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

Ulf Holmberg (), Tomas Sjögren and Jörgen Hellström ()
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Jörgen Hellström: Department of Business Administration, Postal: Umeå University, S 901 87 Umeå, Sweden

No 838, Umeå Economic Studies from Umeå University, Department of Economics

Abstract: 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.

Keywords: lending; screening; business cycle; portfolio diversification; risk; organization; simulations (search for similar items in EconPapers)
JEL-codes: C63 E30 G01 G11 G21 G32 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2012-02-17
New Economics Papers: this item is included in nep-ban and nep-cta
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