Academic journal article Journal of Agricultural and Applied Economics

Optimal Agricultural Credit Association Branch Office Locations

Academic journal article Journal of Agricultural and Applied Economics

Optimal Agricultural Credit Association Branch Office Locations

Article excerpt

Since the farm financial crisis of the 1980s, Farm Credit System banks continue to merge and consolidate to enhance competitiveness. Two mixed-integer programming models of AgChoice Agricultural Credit Association (ACA), a recently merged ACA in Pennsylvania, were developed to determine the optimal number, location, and territory of branches. The approach suggests useful information can be determined regarding the reconfiguration process after bank mergers, especially given the fact that the current AgChoice ACA configuration is available for comparison purposes.

Key Words: Agricultural Credit Association, compromise programming, Farm Credit System, location model, mixed-integer programming

JEL Classifications: C61, G21, Q14

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Mergers and acquisitions in the banking sector are common and have led to fewer, larger banks. Agriculture has not been sheltered from this trend-consolidation has occurred among commercial and Farm Credit System (FCS) banks. In the latter's case, increased competition from commercial banks and the farm financial crisis of the 1980s are two often-cited reasons for some of the restructuring and consolidation that has occurred in recent years. After the Agricultural Credit Act of 1987, the separation of land and production lending was ended with the merger of many Production Credit Associations and Federal Land Banks to create Agricultural Credit Associations (ACAs). Innovations in PCS structure continue today with the recent advent of national charters.1

Many factors contribute to the motivation for consolidation such as improvements in allocative and technical efficiency and the ensuing reduction in total operating expenses (Rose). Ellinger and Neff advised that consolidations in the banking industry will mitigate inefficiencies through the process of better resource allocation. Consolidations also allow for the elimination of duplicate facilities, staff, and other less productive resources, which can result in significant cost savings (Rose).

In response to banking mergers, several efficiency studies of commercial and agricultural banks have been conducted. For example, Rhoades analyzed 898 bank mergers over the years 1981-1986 to measure efficiency. Shaffer used frontier analysis to determine the cost impact of large U.S. commercial bank mergers. Dias and Helmers used nonparametric data envelopment analysis to determine that large bank's primary source of productivity improvement has been technical change and innovation. Others investigations of agricultural bank efficiency include research by Featherstone and Moss and Neff, Dixon, and Zhu.

Although all of the mentioned studies empirically quantified efficiency, no studies have examined the process of becoming more efficient through consolidation from a managerial perspective-that is, from the perspective of those in charge of reconfiguring a system of banks brought about by merger or consolidation. Merging alone does not necessarily result in improved efficiency, because costs have to be reduced through the elimination of duplicate services. Arguably, branch offices are a duplicate service, which implies that the PCS might improve operations by adjusting the number and size of branches that comprise the system in response to changing agricultural credit market structure.

Three Pennsylvania ACAs recently merged, and the outcome provides an excellent opportunity to model the decision process in a normative fashion and compare model and actual outcomes. The central purpose of this research is to examine alternative ACA configurations to learn more about the post-merger reconfiguration process facing bank management. To accomplish this objective, a model is developed to determine the optimal number, size, and location of branch offices under a profit maximization objective. Although PCS banks do seek to be profitable, one cannot overlook the fact that the PCS is organized as a cooperative, which implies that service maximization is a potentially competing objective. …

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