Too small to be compliant?: size and scale economies in the compliance cost structure of italian banks

The banking industry is heavily regulated because of the nature and role it plays in the financial and economic system. If on the one hand the enormous legislative activity that has characterized the banking system in recent years – the evolution of which is still ongoing – has focused on strengthening the protection of ‘weak contractors’ as well as the overall stability and the development of competitive conditions that are the same for international banks in different countries, on the other hand, it has forced banks to bear substantial costs to ensure regulatory compliance. The significance of these costs is highlighted in many researches that show, respectively, the incidence of unatantum and ongoing costs on bank operational expenditures. As clearly emerged in the 2008 investigations carried out by the Center for the Study of Financial Innovation, there is concern regarding the increased costs of compliance that regulated entities and supervisory authorities sustain. This is demonstrated by the increasing importance that is assigned to the analyses of cost-benefit and quantitative impact or by definite initiatives carried out to streamline the regulatory framework started up by the Financial Services Authority (FSA). From a broader perspective, the evaluation of the cost of regulatory compliance compared to the generated benefits is being examined by the European Community under ‘better regulation approach’. According to Italian laws n.229/2003 and n.262/2005, for each regulatory act even the Bank of Italy has to carry out an impact assessment on the markets, on the activities of enterprises, on the operators and on the interests of the consumers/savers. The first pilot case of impact analysis has focused on the legislation of banking and financial transparency (Bank of Italy, 2009). The regulatory attention to costs of compliance and the criticality of these for the banking industry have brought awareness to understanding the magnitude of these costs and what determines these costs and the possible effects on banks of different sizes. An excessive increase in the cost of compliance could result in an increase in the cost of banking services to end-users. Should there be economies of scale, smaller banks would have higher mean costs for compliance than the larger ones: the economies of scale, in fact, arise from the existence of input factors that are undividable, i.e. that may not be used in smaller units. The existence of economies of scale in the activity of regulatory compliance could result in: • a distortion of the level playing field as a result of possible entrance barriers linked to a initial physiologically low output, or the possible inhibition of competition, in specific sectors and on specific products if the economies of scale concern specific regulations; • a change in the market structure by stimulating the process of consolidation in a few large banks.