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Comparing Centralized and Decentralized Banking: A Study of the Risk-Return Profiles of Banks

  • Holmberg, Ulf

    ()

    (Department of Economics, Umeå University)

  • Sjögren, Tomas

    ()

    (Department of Economics, Umeå University)

  • Hellström, Jörgen

    ()

    (Department of Business Administration)

This paper studies the risk-return profile of centralized and decentralized banks. We address the conditions that favor a particular lending regime while acknowledging the effects on lending and returns caused by the course of the business cycle. To analyze these issues, we develop a model which incorporates two stylized facts; (i) banks in which lending decisions are decentralized tend to have a lower cost associated with screening potential borrowers and (ii) decentralized decision-making may generate inefficient outcomes because of lack of coordination. Simulations are used to compare the two banking regimes. Among the results, it is found that asymmetric markets (in terms of the proportion of high ability entrepreneurs) tend to favor centralized banking while decentralized banks seem better at lending in the wake of an economic downturn (high probability of a recession). In addition, we find that even though a bank group where decisions are decentralized may end up with a portfolio of loans which is (relatively) poorly diversified between regions, the ability to effectively screen potential borrowers may nevertheless give a decentralized bank a lower overall risk in the lending portfolio than when decisions are centralized.

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Paper provided by Umeå University, Department of Economics in its series Umeå Economic Studies with number 838.

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Length: 33 pages
Date of creation: 17 Feb 2012
Date of revision:
Handle: RePEc:hhs:umnees:0838
Contact details of provider: Postal: Department of Economics, Umeå University, S-901 87 Umeå, Sweden
Phone: 090 - 786 61 42
Fax: 090 - 77 23 02
Web page: http://www.econ.umu.se/Email:


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  1. Hirofumi Uchida & Gregory F. Udell & Wako Watanabe, 2008. "Bank size and lending relationships in Japan," NBER Chapters, in: Organizational Innovation and Firm Performance, pages 242-267 National Bureau of Economic Research, Inc.
  2. Canales, Rodrigo & Nanda, Ramana, 2012. "A darker side to decentralized banks: Market power and credit rationing in SME lending," Journal of Financial Economics, Elsevier, vol. 105(2), pages 353-366.
  3. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, 08.
  4. Marcelle Chauvet & Jeremy M. Piger, 2005. "A comparison of the real-time performance of business cycle dating methods," Working Papers 2005-021, Federal Reserve Bank of St. Louis.
  5. Jose M. Liberti & Atif R. Mian, 2009. "Estimating the Effect of Hierarchies on Information Use," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4057-4090, October.
  6. Allen, Franklin, 1990. "The market for information and the origin of financial intermediation," Journal of Financial Intermediation, Elsevier, vol. 1(1), pages 3-30, March.
  7. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January.
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