We offer a selected survey of retail payments and suggest areas where additional research would prove useful. After summarizing eight papers presented at a recent Norges Bank (Central Bank of Norway) payment conference and published in this volume, we show how they, and many of the other papers presented there, have contributed to the payments literature. We also illustrate how institutional and other differences across countries led to different payment arrangements historically which now, due to technological innovation affecting bank costs, have made payment arrangements across countries more homogeneous.

This paper demonstrates the importance of using a flexible cost function specification when analyzing economies of scale and estimating the cost effect of banking mergers. The inflexibility of the translog cost function is illustrated and results are compared to more flexible spline and Fourier cost functions. Using these different approaches we predict the ex ante effect on average cost from mergers over 1987–1998 using a balanced panel of 130 Norwegian banks. On average mergers are predicted to lower costs. Predictions using the Fourier or spline approach are in overall agreement with computed actual average merger-cost changes ex post. Cost effects of electronic payments are also estimated and exceed cost reductions associated with mergers.

The payments literature ranges from theoretical general equilibrium models to practical payment issues related to the day-to-day operation of various national networks for the transfer of money. It is an area where economic theory and institutional structure are often closely intertwined and it is currently undergoing significant change, shifting from costly paper-based systems to technologically advanced electronic payments. The extant literature is surveyed here with the aim of integrating the various strands of payment research which have been largely pursued separately. In addition, we present newly available data to illustrate and investigate a number of underdeveloped areas in this literature.

Unfettered nationwide bank branching raises the issue of whether consolidation of banks’ “back-office” operations, such as their payment processing, reduces operating costs. Whether centralized processing of payments reduces costs depends on the size and range of scale economies, the relative prices of data processing and telecommunication inputs, and changes in technology in addition to the number of sites operated. While consolidating payment operations into fewer sites may reduce average data processing costs, those cost savings may be more than offset by associated increases in telecommunications expenses. To investigate the potential effects of consolidation on future banking operations, we look at the experience of the Federal Reserve in consolidating its Fedwire electronic funds transfer operation over 1979 to 1996. Previous research suggested that scale economies in Fedwire payment processing were minimal and that the observed declines in average Fedwire production costs were largely attributable to technical advance. Our estimates suggest more nearly the opposite. We find that the Fedwire funds transfer operation exhibited large scale economies but little technical advance beyond that already embodied in the technology-adjusted input prices of data processing and telecommunication inputs. We also find that the consolidation of Fedwire into fewer offices contributed around one-fourth of the overall reduction in Fedwire average cost.

In providing financial services jointly, banks may reduce costs due to complementarities in production (cost economies of scope) or raise revenues from complementarities in consumption (revenue economies of scope). Cost economies of scope between bank deposits and loans have been found to be small. Revenue economies of scope are investigated here for the first time and found to be insignificant over 1978–1990 for both small and large banks and for those on or off the revenue-efficient frontier. The lack of complementarities between deposits and loans — where benefits are most likely to occur — suggests that claims of important synergies from an expansion of banking powers be taken with caution.

As banking consolidation proceeds and Europe moves toward a single market, cross-country differences in banking efficiency can affect the future competitive position of a country’s financial market, helping to determine which European money centers may expand or contract. Looking at large banks across 10 countries, we find they are roughly equally efficient after controlling for differences in business environment, banking costs, and bank productivity. As no country seems to have a strong efficiency advantage, it seems likely that state efforts to promote “national champions” through favorable mergers which expand scale and market share may determine the outcome.