Vittoria Cerasi

The optimal size of a bank: Costs and benefits of diversification

Abstract This paper provides a theory of diversification and financial structure of banks. It shows that by diversifying the bank portfolio and financing it with debt, the bank can commit to a higher level of monitoring. By linking the benefits of diversification to the costs, the paper derives an optimal size of the bank, which is bounded. The costs of diversification lie in the higher overload costs with which the banker is faced by monitoring more projects. The benefits of diversification lie in increasing the banks owners incentives to monitor the lenders.

Multiple Bank-Lending: Diversification and Free-Riding in Monitoring

This paper analyzes banks’ choice between lending to firms individually and sharing lending with other banks, when firms and banks are subject to moral hazard and monitoring is essential. Multiple-bank lending is optimal whenever the benefit of greater diversification in terms of higher monitoring dominates the costs of free-riding and duplication of efforts. The model predicts a greater use of multiple-bank lending when banks are small relative to investment projects, firms are less profitable, and poor financial integration, regulation and inefficient judicial systems increase monitoring costs. These results are consistent with empirical observations concerning small business lending and loan syndication.

The Impact of Mergers on the Degree of Competition in the Banking Industry

We propose a new test to evaluate the impact of horizontal mergers on competition in the banking industry. The test is designed to be applied ex-ante to potential mergers while being parsimonious in terms of data, as it only uses information on branches in local markets. The test is a counterfactual exercise based on a two-stage model where banks compete in branching and interest rates and consists in comparing the estimated degree of competition in the status- quo, where branching networks by banks are those actually observed, with a counterfactual scenario, where the branching network of the new entity is the sum of the branches of the banks involved in the horizontal merger. The statistical difference between the two estimated measures of competition quantifies the impact of the merger. We apply our test to French and Italian mergers.

Branching and competition in the European banking industry

In this study branching costs and competitiveness of European banks are measured by fitting a monopolistic competition model to a representative sample drawn from nine EEC banking industries in the period from 1990 to 1996. In the theoretical model, banks decide strategically the size of their branching network anticipating the degree of competition faced on interest rates. From the structural equations of the model an econometric test is derived in order to measure branching costs and degree of competition in banking services. The empirical analysis captures their changing over time together with the impact of various European directives aiming at deregulating the banking industry. Furthermore the study shows persistence of segmentation acoss EEC banking industries.

Does Product Market Competition Increase Credit Availability

Abstract With asymmetric information between investors and firms, credit availability is affected by the resale value of collateralized productive assets. If liquidation occurs, investors recover a greater value the higher the probability to find a buyer and the higher his willingness to pay to use the assets for production. We extend the idea of complementarities among firms in the same industry (as in Shleifer and Vishny, 1992) to study under which conditions credit availability is enhanced by competition in the product market when assets are industry specific.

Diversification and Delegation in Firms

This paper shows how separation of ownership and control may arise as a response to overload costs, despite agency costs, and how conglomerates arise as solution to information asymmetries in capital markets. In a context where entrepreneurs have the ability to run projects and improve their future cash flow, there could be rationing of credit due to moral hazard between entrepreneurs and investors. Diversification could mitigate the moral hazard problem. However for a single entrepreneur running many different projects might be increasingly costly due to overload costs. Delegating the running of projects to several managers can not only reduce overload costs, but also the moral hazard problem of external financing. In this paper we show that delegation can be the only way to exploit the gains from diversification when overload costs of diversification are high; delegation thus is the key ingredient to be able to diversify.

Product Market Competition and Collateralized Debt

This paper presents a model where bank credit depends upon borrowers.product market structure. We show that a larger number of competitors in the industry may increase credit availability by enhancing the resale value of the collateralized productive assets. We also study how this bene.t of competition is affected by the existence of outsiders willing to bid for the collateralized productive assets of the insiders. Our model encompasses the standard case of Cournot competition either when the default probability goes to zero or when there are multiple outsiders bidding for the productive assets. We test the empirical implications of the theoretical analysis exploiting information on the access to finance of small and medium Italian firms and find supportive evidence.

Financial Structure, Managerial Compensation and Monitoring

When a firm has external debt and monitoring by shareholders is essential, managerial bonuses are shown to be an optimal solution. A small managerial bonus linked to firms performance not only reduces moral hazard between managers and shareholders, but also between creditors and monitoring shareholders. A negative relation between corporate bond yields and managerial bonuses can be predicted. Furthermore, the model shows how higher managerial pay-performance sensitivity goes hand in hand with greater company leverage and lower company diversification. These predictions find some support in the empirical literature.

How post-crisis regulation has affected bank CEO compensation

This paper assesses whether compensation practices for bank Chief Executive Officers (CEOs) changed after the Financial Stability Board (FSB) issued post-crisis guidelines on sound compensation. Banks in jurisdictions which implemented the FSBs Principles and Standards of Sound Compensation in national legislation changed their compensation policies more than other banks. Compensation in those jurisdictions is less linked to short-term profits and more linked to risks, with CEOs at riskier banks receiving less, by way of variable compensation, than those at less-risky peers. This was particularly true of investment banks and of banks which previously had weaker risk management, for example those that previously lacked a Chief Risk Officer.

Solidarity and Microfinance

In this paper we analyze the role of peer solidarity in fostering productive investments inthe context of microfinance. When there is asymmetric information between lenders and borrowers andloans are not collateralized, borrowers may divert loans towards current consumption rather than investingin production. We assume that solidarity is accorded by a network of individuals close enough to theborrower (peers) so as to share private information about hidden effort in the productive project. Themodel shows that peer solidarity might have contrasting effects on the effort in the productive investment.On the one hand, since solidarity transfers are contingent on the effort, they increase borrowers incentiveto invest. On the other hand, solidarity tranfers decrease the marginal utility of future consumption at theexpense of productive investment. The predictions of the model are tested on households enrolled in micro-lending programs who were surveyed in Bangladesh by the World Bank during the period 1991-1992.Empirical findings suggest a positive relationship between potential solidarity of the network of relativesand the share of loans invested in productive activities.