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Financial synergies and the Organization of Bank Affiliates; A Theoretical Perspective on Risk and Efficiency

  • Elisa Luciano
  • Clas Wihlborg

We analyze theoretically banks’ choice of organizational structures in branches or subsidiaries in the presence of government bailouts, default costs and - possibly - economies of scale as sources of financial synergies. We compare with stand-alone banks. Subsidiary and branch structures are characterized by different arrangements for internal insurance of affiliates against default risk. The cost of debt and leverage are endogenous. For moderate bailout probabilities, subsidiary structures, wherein the two entities provide mutual internal insurance under limited liability, have the highest private group value, but also the highest risk taking as measured by leverage, expected default costs and expected loss. The branch structure, wherein the two affiliates support each other until the whole bank fails, is generally burdened by greater default costs – in excess of bailout benefits – than the subsidiary structures. Stand-alone banks have the highest excess default costs. We explore also the impact on social values and policy implications of "ring-fencing" of affiliates.

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File URL: http://www.carloalberto.org/assets/working-papers/no.322.pdf
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Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 322.

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Length: 59 pages
Date of creation: 2013
Date of revision: 2014
Handle: RePEc:cca:wpaper:322
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  1. Chiesa, Gabriella, 2008. "Optimal credit risk transfer, monitored finance, and banks," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 464-477, October.
  2. Castiglionesi, Fabio & Wagner, Wolf, 2013. "On the efficiency of bilateral interbank insurance," Journal of Financial Intermediation, Elsevier, vol. 22(2), pages 177-200.
  3. Charles M. Kahn & Andrew Winton, 2002. "Moral hazard and optimal subsidiary structure for financial institutions," Proceedings 808, Federal Reserve Bank of Chicago.
  4. Freixas, Xavier & Lóránth, Gyöngyi & Morrison, Alan, 2005. "Regulating Financial Conglomerates," CEPR Discussion Papers 5036, C.E.P.R. Discussion Papers.
  5. Jeon, Bang Nam & Olivero, María Pía & Wu, Ji, 2013. "Multinational banking and the international transmission of financial shocks: Evidence from foreign bank subsidiaries," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 952-972.
  6. International Monetary Fund, 2010. "Risk and the Corporate Structure of Banks," IMF Working Papers 10/40, International Monetary Fund.
  7. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  8. Adam B. Ashcraft, 2004. "Are bank holding companies a source of strength to their banking subsidiaries?," Staff Reports 189, Federal Reserve Bank of New York.
  9. Cerutti, Eugenio & Dell'Ariccia, Giovanni & Martinez Peria, Maria Soledad, 2007. "How banks go abroad: Branches or subsidiaries?," Journal of Banking & Finance, Elsevier, vol. 31(6), pages 1669-1692, June.
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