The impact of technology and regulation on the geographical scope of banking

1. The impact of technology and regulationon the geographical scope of banking Hans Degryse KU Leuven, Tilburg University, and CES-Ifo Steven Ongena Tilburg University Capital Market and Financial Integration in EuropeEuropean Central Bank – Center for Financial Studies NetworkBank of Finland, Helsinki, March 11-12, 2003

2. Outline Geographical Scope of Banking Technology and Regulation Theory Empirical Evidence Open Issues Policy Implications?

3. Outline Geographical Scope of Banking Technology and Regulation Theory Empirical Evidence Open Issues Policy Implications?

4. Outline Geographical Scope of Banking Technology and Regulation Theory Empirical Evidence Open Issues Policy Implications?

5. Recent Reviews We will draw from (but try not to replicate) recent reviews, Berger (JMCB 2003) Berger, Udell (EJ 2002) Buch (CES 2002) Carletti, Hartmann (2002) Danthine (P 2001) Danthine, Giavazzi, Vives, von Thadden (CEPR 1999) Danthine, Giavazzi, von Thadden (OUP 2001) Dermine (ECB 2002) Giannetti, Guiso, Japelli, Padula, Pagano (EP 2002) Gordon, Winton (2002) Pagano (ECB-CFS 2002) Vives (JFSR 2001) Vives (ECB-CFS 2002) but we do not aim to be complete. We acknowledge comments from: Jan Bouckaert

6. Two Themes in this Overview • Distance and Borders: intimately related, yet usefully separable • Distance: transportation, limited role for competitors • Borders: information, behaviour of competitors • “Leapfrogging” Borders by M&As? • Also subject to informational asymmetries • Smaller (diversification)? • Endogenously decreasing?

7. Geographical Scope of Banking

8. Distance? Bank Borrower

9. Borders? Bank Competing Banks Borrower

10. Borders? Bank Competing Banks Borrower

11. Borders? Bank Competing Banks Borrower

12. M&A? Bank Competing Banks Borrower

13. Borders Buch (CES 2002) Economic borders • Endogenous “informational” • De novo banks face adverse selection in screeningBroecker (Ectra 1990); Shaffer (JFI 1998); Gehrig (RE 1998) • Relationships = barriers to entryFisher (1990); Sharpe (JF 1990); Rajan (JF 1992); Von Thadden (2001); Dell’Ariccia (EER 2001) • Information sharing may serve as a collusive device and soften competition Gehrig, Stenbacka (2001);Bouckaert, Degryse (2002) • Exogenous: legal, supervisory practices, corporate governance, political, language, cultural, … Regulatory borders

14. Geographical Scope of Banking

15. Theory • Transportation costs • Monitoring costs • Asymmetric information

16. Transportation Costs Loan Rate t -2t MC = 0 0 1/2 1 Bank A Bank B Distance

17. Monitoring Costs Loan Rate t -t t/2 MCA MCB 0 0 1/2 1 Bank A Bank B Distance

18. Asymmetric Information • Quality of the information signal deteriorates in distance Hauswald, Marquez (2002) • Loan Rate • decreases in distance to informed Relationship Bank • increases in distance to uninformed Transactional Bank

19. Theoretical Predictions

20. Other Determinants • Remote borrowers become informed & get best offers Grossman, Shapiro (RES 1984); Bester, Petrakis (EER 1995) • Other product characteristics (than distance) Elliehausen, Wolken (Fed 1990); Binks, Ennew (SBE 1997) • Experience effects  Borrowers not necessarily patronize closest lender More distant & informed borrowers get best offers

21. Impact of Distance on Loan Rate

22. Impact of Number of Competitors

23. Possible Interpretation • Spatial Price Discrimination • Transportation, monitoring, and/or adverse selection • Degryse , Ongena (2002) • Transportation cost interpretation seems reasonable • No evidence of adverse selection increasing in (short) distances • Distance to the Closest Competitors also seems important for competitive conditions • Actual location of bank branches may be important in determining the intensity of competition!

24. Geographical Scope of Banking

25. “Hard” information “travels better” than “soft” informationStein (JF 2002) • Centralized (large) banks employ hard information Liberti (2002) • Some services can be offered across large distances • Credit card loans can be offered by mail Ausubel (AER 1991) • Opaque (small) firms borrow from close banks Petersen, Rajan (JF 2002); Inderst, Mueller (2002); Saunders, Allen (2002) • Effect may be economically small • No distance related rationing: Carling, Lundberg (2002) • Loan size related: fixed transportation costs? Degryse, Ongena (2002) • Large banks lend to distant, large firms using hard information • Berger, Miller, Petersen, Rajan, Stein (2002); Cole, Goldberg, White (2002)

26. Geographical Scope of Banking

27. Evidence • Number of own branches in sub-market positive (but small) effect on entry decision de Juan (2001) • Control over efficiency of branches in US dissipates only somewhat with distance Berger, DeYoung (JFSR 2001)

28. Geographical Scope of Banking

29. Evidence • Banks “over”-invest domestically (because of country-specific credit risk?)Buch, Driscoll, Ostergaard (2003) • “Outside” banks may be in no better position to extend credit than local lenders • When dealing with small (& even larger) borrowers Shaffer (JFI 1998); Berger, Klapper, Udell (JBF 2001); Harm (JIFMIM 2001); Guiso, Sapienza, Zingales (2002) • When existing relationships are strong Bergstrom, Engwall, Wallerstedt (SJM 1994) • If judicial enforcement of creditor rights is poor Fabbri, Padula (2001); Bianco, Jappelli, Pagano (2002)

30. Geographical Scope of Banking

31. Evidence on Entry • “Follow-your-customer” strategy • Yes! Goldberg, Saunders (JBF 1981); Kindleberger (JBF 1983); Grosse, Goldberg (JBF 1991); TerWengel (JIMF 1995); Brealey, Kaplanis (JIMF 1996); Buch (FMII 2000); Boldt-Christmas, Jacobsen, Tschoegl (BH 2001); Germany: Buch, Golder (KK 2002) • Maybe Not (in US)?Seth, Nolle, Mohanty (FMII 1998); Stanley, Roger, McManis (JSBM 1993); Buch, Golder (JMFM 2001) • Cross-border efficiency • Foreign affiliates less efficient: DeYoung, Nolle (JMCB 1996), Berger, DeYoung, Genay, Udell (Brook 2000) • But maybe ‘sounder’ (in Latin America)? Crystal, Dages, Goldberg (FRBNY 2002) • Lower efficiency = border-, not distance-, related: Buch (JMCB 2003) • Bank nationality and reach Berger, Dai, Ongena, Smith (JBF 2003)“concierge” effect > “home cooking” in Europe • Firms frequently use host nation banks that are local/regional • If home nation bank then global bank

32. Evidence on Cross-Border Bank M&As • Cross-Border Bank M&As rarer than: • Cross-Border M&As in other industries • Domestic Bank M&As Focarelli, Pozzolo (JBF 2001); Berger, Demsetz, Strahan (JBF 1999) • “Borders” make Cross-Border Bank M&As less likely Buch, DeLong (2001) • Combined Cross-Border Bank bidder and target CARs  0, but Combined Cross-Border Other bidder and target CARs > 0 Geographically focused Domestic Bank M&As > 0 Beitel, Schiereck (2001); DeLong (JFE 2001)

33. Questions? Effects of “exogenous” borders? • Lower CARs for M&As in (ex-) regulated industries Campa, Hernando (2003) • Do mutual structures make M&As more difficult?WSJE 18 Feb 2003 • Do Cross-Border Bank M&As result in complex “holding structures”?Dermine (ECB 2002) Effects of “endogenous” borders? • Bank M&As may be subject to winner’s curse as local banks are better judges of portfolio quality of target bank • “National Champions” may partly arise endogenously as a result! Differential impact on borrowers? Sapienza JF 2002

34. Questions? Effects of “exogenous” borders? • Lower CARs for M&As in (ex-) regulated industries Campa, Hernando (2003) • Do mutual structures make M&As more difficult? WSJE 18 Feb 2003 • Do Cross Border Bank M&As result in complex “holding structures”? Dermine (ECB 2002) Effects of “endogenous” borders? • Bank M&As may be subject to winner’s curse as local banks are better judges of portfolio quality of target bank • “National Champions” may partly arise endogenously as a result! Differential impact on borrowers? Sapienza JF 2002

35. Questions? Effects of “exogenous” borders? • Lower CARs for M&As in (ex-) regulated industries Campa, Hernando (2003) • Do mutual structures make M&As more difficult? WSJE 18 Feb 2003 • Do Cross-Border Bank M&As result in complex “holding structures”? Dermine (ECB 2002) Effects of “endogenous” borders? • Bank M&As may be subject to winner’s curse as local banks are better judges of portfolio quality of target bank • “National Champions” may partly arise endogenously as a result! Differential impact on borrowers? Sapienza (JF 2002); Bonaccorsi di Patti, Gobbi (2002)

36. Geographical Scope of Banking

37. Impact of Technology Regulation

38. Impact of Technology Possibly fewer distance-related diseconomies in: Berger (JMCB 2003) • Monitoring and risk management of loans • Traditional banking services: e.g. credit scoring • Management of staff • New services over internet

39. Impact of Technology

40. But maybe … Increased capacity for information need not imply more exchange of information Inside the bank Loan officers = content originators & monopolists in their human capital Want to tie commodity-like distribution to origination Wilhelm (OREP 2001) Between entrepreneur and bank Increased confidentiality concerns? Campbell (JFQA 1979); Yosha (JFI 1995); Bhattacharya, Chiesa (JFI 1995) Between banks Increased free-rider concerns or when information sharing? Von Thadden (1992)

41. But maybe … Increased capacity for information need not imply more exchange of information Inside the bank Loan officers = content originators & monopolists in their human capital Want to tie commodity-like distribution to origination Wilhelm (OREP 2001) Between entrepreneur and bank Increased confidentiality concerns? Campbell (JFQA 1979); Yosha (JFI 1995); Bhattacharya, Chiesa (JFI 1995) Between banks Increased free-rider concerns or when information sharing? Von Thadden (1992)

42. But maybe … Increased capacity for information need not imply more exchange of information Inside the bank Loan officers = content originators & monopolists in their human capital Want to tie commodity-like distribution to origination Wilhelm (OREP 2001) Between entrepreneur and bank Increased confidentiality concerns? Campbell (JFQA 1979); Yosha (JFI 1995); Bhattacharya, Chiesa (JFI 1995) Between banks Increased free-rider concerns or when information sharing? Von Thadden (1992)

43. But maybe … Increased capacity for information need not imply more exchange of information Inside the bank Loan officers = content originators & monopolists in their human capital Want to tie commodity-like distribution to origination Wilhelm (OREP 2001) Between entrepreneur and bank Increased confidentiality concerns? Campbell (JFQA 1979); Yosha (JFI 1995); Bhattacharya, Chiesa (JFI 1995) Between banks Increased free-rider concerns or when sharing information?

44. Impact of Technology

45. Pricing • On-line banking may spur competition Bouckaert, Degryse (EER 1995) • Loan mark-ups in Finland reduced over timeVesala (2000) • Only small increase in contestability in EU loan markets Corvoisier, Gropp (ECB 2001) Better access to information loan rates  Improved ability to process information loan rates and bank profits  Hauswald, Marquez (RFS 2002)

46. Impact of Technology

47. Rationing • Increased competition from capital markets Berger,Udell (1993); Emmons, Greenbaum (1998); Mannonen (2001) • Banks may lend across larger distances Petersen, Rajan (JF 2002) opaque firms transparent firms No financing Banks Capital markets

48. Changes in Estimated Distance in US

49. Changes in Distance in Belgium

50. Impact of Technology