while th e variance of total costs is incrca ·ed, th e stan<lardize<l partial regression coefficient
of bank size is reduced.
15
Importance of Size and Other Factors Affecting Bank Costs
in miscellaneous expenses at large than at
small banks. Part of this increase was due
to a rise in borrowings among larger banks
during 1959; a second part was due to the
comparatively larger advance for large than
for small banks in non-income tax payments
during both 1958 and 1959. The basic advantages of larger-scale operations in banking, which are found in wage and salary exp nses, were just as important in 1959 as
they were in 1956.
Concluding Remarks
The foregoing analysis indicates that although bank size is an important factor affecting tho ability of a hank to operat with
low costs in relation to its assets, it does not
overshadow other factors. Mcani11gf11l comparisons of cost ratios among banks must giv'
att ntion not only to the siz of bank hut also
to a variety of other characteristics of their
assets and liabilities.
The dominant structural characteristics of
assets and liabilities that influence costs are
directly within the control of bank management. However, the avoidance of high costs
by policies such as the selection of assets on
which administrative costs are low, or the
maintenance of low rates of int rest on time
deposits, carries its penalties. It is widely
r cognized that gross earnings rates are directly influenced by choices among alternative typ s of assets, but th growth rate of
a bank also may be affected significantly by
its lending policies and its willingness to attract time deposit customers. From the viewpoint of its influ n c on xpcnses, the int rest
of a hank in growing rapidly is ·lcarly vi 1 nt
in th e relationship between si:1.c and ·osts. For
while th ' irnrm'dial ' result of rapid growth
appears to in -r 'as ·ost , th long r-run i1 flu n c is to r due costs by permitting the
bank to enjoy the cost advantages of largerscale operations.
BANKING IN THE TENTH DISTRICT
loans
Deposits
Reserve
District
PRICE INDEXES, UNITED STATES
Reserve
City
Country
City
Country
Member
Member
Member
Member
Banks
Banks
Banks
Banks
and
Feb.
1961
Index
Jan.
1961
Feb.
1960
Consumer Price Index
( 1947-49 = 100)
127.5
127.4
125.6
Wholesale Price Index
( 1947 - 49 = 100)
120.0
119.8
119.3
Prices Rec'd by Farmers ( 1910-14 = 100)
244
241
233
Prices Paid by Farmers ( 1910-14 = 100 )
302
301
299
February 1961 Percentage Change From
Stales
TENTH DISTRICT BUSINESS INDICATORS
Jan .
Feb.
Jan.
Feb.
Jan .
Feb.
Jan.
Feb.
1961
1960
1961
1960 1961
1960
1961
1960
+4
+e
+2
+16
- 2
+6
t
+s
Colorado
+3
+2
t +11
+1
+5
t
+6
Kansas
+4
+1
t
+1
- 2
+10
Tenth F. R. Dist.
Missouri *
Nebraska
New Mexico*
Oklahoma *
Wyoming
+10
-1
+23
+1a
t
+1
+ s
- 4
+4
+ 2
+:
t
+21
t
+5
- 1
+s
**
**
+s
+14
**
**
+4
+9
+6
+ 18
- 5
+6
+2
+ 11
+s
**
**
- 2
+3
+1
+ a
**
**
*Tenth District portion only.
t Less than 0.5 per cent.
16
- 2
+1
** No reserve cities in this sta te.
District
and Principal
Metropolitan
Areas
Value of
Check
Payments
Value of
Department
Store Sales
Percentage change-1961 from 1960
Feb.
Year
to date
Year
Feb.
to date
+2
+s
+11
+ 13
+5
+1
+5
Denver
Wichita
- 10
- 3
- 7
- 7
Tenth F. R. District
Kansas City
+ s
0
+6
0
+2
Omaha
- 2
+5
+22
+2s
Oklahoma City
+1
+ s
- 6
- 4
+5
+3
0
Tulsa
0
@FedFRASER