Are banks still important for financing large businesses?

As more corporations turn to the securities markets to meet their funding needs, the role of banks as providers of credit to large businesses seems increasingly uncertain. But a look at developments during the financial market turmoil last fall suggests that banks are still a critical source of liquidity at times of economic stress.Bank loans ; Commercial loans ; Financial crises

Diversification, Organization, and Efficiency: Evidence from Bank Holding Companies

We use a portfolio-simulation technique to estimate the value added from diversification by bank holding companies. Using a sample of 412 multi-bank bank holding companies (MBHCs) from 1990 to 1994, we construct pro forma benchmark portfolios for each MBHC composed of shares of single banks, weighted to correspond to the MBHC's distribution of activities. We then compare the performance and characteristics of the MBHCs to that of their pro forma benchmarks. Diversification through the holding company structure does appear to bring certain benefits: the MBHCs hold less capital and engage in more lending, on average, then their pro forma benchmarks. However, these desirable characteristics do not translate into higher profits, implying some organizational inefficiencies inherent in the holding company structure. This suggests that banks should be allowed to realize the benefits of diversification without limiting them to a particular organizational form.

How effective is lifeline banking in assisting the 'unbanked'?

Many consumers who lack checking accounts are paying relatively high costs to access the nation's payments system. Legislation aimed at opening the system to these unbanked individuals has centered on requiring commercial banks to offer low-cost "lifeline" accounts. But will cost savings alone motivate these consumers to access the payments system through banks?Checking accounts ; Banks and banking - Service charges ; Poverty

Banks with something to lose: the disciplinary role of franchise value

As protectors of the safety and soundness of the banking system, banking supervisors are responsible for keeping banks' risk taking in check. The authors explain that franchise value--the present value of the stream of profits that a firm is expected to earn as a going concern--makes the supervisor's job easier by reducing banks' incentives to take risks. The authors explore the relationship between franchise value and risk taking from 1986 to 1994 using both balance-sheet data and stock returns. They find that banks with high franchise value operate more safely than those with low franchise value. In particular, high-franchise-value banks hold more capital and take on less portfolio risk, primarily by diversifying their lending activities.Bank holding companies ; Bank management ; Retail trade

Organizational Structure and the Diversification Discount: Evidence from Commercial Banking

"Journal of Industrial Economics, forthcoming."Includes bibliographical references."This version: August 6, 2008"This paper provides evidence on organizational structure, geographic diversification, and performance at bank holding companies (BHCs). First, we show that a BHC's member banks benefit from access to the parent organization's internal capital market. Second, we ask if the benefits of internal capital markets are best realized within loosely structured, decentralized organizations or more consolidated, centralized firms. We find that BHCs with many subsidiaries are less profitable and have lower q ratios than similar BHCs with fewer subsidiaries. However, because we study multi-unit firms in a single industry, our results suggest that the valuation discount reported in the diversification literature in empirical corporate finance reflects not only industry diversification, but also organizational structure

Agency Problems and Risk Taking at Banks

Abstract The moral hazard problem associated with deposit insurance generates the potential for excessive risk taking on the part of bank owners. The banking literature identifies franchise value --a firm's profit-generating potential --as one force mitigating that risk taking. We argue that in the presence of owner/manager agency problems, managerial risk aversion may also offset the excessive risk taking that stems from moral hazard. Empirical models of bank risk tend to focus either on the disciplinary role of franchise value or on owner/manager agency problems. We estimate a unified model and find that both franchise value and ownership structure affect risk at banks. More important, we identify an interesting interaction effect: The relationship between ownership structure and risk is significant only at low franchise value banks --those where moral hazard problems are most severe and where conflicts between owner and manager risk preferences are therefore strongest. Risk is lower at banks with no insider holdings, but among other banks, there is no relationship between the level of insider holdings and risk. This suggests that the owner/manager agency problem affects the choice of risk for only a small number of banks --those with low franchise value and no insider holdings. Most of these banks increase their insider holdings within a year, and these changes in ownership structure are associated with increased risk. This suggests that owner/manager agency problems are quickly addressed.