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Financial Conglomerates: What we know and do not Gianni De Nicoló IMF Research Department. Overview. Some facts Potential drivers of conglomeration Evidence Policy Implications. Some Facts.
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Financial Conglomerates:What we know and do notGianni De NicolóIMF Research Department
Overview • Some facts • Potential drivers of conglomeration • Evidence • Policy Implications
Some Facts • Conglomerate: a financial firm active in at least 2 business lines (banking, insurance, asset management) • Conglomeration is pervasive, especially in emerging markets and developing economies • However, some “de-conglomeration” has occurred recently, especially in developed economies (focus versus diversification)
Facts (cont.) • Conglomeration among the largest 500 firms worldwide increased between 1995 and 2000 both in terms of number of firms and assets held • About 87 percent of conglomerates are led by banks • The trend in conglomeration appears global (industrialized and emerging market countries).
What are the drivers of conglomeration? • Exploit “synergies” and diversification • Increase market power • Managerial “hubris” and other agency costs • Moral-hazard related expansion of safety net subsidies (e.g. To Big to-Fail, to-Discipline, to- Monitor-Effectively, etc.)
Synergies • Economies of scale/scope • Information sharing • Revenue economies of scope: cross-selling • Cost economies of scope • BUT, there may be managerial diseconomies of scale/scope, firms may become too large/complex to manage
Evidence on “synergies” • The evidence on economies of scope is at best mixed • No clear cost or revenue advantages on average. • Among the top global financial services providers as of end-2002, the largest firms were not necessarily those with the highest market value
Conglomeration discount? • The market value of the whole is lower than that of its components: the difference is the “discount” • Studies that finds it and study that do not (mainly for the U.S.) • Nobody seems to find a conglomeration premium.
Market power? • Difficult to measure • Some business segments are highly concentrated (investment banking, asset management....) • Evidence is scant • Research needed
Diversification and risk-taking incentives • Conglomerates should attain lower variability of returns vs. specialized firms • “Simulation” studies showed potential diversification benefits through mergers among different services (banking, insurance, asset management, etc.) • Results: some mergers might reduce risk, some might not
Financial Risk • Product diversification and efficiency gains may allow firms to attain LOWER RISK PROFILES • Extension of safety-net to non-bank activities may allow firms to choose HIGHER RISK PROFILES • What are the NET EFFECTS? I carried out a simple regression analysis
Questions • Do large financial firms exhibit levels of failure risk lower than small firms? NO • Does failure risk of conglomerate and non-conglomerate firms differ? YES, (LARGE) CONGLOMERATES APPEAR TO BE AT LEAST AS RISKY AS OR RISKIER THAN SPECIALIZED FIRMS
Cross-sectional regressions • Dependent variables: • Z-score (a proxy measure of failure risk) • Z components: ROA, E/A and ROA volatility • Regressors: • Conglomerate dummy • Size of conglomerates and non-conglomerates • Other controls
Table 2: Regression Results on Risk, Size and Conglomeration 1/
Implication • The incentives for firms to take on more risk appear to have offset the risk reductions allowed by either scale and scope economies or geographic and product diversification
Other issues • Conflict of interest? • Large foreign intermediaries in (smaller) financial systems have beneficial effects • BUT, are there risks of “over-dependence” (credit flows) ? • Large conglomerate housed in “small” countries: could they be rescued?
Summing up • Benefits of synergies hard to detect on average • Risk profiles do not appear smaller than those of specialized firms • We do not know enough about market power effects of conglomerates • More research needed, especially for emerging and developing economies
Policy responses • Choose the supervisory architecture that maximizes monitoring capacity • Choose the regulatory architecture that minimizes regulatory arbitrage and the extension of safety net subsidies • To what extent international conglomeration implies “conglomeration” of supervision?
References Amel, D., Barnes, C., Panetta, F. and Salleo, C. , 2004, “Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence,” Journal of Banking and Finance. Bank for International Settlements, 2001, The Banking Industry in the Emerging Market Economies: Competition, Consolidation, and Systemic Stability, BIS Papers, number 4, August. De Nicoló, G., P.Bartholomew, J. Zaman, and M.Zephirin, 2004, Bank consolidation, conglomeration and internationalization: Trends and implications for financial risk, Financial Markets, Institutions and Instruments. Group of Ten, 2001, Report on Consolidation in the Financial Sector, (January), Bank for International Settlements: Basel, Switzerland. Litan, R. and Herring, R. (Editors), 2003, Brookings-Wharton Papers on Financial Services, focusing on Financial Conglomerates.